[Federal Register Volume 63, Number 146 (Thursday, July 30, 1998)]
[Notices]
[Pages 40761-40774]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-20364]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40261; File No. SR-NASD-98-48]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc. Relating 
to the Selection of Arbitrators in Arbitrations Involving Public 
Customers

July 24, 1998.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on July 10, 
1998,\1\ the National Association of Securities Dealers, Inc. (``NASD'' 
or ``Association''), through its wholly-owned subsidiary NASDA 
Regulation, filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by the self-regulatory 
organization. The Commission is publishing this notice to solicit 
comments on the proposed rule change from interested persons.
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    \1\ The NASD filed Amendment Nos. 1 and 2 to the proposed rule 
change on July 14, 1998 and July 23, 1998, respectively, the 
substance of which is incorporated into this notice. See letters 
from Alden S. Adkins, Senior Vice-President and General Counsel, 
NASD Regulation, to Katherine A. England, Assistant Director, Market 
Regulation, Commission, dated July 14, 1998 (``Amendment No. 1'') 
and July 23, 1998 (``Amendment No. 2'').
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    NASD Regulation is proposing to amend Rule 10308 to set forth new 
procedures to be used to select arbitrators for arbitrations involving 
public customers.\2\ Under the new procedures, NASD Regulation will 
allow the parties to an arbitration to rank arbitrators from lists 
generated primarily using an automated process, providing parties with 
a substantial role in determining the composition of their arbitration 
panels. NASD Regulation is proposing conforming changes to Rules 10104, 
10309, 10310, 10311, 10312, and 10313. In addition, NASD Regulation 
proposes to amend Rule 10315 concerning the scheduling of the first 
meeting of the parties and the arbitration panel to reflect that such 
meetings usually occur prior to the first hearing of an arbitration 
proceeding. Finally, NASD Regulation proposes to correctly state in the 
Rule 10000 Series and any other Rules the name of the NASD Regulation 
committee that addresses arbitration and related matters, the National 
Arbitration and Mediation Committee.
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    \2\ NASD Regulation also intends to file a proposed rule change 
to use a similar list selection process for intra-industry 
arbitrations.
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    Below is the text of the proposed rule change. Proposed new 
language is in italics proposed deletions are in brackets.
* * * * *
10104. Composition and Appointment of Panels
    Except as otherwise specifically provided in Rule 10308, t[T]he 
Director [of Arbitration] shall compose and appoint panels of 
arbitrators from the existing pool of arbitrators of the Association to 
conduct the arbitration of any matter which shall be eligible for 
submission under this Code. [The Director of Arbitration may request 
that the Executive Committee of the National Arbitration Committee 
undertake the composition and appointment of a panel or undertake 
consultation with the Executive Committee regarding the composition and 
appointment of a panel in any circumstance where he determines such 
action to be appropriate.]
* * * * *
10308. [Designation of Number of Arbitrators] Selection of Arbitrators 
in Customer Disputes
    [(a) Except as otherwise provided in Rule 10302, in all arbitration 
matters involving public customers and where the amount in controversy 
does not exceed $30,000, the Director of Arbitration shall appoint a 
single public arbitrator knowledgeable in but who is not from the 
securities industry to decide the dispute, claim or controversy. Upon 
the request of a party in its initial filing or the arbitrator, the 
Director of Arbitration shall appoint a panel of three (3) arbitrators 
which shall decide the matter in controversy. At least a majority of 
the arbitrators appointed shall not be from the securities industry, 
unless the public customer requests a panel consisting of at least a 
majority from the securities industry.
    (b) In arbitration matters involving public customers and where the 
amount in controversy exceeds $50,000, exclusive of attendant costs and 
interest, or where the matter in controversy does not involve or 
disclose a money claim, the Director of Arbitration shall appoint a 
panel of three (3) arbitrators, at least a majority of whom shall not 
be from the securities industry, unless the public customer requests a 
panel consisting of at least a majority from the securities industry.
    (c) An arbitrator will be deemed as being from the securities 
industry if he or she:
    (1) Is a person associated with a member or other broker/dealer, 
municipal securities dealer, government securities broker, or 
government securities dealer, or
    (2) Has been associated with any of the above within the past three 
(3) years, or
    (3) Is retired from any of the above, or
    (4) Is an attorney, accountant, or other professional who has 
devoted twenty (20) percent or more of his or her professional work 
effort to securities industry clients within the last two years, or
    (5) Is an individual who is registered under the Commodity Exchange 
Act or is a member of a registered futures association or any 
commodities

[[Page 40762]]

exchange or is associated with any such person(s).
    (d) An arbitrator who is not from the securities industry shall be 
deemed a public arbitrator. A person will not be classified as a public 
arbitrator if he or she has a spouse or other member of the household 
who is a person who is associated with a member of other broker/dealer, 
municipal securities dealer, government securities broker, or 
government securities dealer.]
    This rule specifies how parties may select or reject arbitrators, 
and who can be a public arbitrator in arbitration proceedings involving 
a customer.

(a) Definitions

(1) ``Day''

    For purposes of this rule, the term ``day'' means calendar day.

(2) ``Claimant''

    For purposes of this rule, the term ``claimant'' means one or more 
persons who file a single claim.

(3) ``Neutral List Selection System''

    The term ``Neutral List Selection System'' means the software that 
maintains the roster of arbitrators and performs various functions 
relating to the selection of arbitrators.

(4) ``Non-Public Arbitrator''

    The term ``non-public arbitrator'' means a person who is otherwise 
qualified to serve as an arbitrator and:
    (A) Is, or within the past three years, was:
    (i) Associated with a broker or a dealer (including a government or 
a municipal securities broker or dealer);
    (ii) Registered under the Commodity Exchange Act;
    (iii) A member of a commodities exchange or a registered futures 
association; or
    (iv) Associated with a person or firm registered under the 
Commodity Exchange Act;
    (B) Is retired from engaging in any of the business activities 
listed in subparagraph (4)(A);
    (C) Is an attorney, accountant, or other professional who has 
devoted 20 percent or more of his or her professional work, in the last 
two years, to clients who are engaged in any of the business activities 
listed in subparagraph (4)(A); or
    (D) Is an employee of a bank or other financial institution and 
effects transactions in securities and commodities futures or options 
or supervises or monitors the compliance with the securities and 
commodities laws of employees who engage in such activities.

(5) ``Public Arbitrator''

    (A) The term ``public arbitrator'' means a person who is otherwise 
qualified to serve as an arbitrator and is not:
    (i) Engaged in the conduct or activities described in paragraphs 
(a)(4)(A) through (D); or
    (ii) The spouse or an immediate family member of a person who is 
engaged in the conduct or activities described in paragraphs (a)(4)(A) 
through (D).
    (B) For the purpose of this rule, the term ``immediate family 
member'' means:
    (i) A family member who shares a home with a person engaged in the 
conduct or activities described in paragraphs (a)(4)(A) through (D);
    (ii) A person who receives financial support of more than 50 
percent of his or her annual income from a person engaged in the 
conduct or activities described in paragraphs (a)(4)(A) through (D); or
    (iii) A person who is claimed as a dependent for federal income tax 
purposes by a person engaged in the conduct or activities described in 
paragraphs (a)(4)(A) through (D).

