Subject: Comment to File No. SR-NASD-99-07
Author:  "DAN JAMIESON" <DAN_JAMIESON@intertec.com>
Date:    6/1/99 1:19 PM
     
     
June 1, 1999
     
     
Dan Jamieson
14341 Spa Drive
Huntington Beach, CA 92647
     
     
Office of the Secretary
Securities and Exchange Commission,
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
     
     
Comment to File No. SR-NASD-99-07, Discovery Rules. Via E-mail
     
     
Dear Mr. Katz:
     
     
The proposed guidelines are a helpful step in striking a reasonable balance 
between competing interests. The guidelines as generally proposed would be of 
tremendous help to arbitrators in issuing discovery orders. The clear, but 
flexible nature of the proposed discovery guidelines are an appropriate solution
to the longstanding problems with discovery in NASD arbitration hearings. The 
advantage of an industry arbitration system for commercial disputes is that 
claims and defenses will often be similar, and the documents needed for a 
hearing will be similar from case to case as well. Therefore, guidelines for 
what should typically be produced are appropriate and consistent with the '34 
Act and SRO standards of fair practice.
     
Where the proposal can be criticized is in favoring slightly industry interests.
Litigation is of keen concern to the securities industry and Wall Street has 
long been effective in making sure its views are heard at its own SROs, within 
its own justice system, and at the Commission as well.  Meanwhile, the 
investors' plaintiffs' bar is relatively new and puny, and investor interests 
are completely unorganized.
     
Therefore, the Commission must take extreme caution in making sure the 
disaffected are heard. To that end, this letter offers suggestions that in this 
commentator's opinion would better balance the proposal.
     
     
Regarding List 2 
     
Item 2 is unfair, since many if not most customers would have to create these 
financial statements of assets, liabilities and or net worth for possibly up to 
six years running. Most public customers have a hodge podge of accounts and 
statements--with no centralized reporting available from different custodians. 
Uncertain valuations on homes and other property would make production of this 
information difficult. Business owners are unlikely to have a current, 
independent valuation of their enterprise/s. 
Therefore, production of such information will be a large and costly burden for 
most customers. The net worth and other financial information about the customer
that the broker and brokerage firm have on file should suffice for most cases. 
    Of course,  in certain cases, a panel could order production of such balance
sheet type information from customers, and can continue to do so under the 
proposed guidelines.
     
    Item 10 seems quite invasive. Requiring a peek into the private
communications from other professionals seems misplaced. Perhaps the industry 
has pushed for this item in an attempt to see if a claimant has been goaded by a
competing brokerage firm or adviser. Whatever, the need for Item 10 is unclear, 
especially given the sensitive and possibly privileged nature of this 
information. If such information is relevant, either side can ask for its 
production, but it should not be on the list.
     
    Items 11 and 12, although helpful in rooting out bad-actor customers who
have been parties in other securities-related litigation, also puts an unfair 
burden on customers. This type of information relating to brokers is available 
with a single request to the CRD system. But customers have no central source to
easily access this information. While these Items might be kept on the list, 
their existence certainly helps kill any industry argument that the discovery 
demands in these proposed rules are unbalanced, or that similar information 
about a firm or broker should not be part of the lists due to its prejudicial 
nature.
     
Regarding List 3
     
    A new "Item 4" should be added. The NASDR has left off critical information
relating to churning, namely, financial and career incentives faced by both the 
firm and the firm's management relating to sale of the securities at issue. 
Managers have far more impact on what gets sold than do lone brokers.
Therefore, regarding the investments at issue, firms should also have to produce
under a new Item 4: 1) a summary of all revenue earned by the firm from sales of
the products, including total dealer reallowance (not just gross credited to the
rep), "revenue sharing" arrangements and support payments received by the firm 
from the products' vendors; 2) the products' due diligence file; 3) full 
documentation of all incentives given to branch managers, regional managers, 
district managers and sales managers, including any sales quotas and a history 
of sales meetings regarding the product; 4) documentation of any sales contests.
    This is nearly identical compensation information to that required  for
brokers. It is both absurd and dangerous to assume that incentives start and end
with the retail salesforce. Firms and  management cannot be exempted from this 
disclosure. 
     
Regarding List 11
     
    Regarding the best execution issue, only the production of order tickets
would be of help. An additional list could be created for best execution claims.
Additional documents could include the time-and-trade reports used by the firm; 
compensation information for the broker, trader,  and trading desk management; 
records of conversations/communications between the broker and trader; and the 
firm's best-execution procedures, including financial arrangements with 
specialist firms.
     
