Neutrals: California's arbitrator ethics rules no longer apply in NASD proceedings (Web)
February 9, 2005
Neutrals: A federal circuit court overturned California’s arbitrator ethics standards for cases involving NASD arbitrations on March 1.
The NASD, which abandoned California arbitrations in the wake of the California Judicial Council’s 2002 ethics rules, already had permission from the U.S. Securities and Exchange Commission via a special rule to allow parties to waive the application’s standards before proceeding with arbitrations in the state.
California Chief Justice Ronald George, via the state’s policymaking Judicial Council, which he oversees, pushed hard for the disclosure rules. A state case testing the validity of the rules is set to be argued before the Court on Tuesday, March 8; George has recused himself from hearing the case.
The Ninth U.S. Circuit Court of Appeals in Credit Suisse First Boston Corporation v. Grunwald, No. 0315695 (March 1, 2005) (available at http://www.ca9.uscourts.gov/ca9/newopinions.nsf/85E12F7AAC2A420688256FB70000CDB6/$file/0315695.pdf?openelement), in a unanimous decision written by Circuit Judge Richard A. Paez, and joined by Senior Judge Edward Leavy and Circuit Judge Marsha S. Berzon, held that the Securities and Exchange Act of 1934 preempts application of California’s ethics standards to NASD arbitrations, and that the NASD rules approved by the Securities and Exchange Commission have preemptive force over conflicting state law.
The SEC also allowed the NASD, along with the New York Stock Exchange, to require waivers before proceeding with arbitrations in California in 2002. Both self-regulatory organizations had halted California arbitrations in the wake of the July 2002, effectiveness date, of the arbitrator ethics rules.
The plaintiff in the case took a classic multistep ADR path to the March 1 federal circuit court decision. He was director of the “Technology Private Client Services Program” at a Credit Suisse First Boston, which fired him, according to the opinion. He mediated first with Jams Inc. under the financial services company’s “Employment Dispute Resolution Program. He then filed a demand to arbitrate the case with the American Arbitration Association, but was enjoined by Credit Suisse because the company’s dispute resolution program requires NASD-registered employees to arbitrate before NASD-appointed arbitrators.
The plaintiff filed a demand for NASD arbitration, but the opinion says that the California ethics rules had taken effect before the two arbitration demands. After the demand, the NASD invoked the rule it sought and received from the SEC that allowed the NASD to require California parties to waive the state arbitrator disclosure rules.
The plaintiff declined to waive the California rules. The NASD refused to proceed in the wake of the plaintiff’s court request to lift the preliminary injunction so he could re-file his claims in state court or with the AAA. The court allowed the plaintiff to file a motion for reconsidering the injunction, but it was denied, leading to the Ninth Circuit opinion on March 1.
The Paez Ninth Circuit opinion says that the California Judicial Council didn’t overstep its bounds by making its 2002 disclosure rules apply to NASD arbitrators. But it found that the SEC rule preempted the California rules under Merrill Lynch, Pierce, Fenner & Smith v. Ware, 414 U.S. 117 (1973) and Securities Exchange Act rules.
The opinion found a clash between specific California and the NASD arbitrator disqualification and disclosure rules. It says that the sets of disclosures in the two schemes don’t conflict, but the California rules interfere with the application of federal securities laws sufficiently—including increasing the costs of NASD arbitrations—to preempt the California ethics rules from applying to the securities processes.
Circuit Judge Berzon wrote a concurrence, agreeing that the NASD rules pre-empt California’s ethics rules, but questioning the extent of the application of the preemption. She had doubts about whether the NASD arbitration and waiver rules as applied to employer-employee disputes was within the NASD’s authority to issue, and the SEC’s to approve. She wrote that the opinion focused on procedural rulemaking as opposed to the substance of the rules being made.
The ethics rules will be tested next week before the California State Supreme Court. The NASD has intervened in that case. Chief Justice George, and Justice Marvin Baxter, a California Judicial Council member, have recused themselves from hearing the case, Jevne v. Superior Court, Docket No. S121532. For more information, see http://www.courtinfo.ca.gov/courts/calendars/documents/SMARD05.PDF.
The Recorder of San Francisco reports on March 3 that the state case plaintiff-- an investor who was attempting to arbitrate, and later litigate, against a broker he alleged misappropriated his money--plans to argue that the NASD and NYSE aren't governmental agencies and therefore rules lack the pre-emptive force of federal regulations. The Recorder article can be found at http://www.law.com/jsp/article.jsp?id=1109597712267.