(6) ``Respondent''

    For purposes of this rule, the term ``respondent'' means one or 
more persons who individually or jointly file an answer to a complaint.

(7) ``Send''

    For purposes of this rule, the term ``send'' means to send by first 
class mail, facsimile, or any other method available and convenient to 
the parties and the Director.

(b) Composition of Arbitration Panel; Preparation of Lists for Mailing 
to Parties

(1) Composition of Arbitration Panel

(A) General Rule Regarding Panel Composition

    (i) If the amount of a claim is $50,000 or less, the Director shall 
appoint an arbitration panel composed of one public arbitrator, unless 
the parties agree otherwise.
    (ii) If the amount of a claim is more than $50,000, the Director 
shall appoint an arbitration panel composed of one non-public 
arbitrator and two public arbitrators, unless the parties agree 
otherwise.

(B) Special Request

    If the amount of a claim is greater than $25,000 and not more than 
$50,000 and the claimant requests that a panel of three arbitrators be 
appointed, the Director shall appoint an arbitration panel composed of 
one non-public arbitrator and two public arbitrators, unless the 
parties agree otherwise.

(2) One List for Panel of One Arbitrator

    If one arbitrator will serve as the arbitration panel, the Director 
shall send to the parties one list of public arbitrators, unless the 
parties agree otherwise.

(3) Two List for Panel of Three Arbitrators

    If three arbitrators will serve as the arbitration panel, the 
Director shall send two lists to the parties, one with the names of 
public arbitrators and one with the names of non-public arbitrators. 
The lists shall contain numbers of public and non-public arbitrators, 
in a ratio of approximately two to one, respectively, to the extent 
possible, based on the roster of available arbitrators.

(4) Preparation of Lists

    (A) Except as provided in subparagraph (B) below, the Neutral List 
Selection System shall generate the list of public and non-public 
arbitrators on a rotating basis within a designated geographic hearing 
site and shall exclude arbitrators based upon conflicts of interest.
    (B) If a party requests that the lists include arbitrators with 
expertise classified in the Neutral List Selection System, the list may 
include some arbitrators having the designated expertise.

(5) Sending of Lists to Parties

    The Director shall send the list of arbitrators to all parties at 
the same time approximately 30 days after the last answer is due.

(6) Information About Arbitrators

    The Director shall send to the parties employment history for each 
listed arbitrator for the past 10 years and any information disclosed 
by the arbitrator under Rule 10312 relating to personal financial 
interests or the existence of a relationship that gives rise to an 
appearance of a conflict of interest or bias. If a party requests 
additional information about an arbitrator, the Director shall send 
such request to the arbitrator, and shall send the arbitrator's 
response to all parties at the same time. When a party requests 
additional information, the Director may, but is not required to, toll 
the time for the parties to return the ranked lists under paragraph 
(c)(2).

[[Page 40763]]

(c) Striking, Ranking, and Appointing Arbitrators on Lists

(1) Striking and Ranking Arbitrators

(A) Striking An Arbitrator

    A party may strike one or more of the arbitrators from each list 
for any reason.

(B) Ranking--Panel of One Arbitrator

    Each party shall rank all of the arbitrators remaining on the list 
by assigning each arbitrator a different, sequential, numerical 
ranking.

(C) Ranking--Panel of Three Arbitrators

    Each party shall rank all of the public arbitrators remaining on 
the list by assigning each arbitrator a different, sequential, 
numerical ranking, and separately shall rank all of the non-public 
arbitrators remaining on the list, using the same procedure.

(D) Joint Action Permitted

    All claimants may act jointly and all respondents, including 
thirdparty respondents, may act jointly to file a single list that 
reflects their unanimous agreement as to the striking and ranking of 
arbitrators. If multiple claimants or respondents do not act jointly, 
the rankings of multiple claimants or respondents will be consolidated 
as described in subparagraph (b)(3)(A).

(2) Period for Ranking Arbitrators; Failure To Timely Strike and Rank

    A party must return to the Director the list or lists with the 
ranking not later than 20 days after the Director sent the lists to the 
parties, unless the Director has extended the period. If a party does 
not timely return the list or lists, the Director shall treat the party 
as having retained all the arbitrators on the list or lists and as 
having no preferences.

(3) Process of Consolidating Parties' Rankings

(A) General Rule

    The Director shall prepare one or two consolidated lists of 
arbitrators, as appropriate under subparagraph (b)(2) or (b)(3), based 
upon the parties' numerical rankings. The arbitrators shall be ranked 
by adding the rankings of all claimants together and all respondents 
together, including third-party respondents, to produce separate 
consolidated rankings of the claimants and the respondents. The 
Director shall then rank the arbitrators by adding the consolidated 
rankings of the claimants, the respondents, including third party 
respondents, and any other party together, to produce a single 
consolidated ranking number, excluding arbitrators who were stricken by 
any party.

(B) Exception

    If the Director determines that the interests of a party are 
sufficiently different from the interests of other claimants or 
respondents, the Director may determine not to consolidate the rankings 
of that party with the rankings of the other claimants or respondents.

(4) Appointment of Arbitrators

(A) Appointment of Listed Arbitrators

    The Director shall appoint arbitrators to serve on the arbitration 
panel based on the order of rankings on the consolidated list of lists, 
subject to availability and disqualification.

(B) Discretion To Appoint Arbitrators Not on List

    If the number of arbitrators available to serve from the 
consolidated list is not sufficient to fill a panel, the Director shall 
appoint one or more arbitrators to complete the arbitration panel; 
provided, however, unless the parties agree otherwise, the Director may 
not appoint a non-public arbitrator under paragraphs (a)(4)(B) or 
(a)(4)(C).

(5) Selecting a Chairperson for the Panel

    The parties shall have 15 days from the date the Director sends 
notice of the names of the arbitrators to select a chairperson. If the 
parties cannot agree, the Director shall appoint one of the public 
arbitrators as the chairperson. Unless all parties agree otherwise, the 
Director shall not appoint as the chairperson a public arbitrator who:
    (A) Is an attorney, accountant, or other professional, and
    (B) Has devoted 50% or more of his or her professional or business 
activities, within the last two years, to representing or advising 
public customers in matters relating to disputed securities or 
commodities transactions or similar matters.

(6) Additional Parties

    If a party is added to an arbitration proceeding before the 
Director has consolidated the other parties' rankings, the Director 
shall send to that party the list or lists or arbitrators and permit 
the party to strike and rank the arbitrators. The party must return to 
the Director the list or lists with numerical rankings not later than 
20 days after the Director sent the lists to the party. The Director 
shall then consolidate the ranking as specified in this paragraph (c).

