Legal Ethics and Reform

The NASD Dispute Resolution Organization May Initiate Ground Breaking Reform

The members of the NASD and NYSE have for many years had clauses in their new account paperwork that require the brokerage firm and the customer to submit any dispute to arbitration. These clauses were needed because the civil justice system was unable to consistently deliver just results. Juries seemed to have trouble understanding that the entire securities industry is based upon (1) fluctuating markets where loses are nearly as common as gains and (2) where transactions are most often based upon oral (rather than written) understandings.

The arbitration proceeding eliminated the jury and substituted an arbitrator or, for larger cases, an arbitration panel. These proceedings featured streamlined discovery with an informal hearing. However, these proceedings kept the basic adversary format found in the civil courts where lawyers on both sides have to bring themselves up to speed on all the facts and law bearing on the matter. The hearing itself though informal retains most of the steps of a “judge tried” adversary proceeding in a civil court

The costs for these arbitration panels were handled differently at different times, but in recent years the costs have mostly been born by the brokerage firm involved in the dispute. It is common for even a small case to generate $3,000 or $4,000 in forum costs for the brokerage firm over and above the cost of lawyers. Not much was gained by arbitration in terms of speed or expense. In fact for the firms, expenses probably rose because of the high forum costs. But arbitration proceedings did tend to reign in outsized damage awards against the brokerage industry.

Along with arbitration, the NASD and NYSE dispute resolution organizations offer voluntary mediation services. Mediation is generally seen as an “add on” to the arbitration process where a trained mediator tries to lead the parties to a settlement. If it succeeds it cuts costs, but oftentimes it doesn’t succeed because either (1) the mediation process occurred before discovery had been completed so the mediator (and the parties) did not have all the facts at hand when discussing a settlement, or (2) the mediator starts work late in the process after both sides have invested huge amounts of money on lawyers and are psychologically locked into their positions.

Lately the NASD has been receiving complaints from firms that unprincipled plaintiff’s lawyers have been bringing small frivolous cases (claiming $10,000 to $20,000 in damages) knowing that the legal bills and forum costs will force the firm to simply write a check regardless of merits. It is apparent that relief is needed.

So members of the NASD are considering several alternatives that would allow firms to deal with these frivolous cases. One of these alternatives is to allow firms to force disputes into “immediate compulsory mediation” where the parties would be compelled to (1) submit their claim to a mediator and (2) to accept the decision of the mediator. This suggestion offers the chance to do a lot of desirable things: speed up the process, cut cost out of the process, and quickly eliminate frivolous complaints. There is, of course one big problem: the facts can not be known with any certainty till some kind of discovery is accomplished. There are three ways to do this discovery:

(1) Let the lawyers on both sides do their usual slow, expense discovery, but this eliminates much of the cost and time savings envisioned by going to early mediation.

(2) Have the mediator (who is usually a lawyer) take a couple of weeks or months reviewing documents and conducting telephone and personal interviews of the parties and witnesses preferably without the lawyers for the parties present. Subpoena power would have to be provided to the mediator.

(3) A even better approach would be to have an experienced NASD examiner do the investigation process and create a report (or dossier) on the case for the mediator’s review. This dossier might be refined by a back and forth process between the mediator and examiner. By using a combination of an experienced NASD examiner with a legally trained mediator, the case gets the benefit of a man knowledgeable in securities industry’s regulation and practices as well as the legal expertise of the mediator. A copy of the final dossier would be provided to the parties for their comments. Perhaps more important, the hourly cost of the examiner is likely to be far less than the hourly cost of the mediator. Obviously where testimony diverges on key points, the mediator is going to have to interview the witnesses in person probably with the lawyers for the parties present.

These dossiers created by NASD examiners could be made available to NASD supervisors as they design plans for examiners to use in their periodic exams of member firms or as the NASD testing service designs CE materials. The NASD’s first responsibility is to protect the customers of the securities industry. These dossiers prepared by experienced NASD examiners would disclose in a concrete, concise way “how things go wrong in a brokerage environment”.

Finally, if this worked for the brokerage industry to reduce cost and speed the process while providing just results, it is safe to say other industries would want the same process. That could lead to a complete overhaul of the civil justice system. The securities industry could be the catalyst for one of the most needed legal reforms in America.

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