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SEC Finally Approves Overhaul of Arbitration Code: Some Lawyers Are Underwhelmed

The Securities and Exchange Commission on Jan. 24 approved a new code of procedures that govern arbitrations at the NASD Dispute Resolution. The changes were a long time coming: Some of them have been sitting at the SEC since 2003.

The Securities and Exchange Commission on Jan. 24 approved a new code of procedures that govern arbitrations at the NASD Dispute Resolution. The changes were a long time coming: Some of them have been sitting at the SEC since 2003. But as arbitration lawyers downloaded and began printing out the 137-page document from the SEC’s Web site, there was not much to write home about.

The new code, when it takes effect in April, will bring one big change: It alters the crazy-quilt method by which the opposing sides select the three arbitrators who will serve on the hearing panel that hears a customer’s dispute against a brokerage firm. The rules require that two members, including the chair, be members of the “public,” and that the remaining panelist come from the brokerage industry.

Under current practice, the parties are given a list of 10 public arbitrators and five industry arbitrators to rank according to preference. But they can strike as many names as they want for no reason at all—known as making a “peremptory” challenge in the legal jargon. Often, there weren’t three arbitrators left, and the parties were stuck with an arbitrator randomly selected from the NASD’s computer.

Under the new rule, parties will get three lists, each containing eight names: one for a public arbitrator, another for a public arbitrator who has qualified to be a panel chair and another from the brokerage industry. But now, parties are limited to four strikes on each list, thus upping the mathematical chances that they will land with a panel of arbitrators chosen by them rather than the NASD computer.

“This will supposedly reduce the number of cram-downs,” says Seth Lipner of Deutsch & Lipner in Garden City, N.Y., a lawyer who specializes in representing customers. “I personally don’t believe it’s going to work.” Defense lawyer Matthew Farley of New York’s Drinker Biddle & Reath has more faith: “It increases the odds that the three on the panel were all on the lists and that there’s some input from the parties,” he says, adding, “It may be each side’s worst nightmare!”

But Lipner and Farley agreed that there’s not much else new in the code. “What’s left in this code revision is a bunch of wonk-type detail stuff,” says Lipner, while Farley described it in geological terms: “This is not an earthshaking, tectonic change,” he says.

For instance, the code clarifies that once the Byzantine process of selecting the three arbitrators is finished by opposing sides, a new party, such as an additional defendant, cannot demand that the selection process start all over again. It codifies standard NASD practice that a party has 10 days to respond to any legal motion filed in the case. It aims for plain language. The code makes it clear that arbitrators can issue sanctions for failure to comply with the discovery rules, but Lipner doesn’t hold out much hope that arbitrators will make much use of it. “My experience is that the arbitrators’ willingness to award sanctions is marginal,” he says.

There’s one proposed change to the code that’s missing from this doorstop of a document—a rule on motions to dismiss claims in arbitration. Lawyers for customers claim the brokerage industry abuses this motions practice, routinely asking panels to dismiss cases, though they have no solid ground, in order to delay and increase costs. A proposal to limit motions to dismiss to “extraordinary circumstances” has been roundly criticized by plaintiffs’ and defense lawyers since it was first proposed in 2005. It was taken out of the code and sent out for comments in August 2006.

Lawyers for customers claim motions to dismiss have no place in arbitrations, which are supposed to examine the equities of each case rather than hew to strict legal principles. A list of examples describing what amounted to “extraordinary circumstances” pleased the defense bar, but infuriated the customer lawyers and was removed from the proposed rule. Now the brokerage industry complains that the elimination of that list “makes a bad proposal worse.”

The SEC is weighing the proposal on motions to dismiss in arbitrations, When it issues a final rule, perhaps the earth will move—but don’t hold your breath waiting.

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