(d) Disqualification and Removal of Arbitrator Due to Conflict of 
Interest or Bias

(1) Disqualification by Director

    After the appointment of an arbitrator and prior to the 
commencement of the earlier of (i) the first prehearing conference or 
(ii) the first hearing, if the Director or a party objects to the 
continued service of the arbitrator, the Director shall determine if 
the arbitrator should be disqualified. If the Director sends a notice 
to the parties that the arbitrator shall be disqualified, the 
arbitrator will be disqualified unless the parties unanimously agree 
otherwise in writing and notify the Director not later than 15 days 
after the Director sent the notice.

(2) Authority of Director of Disqualify Ceases

    After the commencement of the earlier of (i) the first prehearing 
conference or (ii) the first hearing, the Director's authority to 
remove an arbitrator from an arbitration panel ceases.

(3) Vacancies Created by Disqualification or Resignation

    If an arbitrator appointed to an arbitration panel is disqualified 
or resigns from an arbitration panel, the Director shall appoint from 
the consolidated list of arbitrators the arbitrator who is the most 
highly ranked available arbitrator of the proper classification 
remaining on the list. If there are no available arbitrators of the 
proper classification in the consolidated list, the Director shall 
appoint an arbitrator of the proper classification subject to the 
limitation set forth in paragraph (s)(4)(B).

(e) Discretionary Authority

    The Director may exercise discretionary authority and make any 
decision that is consistent with the purposes of this rule and the Rule 
10000 Series to facilitate the appointment of arbitration panels and 
the resolution of arbitration disputes.
Rule 10309. Composition of Panels
    Except as otherwise specifically provided in Rule 10308, t[T]he 
individuals who shall serve on a particular arbitration panel shall be 
determined by the Director [of Arbitration]. Except as otherwise 
specifically provided in Rule 10308, t[T]he Director [of Arbitration] 
may name the chairman of the panel.

[[Page 40764]]

Rule 10310. Notice of Selection of Arbitrators
    (a) The Director shall inform the parties of the arbitrators' names 
and employment histories for the past 10 years, as well as information 
disclosed pursuant to Rule 10312, at least 15 business days prior to 
the date fixed for the first hearing session. A party may make further 
inquiry of the Director [of Arbitration] concerning an arbitrator's 
background. In the event that, prior to the first hearing session, any 
arbitrator should become disqualified, resign, die, refuse or otherwise 
be unable to perform as an arbitrator, the Director shall appoint a 
replacement arbitrator to fill the vacancy on the panel. The Director 
shall inform the parties as soon as possible of the name and employment 
history of the replacement arbitrator for the past 10 years, as well as 
information disclosed pursuant to Rule 10312. A party may make further 
inquiry of the Director [of Arbitration] concerning the replacement 
arbitrator's background and within the time remaining prior to the 
first hearing session or the 10 day period provided under Rule 10311, 
whichever is shorter, may exercise its right to challenge the 
replacement arbitrator as provided in Rule 10311.
    (b) This rule shall not apply to arbitration proceedings that are 
subject to Rule 10308.
Rule 10311. Peremptory Challenge
    (a) In an[y] arbitration proceeding, each party shall have the 
right to one [(1)] peremptory challenge. In arbitrations where there 
are multiple Claimants, Respondents, and/or Third-Party Respondents, 
the Claimants shall have one [(1)] peremptory challenge, the 
Respondents shall have one [(1)] peremptory challenge, and the Third-
Party Respondents shall have one [(1)] peremptory challenge. The 
Director [of Arbitration] may in the interests of justice award 
additional peremptory challenges to any party to an arbitration 
proceeding. Unless extended by the Director [of Arbitration], a party 
wishing to exercise a peremptory challenge must do so by notifying the 
Director [of Arbitration] in writing within 10 business days of 
notification of the identity of the person(s) named under Rule 10310 or 
Rule 10321(d) or (e), whichever comes first. There shall be unlimited 
challenges for cause.
    (b) This rule shall not apply to arbitration proceedings that are 
subject to Rule 10308.
Rule 10312. Disclosures Required of Arbitrators and Director's 
Authority To Disqualify
    (a) through (c) No change.
* * * * *
    (d) The Director shall inform the parties to an arbitration 
proceeding of any information disclosed to the Director under this Rule 
unless the arbitrator who disclosed the information withdraws from 
being considered for appointment voluntarily and immediately after the 
arbitrator learns of any interest or relationship described in 
paragraph (a) that might preclude the arbitrator from rendering an 
objective and impartial determination in the proceeding.
    ([d]e) [Prior to the commencement of the first hearing session] 
Prior to the commencement of the earlier of (i) the first prehearing 
conference or (ii) the first hearing, the Director [of Arbitration] may 
remove an arbitrator based on information disclosed pursuant to this 
Rule. [The Director of Arbitration shall also inform the parties of any 
information disclosed pursuant to this Rule if the arbitrator who 
disclosed the information is not removed.]
    (f) After the commencement of the earlier of (i) the first 
prehearing conference or (ii) the first hearing, the Director's 
authority to remove an arbitrator from an arbitration panel ceases.
Rule 10313. Disqualification or Other Disability of Arbitrators
    In the event that any arbitrator, after the commencement of the 
first hearing session but prior to the rendition of the award, should 
become disqualified, resign, die, refuse or otherwise be unable to 
perform as an arbitrator, the remaining arbitrator(s) shall continue 
with the hearing and determination of the controversy, unless such 
continuation is objected to by any party within 5 days of notification 
of the vacancy on the panel. Upon objection, the Director [of 
Arbitration] shall appoint a replacement arbitrator to fill the vacancy 
and the hearing shall continue. The Director [of Arbitration] shall 
inform the parties as soon as possible of the name and employment 
history of the replacement arbitrator for the past 10 years, as well as 
information disclosed pursuant to Rule 10312. A party may make further 
inquiry of the Director [of Arbitration] concerning the replacement 
arbitrator's background. If the arbitration proceeding is subject to 
Rule 10308, the party may exercise his or her right to challenge the 
replacement arbitrator within the time remaining prior to the next 
scheduled hearing session by notifying the Director in writing of the 
name of the arbitrator challenged and the basis for such challenge. If 
the arbitration proceeding is not subject to Rule 10308, [and] within 
the time remaining prior to the next scheduled hearing session or the 5 
day period provided under Rule 10311, whichever is shorter, a party may 
exercise the party's [its] right to challenge the replacement 
arbitrator as provided in Rule 10311.
* * * * *
Rule 10315. Designation of Time and Place of First Meeting [Hearing]
    The Director shall determine [T]the time and place of the first 
meeting of the arbitration panel and the parties, whether the first 
meeting is a pre-hearing conference or a hearing, [initial hearing 
shall be determined by the Director of Arbitration and each hearing 
thereafter by the arbitrators.] and shall give [N]notice of the time 
and place [for the initial hearing shall be given] at least [eight 
(8)]15 business days prior to the date fixed for the first meeting 
[hearing] by personal service, registered or certified mail to each of 
the parties unless the parties shall, by their mutual consent, waive 
the notice provisions under this Rule. The arbitrators shall determine 
the time and place for all subsequent meetings, whether the meetings 
are pre-hearing conferences, hearings, or any other type of meetings, 
and shall give [N]notice [for each hearing thereafter shall be given] 
as the arbitrators may determine. Attendance at a meeting [hearing] 
waives notice thereof.
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the self-regulatory organization 
included statements concerning the purpose of and basis for the 
proposed rule change and discussed any comments it received on the 
proposed rule change. The text of these statements may be examined at 
the places specified in Item IV below. The self-regulatory organization 
has prepared summaries, set forth in Sections A, B, and C below, of the 
most significant aspects of such statements.