Regarding List 13
     
    Items 1 and 2 lay all blame on the retail rep for unsuitability. Again, it
is absurd and dangerous to assume that management incentives are not affecting 
what gets sold. In fact, for purposes of assessing damages, management's role in
an unsuitability case will be key. Therefore, the same compensation information 
in Item 2 as is being proposed for retail reps should also be produced for all 
sales managers, branch mangers, regional managers and district managers. The 
worksheets or notes referred to in Item 1 should also apply to these managers 
since wronged customers have a right to know if managers who encourage reps to 
sell a particular security have also reviewed pertinent documents.
     
Note on Part II, B
     
The Commission should regard with care Part II, B, of the proposed rule, which 
says:
     
 " ... one of the parties may suggest a stipulation between the parties that the
document(s) in question will not be disclosed or used in any manner outside of 
the arbitration of the particular case, or the arbitrator(s) may issue a 
confidentiality order."
     
While important for arbitrators to have the confidentiality tool available, this
seemingly innocent phrase could serve to further close the industry's 
arbitration process to public scrutiny. Unlike a court of law, NASD arbitration 
hearings are not now open to the public. Even if one party wants an open 
hearing, the sessions remain closed to sunlight. 
     
This lack of sunlight into the process erodes confidence in the system, despite 
the fact that the system, for the most part, works well. Yet investors  can 
learn little of what happens in closed sessions, unlike industry participants 
who enjoy repeat player status and know full well how the system operates.
     
This proposed confidentiality wording could further tempt participants into 
asking for gag orders and document seals. Already, the discovery process has 
been abused with participants demanding a vague standard of confidentiality in 
return for documents that should have been produced anyway. 
     
The rule should instead clarify the use of confidentiality orders. Panelists 
should be given direction as to the limited reasons why documents should be kept
confidential, such as where material financial or trade secret information is at
stake, or sensitive tax information at risk. Otherwise, panelists should be 
discouraged from using such orders.
     
Comments on SEC Questions
     
    B. Customer Personal Financial Information
        Requiring both a balance sheet and tax return from customers is unduly
burdensome. Unlike firms, customers are not in the business of keeping records. 
A balance sheet OR basic tax return information should suffice in most cases. 
Six years of such information could be far too long in many cases. A year prior 
to an alleged incident would seem reasonable. Production of this information 
should be limited to relevant claims, such as unsuitability. 
    Requiring customers to produce this information DOES NOT balance the
requirement of firms to produce customer complaints and disciplinary action from
all time periods. Firms already retain customer complaints (letters and a log) 
as required by industry rules, and full broker disciplinary histories are 
available to customers via the CRD and to firms via their own terminals--hardly 
a burden for the industry.
    The Commission should avoid defining legal privileges. Arbitrators are quite
capable of deciding privilege issues under well-established legal principles.
     
    D. Internal Audit Reports
     
Regarding Item 3(a), the Commission is correct in questioning the "focused on" 
language in regard to the production of internal audit reports. In fact, it is 
critical that the Commission avoid restricting in any way what relevant audit 
reports are presumptively discoverable. Better language would be an audit report
 that "could relate to" a claim at issue. "Focused on" creates a semi-truck
sized loophole for hiding a problem broker--a critical audit report could well 
avoid naming any one broker in particular, even though that very broker 
precipitated the audit. Many of these reports or audits will be general in 
nature but will be specific to a failure-to-supervise claim. Therefore, the 
broadest possible language should be used in describing what reports should be 
produced.
    Absolutely no date limitations should be placed around any audit reports.
Generally, the older the audit report, the more longstanding the problem and the
greater the failure to supervise liability the report could show. One could 
logically exempt newer reports, but not older ones. The wording of List 5, Item 
3(a), will not help firms produce documents as much as it will help them bury 
adverse material. Expanding this language will not upset any purported balance; 
firms routinely generate and archive all such documents and can produce them 
with little trouble. That they want to bury past adverse reports is only 
natural, but the Commission should not go along with the idea.
    Also in Item 3, the description of audit reports "at the branch" is vague.
Is this a report held at the branch, or done at the branch? This language should
be removed. Particularly egregious behavior is often investigated by off-site 
personnel, and the subsequent report would likely be held off-site as well, 
resulting in a discovery exemption for these potentially "smoking gun" 
documents. Again, the Commission should close this industry-inspired loophole.
     