[[Page 40765]]

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose

Background

Recommendations of the Task Force

    The Arbitration Policy Task Force (``Task Force'') in Securities 
Arbitration Reform: Report of the Arbitration Policy Task Force To the 
Board of Governors of NASD (``Task Force Report''), published in 
January 1996, made fourteen broad recommendations to the NASD Board to 
improve the securities arbitration process administered by the NASD. 
Recommendation No. 8 provided: ``Arbitrator selection, quality, 
training, and performance should be improved by various means, 
including adoption of a list selection method, earlier appointment of 
arbitrators, enhancement of arbitrator training, and increased 
[arbitrator] compensation.'' \3\
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    \3\ Task Force Report at 2.
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    The Task Force recommended that the NASD adopt ``a variant of the 
AAA's method of selecting arbitrators'' (``Recommendation One'').\4\ 
Under the system proposed by the Task Force:

    \4\ Task Force Report at 94.
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    The parties would be provided with three lists of candidates: 
(1) A list of public arbitrators qualified to be panel chairs to 
contain no fewer than three names, (ii) a list of other public 
arbitrators, to contain no fewer than five names; and (iii) a list 
of industry arbitrators, to contain no fewer than five names. Each 
party could strike names from any of the lists and would then rank 
the remaining names on each list in order of preference. If mutually 
agreeable arbitrators are not selected, new lists would be provided 
for each category in which agreement was not reached. This process 
would continue for no more than three rounds. If, at the end of 
three rounds, an industry and two public arbitrators, one qualified 
as a panel chair, had not been chosen, the NASD Arbitration 
Department would appoint the remaining arbitrator or arbitrators. 
Arbitrators selected by the staff could be challenged only for 
cause. (Footnotes omitted) \5\

    \5\ Task Force Report at 94-95.
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    The Task Force also made two other recommendations to implement 
improvements in the selection of arbitrators. The Task Force 
recommended that the appropriate NASD staff (now NASD Regulation's 
Office of Dispute Resolution (``ODR'') should be able to exercise 
flexibility in designating arbitrators as either ``public'' or 
``industry'' (``Recommendation Two'').\6\ In addition, the Task Force 
recommended that arbitrators be placed on the selection lists on a 
rotating basis to promote more frequent selection of arbitrators who 
complete an arbitrator training program (``Recommendation Three'').\7\
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    \6\ Task Force Report at 96.
    \7\ Task Force Report at 97.
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Parties Consulted in Development of Rule

    NASD Regulation considered the Task Force's recommendations at 
length. NASD Regulation also consulted with its National Arbitration 
and Mediation Committee (``NAMC''),\8\ the Securities Industry 
Conference on Arbitration (``SICA''),\9\ PIABA, the staff of the SEC, 
and others about the efficacy of the proposals. All persons consulted 
favored the selection of arbitrators by the parties using some form of 
list selection. In addition, most were in favor of developing a system 
featuring the capability, when appropriate and as technologically 
feasible, to generate the arbitrator lists from a computer programmed 
to incorporate relevant selecting factors, such as geographic proximity 
of an arbitrator to the proposed site of the hearing, subject matter 
expertise, and classification of an arbitrator as a public arbitrator 
\10\ or a non-public arbitrator,\11\ rather than developing a system in 
which the lists of arbitrators to be forwarded to parties for ranking 
would be generated solely on the basis of ODR's judgment.
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    \8\ The NAMC is a balanced committee of NASD Regulation. 
Committee members are individuals with broad and diverse experience 
in securities arbitration and mediation as representatives of 
investors, firms, firm employees, and neutrals (arbitrators and 
mediators).
    \9\ The membership of SICA is diverse and includes persons 
representing the interests of public customers (including members of 
the Public Investors Arbitration Bar Association (``PIABA'')), 
representatives from the self-regulatory organizations, and the 
Securities Industry Association (``SIA'').
    \10\ The term ``public arbitrator'' is defined in proposed Rule 
10308(a)(5).
    \11\ The term ``non-public arbitrator'' is defined in proposed 
Rule 10308(a)(4).
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General Principles Underlying Proposed Rule Change

    NASD Regulation recommends as a general principle that parties in 
arbitration be given more input into the selection of arbitrators. In 
furtherance of this principle, NASD Regulation has developed a rule 
providing that, in a one-arbitrator panel case, the parties to the 
arbitration will be provided a list of public arbitrators, and, in a 
three-arbitrator panel case, the parties will be provided a list of 
public and a list of non-public arbitrators.\12\ The parties will use 
the lists to express numerical preferences for the arbitrators listed 
and those rankings will determine the outcome of the arbitrator 
selection process, unless all ranked arbitrators decline to serve 
because they are unavailable, recuse themselves, or are disqualified 
because of conflicts of interests.
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    \12\ In this rule filing, for ease of reference the discussion 
of the process of selecting an arbitration panel focuses more on the 
selection of a three-person arbitration panel than a one-person 
panel because the process of selecting one arbitrator is simpler and 
much less frequently employed.
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    The list or lists of arbitrators will be generated from an 
arbitrator database by a computer to further fairness and neutrality. 
This automated system is the Neutral List Selection System 
(``NLSS'').\13\ However, to preserve the exercise of discretion and 
judgment when appropriate and to act on behalf of a party's request, 
when a party or parties express a request for a process that may 
legitimately be considered in the selection of an arbitration panel but 
that NLSS is not capable of performing, or request an arbitration panel 
that may not be ``selected'' or ``sorted'' using NLSS, the Director of 
Arbitration (``Director'') may supplement the NLSS process.
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    \13\ The term ``Neutral List Selection System'' is defined in 
proposed Rule 10308(a)(3).
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    In developing an arbitrator list selection rule to implement the 
Task Force's Recommendation One, NASD Regulation concluded that there 
were not enough arbitrators on the arbitrator roster of the ODR to 
provide sufficient names for three selection rounds. In addition, 
although NASD Regulation also initially considered a two-round, two-
list selection method, NASD Regulation concluded that the operational 
burdens of administering such a process, especially given the limited 
number of arbitrators relative to the large caseload, would be too 
great. Also, NASD Regulation was concerned that a two-round, two-list 
selection method would make the process of appointing arbitrators too 
lengthy and would be too costly. Accordingly, NASD Regulation is 
proposing that the list selection contain a single-round, two-list 
selection process as set forth in greater detail below.
    Notwithstanding, NASD Regulation's proposed rule change implements 
the fundamental aspect of Recommendation One in that it sets forth a 
list selection process that allows the parties to play the dominant 
role in selecting their arbitrators. In this proposed rule filing, NASD 
Regulation is also implementing Recommendation Three by placing 
arbitrators on a rotating list. By implementing Recommendations One and 
Three, the list selection process will function primarily through the

[[Page 40766]]

operation of the NLSS, supplemented by the actions and judgments of the 
Director, but only when required to effect the appointment of a panel.
    NASD Regulation is not implementing the Task Force's Recommendation 
Two that NASD staff should have discretionary authority regarding the 
classification of an arbitrator. Applying the explicit standards set 
forth in proposed paragraph (a) of Rule 10308, ODR will designate an 
arbitrator as either ``public'' or ``non-public'' (i.e., ``industry'') 
based upon the information provided about the person. At this time, 
NASD Regulation believes that it is impracticable to grant to the 
Director or the ODR the discretion or flexibility to modify the 
classification of an arbitrator based on information or criteria other 
than that which is set forth in the defined terms of ``public 
arbitrator'' or ``non-public'' arbitrators. Perceptions and 
expectations of participants about the backgrounds of potential 
arbitrators indicate that the participants do not believe that this 
flexibility would enhance the arbitrator selection process.\14\
---------------------------------------------------------------------------

    \14\ However, the ODR will have authority to change the 
classification of an arbitrator already classified in the NLSS based 
upon new information (e.g., an arbitrator changes his or her 
employment and, after such change, the arbitrator fits the criteria 
for non-public arbitrator, rather than the criteria for a public 
arbitrator).
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    NASD Regulation believes that the proposed methodology for 
selecting arbitrators will benefit investors, firms, associated 
persons, and other users of the arbitration forum. First, proposed Rule 
10308 and NLSS, the technology developed to implement key parts of the 
proposed Rule, provide a system for selecting arbitrators that allows 
parties to have the greatest impact in the composition of their 
arbitration panel. Second, Proposed Rule 10308 is a more streamlined 
process than the process envisioned in the Task Force's Recommendation 
One. Third, proposed Rule 10308, a single-round process, will be less 
costly. Fourth, the proposed process borrows from the process used 
successfully for some time by the American Association of Arbitration 
(``AAA''), the largest domestic arbitration forum sponsor

Description of Proposed Rule Change

    The proposed rule change, which only governs the selection of 
arbitrators in cases involving public customers, is divided into five 
parts. Paragraph (a) contains definitions. In paragraph (b), NASD 
Regulation specifies how the lists of public and non-public arbitrators 
will be compiled and forwarded to the parties. Paragraph (c) specifies 
how the parties indicate their preferences by numerical rankings and 
how the Director reconciles the preferences of the parties, selects the 
arbitrators, selects the chairperson if the parties do not make the 
selection, and, if necessary, disqualifies an arbitrator before the 
arbitrator is appointed. Paragraph (d) describes generally how parties 
and the Director may remove a person from serving as an arbitrator if 
the person has a conflict of interest or a bias. Paragraph (e) 
specifies that the Director has discretionary authority to resolve 
issues arising in the administration of the list selection process.
    There are several other rules in the Rule 10000 Series that NASD 
Regulation must amend in order to make the Rule Series 10000 
consistent. The proposed amendments to those rules are discussed at the 
end of the discussion of the proposed changes to Rule 10308.\15\ 
Finally, NASD Regulation requests comments on the proposed rule change, 
including one important specific topic set forth separately below.\16\
---------------------------------------------------------------------------

    \15\ See Miscellaneous Related Proposed Rule Changes, infra.
    \16\ See Request for Comments on Specific Issue, Infra.
---------------------------------------------------------------------------

Definitions--Paragraph (a)

    Paragraph (a) of Rule 10308 of the proposed rule change contains 
seven definitions: ``day,'' ``claimant,'' ``Neutral List Selection 
System,'' ``non-public arbitrator ,'' ``public arbitrator,'' 
``respondent'' and ``send.'' ``Public arbitrator,'' ``non-public 
arbitrator,'' and ``Neutral List Selection System'' are the three terms 
that are central to understanding how proposed Rule 10308, the proposed 
list selection rule, will operate.
    In proposing paragraph (a)(4) of Rule 10308, a ``non-public 
arbitrator'' is defined as a person who is otherwise qualified to be an 
arbitrator and is employed in or retired from the securities or 
commodities industry or in a related position in the banking industry. 
The rule includes in the definition a person who is a professional, 
such as a lawyer or an accountant, who has a substantial client base 
that is engaged in the securities or commodities industry, or in a 
related banking activity described in the rule. Specifically, for 
arbitrator classification purposes, a non-public arbitrator is a person 
who:
    (A) Is, or within the past three years, was:
    (i) Associated with a broker or a dealer (including a government or 
a municipal securities broker or dealer);
    (ii) Registered under the Commodity Exchange Act;
    (iii) A member of a commodities exchange or a registered futures 
association; or
    (iv) Associated with a person or firm registered under the 
Commodity Exchange Act;
    (B) Is retired from engaging in any of the business activities 
listed in subparagraph (4)(A);
    (C) Is an attorney, accountant, or other professional who has 
devoted 20 percent or more of his or her professional work, in the last 
two years, to clients who are engaged in any of the business activities 
listed in subparagraph (4)(A); or
    (D) is an employee of a bank or other financial institution and 
effects transactions in securities and commodities futures or options 
or supervises or monitors the compliance with the securities and 
commodities laws of employees who engage in such activities.
    The definition largely retains the existing definition of the Rule 
10000 Series of an arbitrator who is deemed to be ``from the securities 
industry,'' but it adds to that defined term persons employed by banks 
and other financial institutions who are engaged in securities 
activities or in the supervision of such activities.
    The second key defined term, ``public arbitrator,'' is defined in 
paragraph (a)(5) of Rule 10308. ``Public arbitrator'' generally means a 
person who is otherwise qualified to serve as an arbitrator and is not 
engaged in the conduct of, or business activities that indicate an 
affiliation with, the securities industry or the related industries. 
Thus, in order to be classified as a public arbitrator one may not be 
engaged in any of the activities listed under the definition of ``non-
public arbitrator'' in paragraphs (a)(4)(A) through (D), set forth 
above. The definition generally excludes: A person currently employed 
in the securities or commodities industry or a person retired from such 
business activities; a professional who devotes 20 percent or more of 
his or her time to securities industry clients; and an employee of a 
bank or other financial institution who is engaged in securities 
activities or in the supervision of such activities.
    In addition, a spouse or an immediate family member of a current or 
retired member of the securities or commodities industry, or a person 
engaged in any of the other types of business activities that require 
one to be classified as a ``non-public arbitrator,'' is also excluded 
from being a ``public