Comments re Other Commentators
     
    The Securities Industry Association has questioned the wisdom of the SEC
effecting this rule that institutes guidelines as part of the SICA manual. The 
SIA says it will not support the guidelines because they will "interfere with 
the discretion" of panelists. 
First, because the rule is a set of guidelines, not mandates, there can  be no 
interference with arbitrators.  
Secondly, that the guidelines are issued as a rule is immaterial. The SEC has 
every right to set forth any kind of guideline or rule, with or without industry
participation. The proposed discovery guidelines, formulated with a good deal of
debate, and  passed as a rule and added to the manual are entirely appropriate. 
Indeed, the SIA's position is puzzling since the guidelines are widely 
considered as necessary given past discovery abuses within the industry's own 
justice system. Further, the Commission is to be commended for allowing the 
public to comment on the guidelines via the formal rulemaking process; the 
public, which is mandated to litigate in the industry's own forums, has no 
organized lobbying constituency--quite unlike Wall Street. Remember, the public 
investor has interests different even from the plaintiffs' bar, which itself 
might lobby for rules that would make litigation more common and costly for 
investors, but more profitable for itself. The public  comment process is the 
sole opportunity for the public customer to address this important rule 
proposal. The SIA's concerns about the process are misplaced.
    The SIA also worries about the "codifying" of an arbitrary list of items
that must be produced. Again, these are guidelines. And they are needed now more
than ever with implementation of the list-selection method for NASD arbitrators.
This method will probably produce more diverse--but less experienced--groups of 
panelists who will need the guidance. The guideline's lists are far from 
arbitrary; they contain items that should be, and have been, routinely produced.
    In addition, the SIA complains of an unfair burden: "far more documents are
required to be produced by firms," the SIA writes. A precise item count is not 
necessary to see that all of the material ordered to be produced by firms and 
brokers is produced and kept in the normal course of business, per industry 
recordkeeping requirements. Not so for customers (such as the balance sheet 
item). While it is true that certain cases require "liberal discovery" of 
customer financial information, which the industry of course wants, Wall Street 
really has no argument here as it already owns detailed information on 
customers (see footnote No. 1). Full tax returns are not needed in most cases.
Where full returns are needed, the Street should trust its own process and count
on arbitrators to order further discovery.
The SIA comment letter discusses the need for providing past  disciplinary 
actions of a broker, and the slight probative value to be gained  from this 
information as well as its prejudicial nature. The points made are irrelevant, 
however, since the issue at hand is failure to supervise, not individual broker 
misconduct. Past disciplinary actions relate directly to failure to supervise. 
This is precisely why audit reports should not be restricted in any way. 
Meanwhile, the industry does not object to the equally prejudicial information 
on List 2, Items 11 and 12--past customer litigation and complaints.
The Commission should discount the SIA's argument here. The hand-wringing over 
List 1, Items 8 and 12 is likely a straw man created for the Commission's own 
benefit, since substantial disciplinary information will remain publicly 
available regardless of the Commission's action on this rule. When the industry 
is "defeated" on this item the SIA can claim to have "given up" something in the
interest of achieving balance--even though the status quo remains.  
The SIA is correct in warning against an "exhaustive list of potential 
privileges." The SEC should take heed of the SIA's suggestion that the 
Commission "should not tread in an area that is governed by the law of the state
where the hearing occurs. ..." 
    SIA commentators further claim that the vitality and candor of internal
audit reports will be hurt by their production, and that the self-policing 
function will therefore be harmed. The opposite is true. Any increased exposure 
of internal audit reports will help ensure that the reports' recommendations are
followed internally, rather than buried. Self-policing will be improved as a 
result. Specific questions about which reports are material to a case can be 
easily handled by arbitrators. Therefore, no time limits or "focused on" 
definitions should be suggested--the possible negative impact on investor 
protection would be too risky.
    The proposed discovery rules are, overall, well-thought out and clearly
needed. There is some industry bias in the lists, but that is to be expected as 
a natural outcome of a  process that does not directly involve investor 
interests, yet includes well-financed and well-connected industry interests. 
Despite the industry tilt, participants in the drafting process should be 
commended for their thorough work. Some minor rebalancing by the Commission is 
all that is needed to create a truly fair and workable set of guidelines.
     
Sincerely
     
     
Dan Jamieson
Huntington Beach, Calif.