[[Page 40767]]

arbitrator'' because such persons' economic interests are too closely 
tied to those of the securities or commodities industry, even though 
such spouses and immediate family members may not be directly involved 
in the relevant business activities. ``Immediate family member'' is 
defined in proposed Rule 10308(a)(5)(B) with reference to the person's 
familial or economic ties to the person associated with the securities 
or commodities industry.\17\ A person who has a close familial, 
personal, or economically dependent relationship with an associated 
person may be viewed as possessing a bias in favor of the securities or 
commodities industry even though he or she is not involved directly 
with the identified industry.\18\
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    \17\ ``Immediate family member'' means:
    (i) a family member who shares a home with a person engaged in 
the conduct or activities described in paragraphs (a)(4)(A) through 
(D);
    (ii) a person who receives financial support of more than 50 
percent of his or her annual income from a person engaged in the 
conduct or activities described in paragraphs (a)(4)(A) through (D); 
or
    (iii) a person who is claimed as a dependent for federal income 
tax purposes by a person engaged in the conduct or activities 
described in paragraphs (a)(4)(A) through (D).
    \18\ A small group of persons will be excluded from serving as 
either public or non-public arbitrators (e.g., spouse and immediate 
family members of registered representatives). Excluded by 
subparagraph (a)(5) from serving as public arbitrators, such persons 
are also excluded from serving under subparagraph (a)(4) as non-
public arbitrators because a non-public arbitrator must have the 
professional securities experience (or the related qualifications) 
listed in subparagraph (a)(4). For example, unless the spouse of a 
registered representative was also employed in the securities or 
commodities industry (or engaged in one of the business activities 
related to the securities industry), that person might not possess 
securities industry experience (or the related qualifications) and 
therefore could not serve as a non-public arbitrator. In addition, 
because of the marital relationship, the spouse would be excluded 
from serving as a public arbitrator.
---------------------------------------------------------------------------

    The third key defined term, ``Neutral List Selection System,'' 
defines the new software program that will implement the proposed list 
selection rule. NASD Regulation defines ``Neutral List Selection 
System'' as ``the software that maintains the roster of arbitrators and 
performs various functions relating to the selection of 
arbitrators.''\19\ Among other things, NLSS will maintain the roster of 
arbitrators, identify arbitrators as public or non-public, screen 
arbitrators for conflicts of interest with parties, list arbitrators 
according to geographic hearing sites and, on occasion, by expertise, 
and consolidate the numerical rankings that parties assign to listed 
arbitrators.
---------------------------------------------------------------------------

    \19\ Proposed Rule 10308(a)(3).
---------------------------------------------------------------------------

    Two other terms, ``claimant'' and ``respondent,'' are defined in 
paragraph (a) to simplify certain aspects of the rule. Under proposed 
Rule 10308(a)(2), if one or more persons files a single claim they will 
be treated as one claimant. A parallel definition is proposed for 
respondents; one or more persons who file the same answer will be 
treated as one respondent.\20\ The ODR views claimants who file one 
claim or respondents who file one answer as generally having 
sufficiently similar interests in the outcome of the proceeding to be 
considered as one party for purposes of the list selection process.\21\ 
This approach will simplify consolidating the parties' preferences for 
arbitrators described below.\22\
---------------------------------------------------------------------------

    \20\ Proposed Rule 10308(a)(6).
    \21\ The consolidation process is described in greater detail 
below. However, it should be noted that a group of claimants that 
does not file a single claim, or, similarly, a group of respondents 
that does not file a single answer, does not obtain an advantage in 
the consolidation process or in the weighting of their preferences 
for arbitrators. For example, if in a case there are two claimants 
who are not viewed as one claimant under the rule, and one 
respondent, the two claimants' arbitrator rankings will be weighted 
as only 50% of the total; the one respondent's arbitrator rankings 
will be weighted as the other 50%.
    \22\ The terms ``day'' and ``send'' are also defined in 
paragraph (a).
---------------------------------------------------------------------------

Composition of Arbitration Panel; Compilation of Lists of Arbitrators 
for Parties' Selection--Paragraph (b)

    Under proposed Rule 10308(b)(1), the rule sets for the number of 
arbitrators that the Director should appoint to a panel, general panel 
composition requirements, and exceptions to those requirements. If the 
claim is $50,000 or less, the claim will be heard by a single public 
arbitrator, unless the parties agree otherwise.\23\ If the claim is 
more than $50,000, a panel of two public arbitrators and one non-public 
arbitrator will hear the dispute, unless the parties agree 
otherwise.\24\ Under proposed paragraph (b)(1)(B) of Rule 10308, a 
claimant with a claim valued greater than $25,000 and not more than 
$50,000 may request a three-person arbitration panel.\25\ Whether for a 
one-person or a three-person panel, the requirement that public 
arbitrators be empaneled is for the protection of investors, and 
parties may agree to waive this compositional requirement.
---------------------------------------------------------------------------

    \23\ Proposed Rule 10308(b)(1)(A)(i).
    \24\ Proposed Rule 10308(b)(1)(A)(ii).
    \25\ Obtaining a three-person panel under this subparagraph then 
obligates the parties to pay hearing session deposit fees for a 
three-person panel under Rule 10332.
---------------------------------------------------------------------------

    When the parties agree to change the composition of an arbitration 
panel from that set forth in proposed paragraph (b)(1)(A) (i) or (ii), 
references in the balance of the rule to a panel must be interpreted 
according to the panel composition that the parties have chosen. For 
example, if the parties agree to a panel composed of three public 
arbitrators, under proposed paragraph (c)(1)(C) the parties would rank 
a list of public arbitrators only, since the Director would not send 
the parties a list of non-public arbitrators. In addition, parties 
should be aware that if the panel composition varies from that provided 
in proposed paragraph (b)(1)(A) (i) or (ii), NLSS is not capable of 
processing all such combinations. NLSS can generate the lists and 
consolidate the rankings for a one-person panel of either public or 
non-public classification. For a three-person panel, NLSS can generate 
the lists and consolidate the rankings for a panel composed of one non-
public and two public arbitrators or three non-public arbitrators. NLSS 
cannot process requests for a panel composed for one public arbitrator 
and two non-public arbitrators or three public arbitrators.\26\
---------------------------------------------------------------------------

    \26\ Although in theory the parties could agree to an 
arbitration panel composed of three public arbitrators, experience 
indicates that a panel of this type for disputes involving customers 
is almost never convened.
---------------------------------------------------------------------------

    Under proposed paragraphs (b)(2) and (b)(3) of Rule 10308, the 
Director will send lists of names of arbitrators for ranking to the 
claimant and the respondent. As noted above, by operation of paragraph 
(a) of the proposed rule, a group of claimants who have filed one 
complaint will be viewed as one claimant; the same treatment is 
accorded to respondents who file a single answer. Thus, when reviewing 
the lists and otherwise taking action under the proposed rule, one or 
more persons viewed as one claimant must act jointly, and one or more 
persons viewed as one respondent must act jointly.
    When only one arbitrator will hear the proceeding, the Director 
will send to the parties one list of public arbitrators.\27\ When three 
arbitrators will hear the proceeding, the Director will sent the 
parties two lists, one containing the names of public arbitrators and 
the other containing the names of non-public arbitrators.\28\
---------------------------------------------------------------------------

    \27\ Proposed Rule 10308(b)(2).
    \28\ Proposed Rule 10308(b)(3).
---------------------------------------------------------------------------

(i) Director's Minimum Numbers for Lists

    Proposed Rule 10308 is flexible, and although subparagraphs (b)(2) 
and (b)(3) do not set a fixed ratio of arbitrators or a minimum number 
of arbitrators that ODR must list, ODR has established the following 
guidelines, For a panel of one arbitrator, the Director intends to 
provide five names of public arbitrators whenever possible, but not 
less than three names. For a panel of three

[[Page 40768]]

arbitrators, the Director intends to provide lists that contain up to 
10 public arbitrator names and five non-public arbitrator names; when 
that is not possible, the Director will provide a public arbitrator 
list of not less than six names, and a non-public arbitrator list of 
not less than three names. In addition, as illustrated by the example 
of the minimum numbers set forth above, to the extent possible, for a 
three-person panel, the list of public arbitrators will contain 
approximately twice as many names as the list of non-public 
arbitrators. The Director's ability to provide full lists of names will 
vary and is dependent on the number of available arbitrators and the 
local demands on the arbitrator roster. Circumstances may arise where a 
small arbitrator roster in a particular hearing location (for example, 
Richmond, Va., Norfolk, Va., Alaska, or Hawaii), combined with a high 
demand for arbitrators, will prevent the Director from meeting the 
objectives.
    To address possible arbitrator shortages, the Director plans to 
combine arbitrators from proximate hearing locations when necessary. 
For example, under proposed paragraph (b)(2), the list to be sent to 
the parties should contain, at a minimum, three names of public 
arbitrators. If, with one hearing location coded into NLSS, NLSS does 
not generate the names of three public arbitrators, the Director will 
return to NLSS, add a second hearing location code, and generate a list 
of public arbitrators that will include the additional arbitrators. The 
second hearing location coded will be one that is geographically 
proximate to the first hearing location code used (e.g., for a 
Richmond, VA hearing, the Richmond hearing location code will be used 
first, and then the Atlanta or the Washington, D.C. hearing location 
code could be added). The additional process in NLSS will be performed 
at no additional cost to the parties. The same process will be used to 
address any shortages in arbitrators under the lists prepared under 
proposed paragraph (b)(3).

(ii) NLSS Functions and Capabilities

    Proposed paragraphs (b)(2), (3), and (4) of Rule 10308 together set 
forth the four factors which are used by NLSS to generate the list or 
lists of arbitrators by ``selecting'' or ``sorting'' the NLSS database. 
The four factors are arbitrator classification, hearing location code, 
rotation, and identified conflicts of interests.
    To generate a list, NLSS performs the following steps. NLSS first 
identified the subgroup of arbitrators by classification (public or 
non-public arbitrators). NLSS then identifies those arbitrators in the 
same hearing location as the arbitration. Thereafter, NLSS selects such 
public or no-public arbitrators who are located in the hearing location 
in rotation from the NLSS database.\29\ Finally, NLSS excludes from the 
selection an arbitrator subject to a clear conflict of interest with 
one of the parties.\30\
---------------------------------------------------------------------------

    \29\ The NLSS rotation feature also may be described as a 
``first-in-first-out'' feature. For a case that will be heard by one 
public arbitrator, the following steps would apply. As an 
arbitrator's name rise to the top of the list of all arbitrators who 
are, for example, public arbitrators and found in one hearing 
location, the arbitrator's name will be generated by NLSS, absent an 
identified conflict of interest, on a list for ranking by parties to 
an arbitration. Once the arbitrator's name is sent to the parties, 
even if the arbitrator is later not appointed an arbitrator for the 
panel, NLSS places such arbitrator at the bottom of the computerized 
NLSS list. Thus, an arbitrator may be listed, and thereafter rotated 
to the bottom of the NLSS list even if: (1) The arbitrator recuses 
him or herself: (2) the arbitrator is not ranked highly enough by 
the parties to be appointed or the arbitrator was struck; or (3) the 
arbitrator is ranked highly enough to serve, is contacted, has no 
conflict or interest or bias that would disqualify him, to is 
unavailable to serve.
    When a three person panel will be appointed, generally two 
public arbitrators and one non-public arbitrator are needed. For the 
generation of the list of non-public arbitrators and the list of 
public arbitrators, the same process would be used. For the 
selection of the non-public arbitrators, the first five non-public 
arbitrators in the system will be rotated forward for the first 
arbitration case. However, if, for example, the case is against Firm 
X and the first person that NLSS generates, Arbitrator A51000, is 
employed by Firm X, NLSS will not select Arbitrator A51000 but will 
skip over time or her and will list the next person classified as a 
non-public arbitrator. Arbitrator A51000 will remain at the top of 
the internal NLSS rotating list for non-public arbitrators, and the 
NLSS will generate his or her name when next requested to produce 
the names of non-public arbitrators for a case in the same hearing 
location. The process for obtaining the list of public arbitrators 
is the same.
    \30\ Proposed Rule 10308(b)(4). NLSS can identify only obvious, 
disclosed conflicts of interest. For example, NLSS recognizes a 
conflict of interest when the member firm that is the respondent is 
also the employer of an arbitrator rotating forward in NLSS. NLSS 
would not list such a person on a non-public arbitrator list being 
generated for that case.
---------------------------------------------------------------------------

    Although some who participated in developing the proposed rule 
suggested selecting arbitrators on a random basis, NASD Regulation 
selected the rotation method instead. Among other things, random number 
selection algorithms in computer programs are extremely difficult to 
design, and such algorithms ultimately do not produce mathematically 
perfect randomness. If NASD Regulation used an imperfect random-
selection software program, over time, some arbitrators would be chosen 
more often than others. Arbitrators chosen less often or not at all 
would be underutilized even though they might be highly qualified. By 
using a rotation method, all arbitrators on the roster will be placed 
on a selection list with the same regularity.
    Under proposed Rule 10308(b)(4)(B), the automated NLSS selection 
process that generate the arbitrators may be altered in order to 
accommodate a fifth factor, expertise. Expertise has three 
subcategories: (1) Subject matter expertise (also know as a controversy 
code); (2) security expertise (also known as a security code); and (3) 
case expertise (also known as a qualification code).
    Two of these types of expertise, subject matter expertise and 
security expertise, are factors that may be included in the NLSS' 
selection or sorting process at the option of a party as provided in 
proposed paragraph (b)(4)(B) of Rule 10308. These are discussed in the 
following paragraphs. The third type of expertise, case expertise, will 
be a factor in the NLSS selection process at the option of the Director 
or at the request of the parties; the category is very narrow and its 
use is primarily to aid in the administration of a case. Case expertise 
contains only three subcategories: injunctive relief cases; employment 
law cases; and large and complex cases. Only one of the subcategories, 
that identifying expertise in large and complex cases, is relevant for 
any customer arbitration and is very infrequently utilized.\31\ When 
used, the NLSS will search for the names of arbitrators, if such 
arbitrators exists, in the appropriate hearing location with expertise 
in large and complex cases.
---------------------------------------------------------------------------

    \31\ The two other types of case expertise, expertise involving 
injunctive relief and employment issues, are used only in intra-
industry arbitrations.
---------------------------------------------------------------------------

    As noted above, the two types of expertise that may be factors to 
be included in the NLSS's selection or sorting process at the option of 
a party are subject matter expertise and security expertise. First, a 
party may request for listing arbitrators who possess certain types of 
subject matter expertise.\32\ Thus, although NLSS will always ``sort'' 
or ``search'' for arbitrators according to the four primary factors 
(arbitrators classification, hearing location code, rotation, and 
identified conflicts of interest), when a party requests that the lists 
include arbitrators with subject matter expertise, the NLSS will add 
the additional factor and sort or select for placement on the lists 
some arbitrators having the subject matter expertise identified. 
However, the Director is not obligated to provide a list that contains 
one or more arbitrators having the requested subject matter expertise

[[Page 40769]]

because (1) such arbitrators may not be available in the applicable 
hearing location; or, (2) even if such persons exist in the hearing 
location, the NLSS or the Director may be required to exclude them from 
the lists under another provision of the proposed rule (e.g., a 
conflict of interest identified by the ODR upon a review of the 
proposed arbitrator's Central Registration Depository (``CRD'') record, 
discussed below). In addition, NLSS currently is limited to those areas 
of subject matter expertise that have been coded for the NLSS and, if 
not coded into the NLSS, ODR does not have the administrative capacity 
to identify arbitrators who might possess in-depth knowledge in the 
desired subject (e.g., bankruptcy is not a category of expertise 
identified in the NLSS; ``churning'' and ``suitability'' are subject 
matter categories that are identified.) \33\
---------------------------------------------------------------------------

    \32\ An arbitrator is deemed to have certain subject matter 
expertise if he or she represents on an NASD arbitration intake form 
that he or she possesses it. ODR does not verify such 
representations.
    \33\ The areas of subject matter expertise that are coded in 
NLSS are those that previously have been identified in arbitrator 
disclosure forms. NASD Regulation plans in the future to update and 
to amend the designated subject matter areas. At that time, NASD 
Regulation will make corollary changes to NLSS.
---------------------------------------------------------------------------

    The second subcategory of expertise, security expertise, is also 
added to the NLSS selection process at the option of a party. There are 
22 security subcategories, listing various types of securities or other 
financial instruments (e.g., common stock, municipal bonds, stock index 
futures, Ginnie Maes, etc.), and a party may indicate whether expertise 
regarding a particular instrument is desired. The same procedure 
described above regarding NLSS selection to accommodate the additional 
factor of subject matter expertise will apply if a party opts to 
include security expertise in the NLSS selection process. If available 
in the hearing location, certain arbitrators may be include in the 
arbitrator lists generated by NLSS. However, the Director is not 
obligated to provide a list that contains one or more names having the 
requested security expertise.

(iii) Conflicts-of-Interest

    During the preparation of the arbitrator lists, two types of 
conflict-of-interest checks will occur. The first is the check for 
conflicts of interests between parties and potential arbitrators that 
will be performed as part of the automated NLSS process that was noted 
above.\34\ The second process will be review for conflicts of interest 
performed manually by ODR.
---------------------------------------------------------------------------

    \34\ See discussion regarding proposed Rule (b)(4)(A) and n. 30, 
supra.
---------------------------------------------------------------------------

    The second review for conflicts of interest will occur after the 
NLSS creates a list of arbitrators, but before the list is finalized, 
ODR will perform a review based upon information that each arbitrator 
discloses to ODR and, for non-public arbitrators, additional 
information found in the CRD. After a review of available information, 
ODR may remove an arbitrator based upon such disclosure.\35\ ODR's 
screening for a conflict of interest will avoid limiting the parties' 
choices later. ODR will eliminate arbitrators from a list who would 
almost certainly be disqualified at a later stage in the proceeding due 
to conflict of interest. If arbitrators are eliminated during his 
process, ODR will replace them by returning to NLSS so that the minimum 
number of public arbitrators, and, if applicable, non-public 
arbitrators, are on the list or lists that will be mailed to the 
parties.
---------------------------------------------------------------------------

    \35\ At this stage of the arbitrator appointment process, ODR 
staff would not make telephone inquiries.
---------------------------------------------------------------------------

    After the parties receive the lists, the parties also will have the 
ability to review information disclosed by the potential arbitrators to 
determine if a conflict of interest exists. Under proposed paragraph 
(b)(6) of Rule 10308, for each arbitrator listed, the Director will 
provide the parties with the arbitrator's employment history for the 
past 10 years and other background information. This information may 
disclose a conflict of interest between a party and the arbitrator 
listed and permits the parties to make more informed decisions during 
the process of ranking and striking the listed arbitrators. Under 
paragraph (b)(6), the parties may request additional information from 
the arbitrators; any response by an arbitrator is forwarded to all 
parties. If a party identifies a conflict of interest, the party's 
remedy is to strike the person from the list, in the process described 
in greater detail below.\36\
---------------------------------------------------------------------------

    \36\ Proposed Rule 10308(c)(1)(A).
---------------------------------------------------------------------------

(iv) Transmittal to Parties

    The Director shall send the lists to all parties approximately 30 
days after the respondent's answer is due, or, if there are multiple 
respondents, approximately 30 days after the last answer is due. If 
there is a third-party claim, the Director shall send the lists 
approximately 30 days after the third-party respondent's answer is due 
or, if there are multiple third-party respondents, approximately 30 
days after the last answer is due.\37\ Under proposed paragraph (a)(7) 
of Rule 10308, ``send'' means to send by first class mail, facsimile, 
or any other method available and convenient to the parties and the 
Director, and the lists and all other transmissions between the parties 
and the Director shall be sent using one of these methods.
---------------------------------------------------------------------------

    \37\ Proposed Rule 10308(b)(5).
---------------------------------------------------------------------------

Striking, Ranking, and Appointing Arbitrators--Paragraph (c)

    Generally, paragraph (c) of proposed Rule 10308 sets forth the 
method by which a party strikes and ranks arbitrators and the 
procedures ODR will use to consolidate the parties' preferences and 
appoint an arbitration panel. Under paragraph (c), the parties rank the 
arbitrators on the list according to the parties' preferences, and 
strike arbitrators to remove them from consideration. Proposed 
paragraph (c) will implement the most important feature of the list 
selection rule, that of allowing a party to exercise significant 
influence over the composition of the party's arbitration panel.

(i) Striking and Ranking Arbitrators

    Proposed paragraph (c)(1) provides the basic structure for the 
parties to exercise their influence in selecting arbitrators for their 
arbitration proceeding. First, each claimant and each respondent may 
strike any one or more arbitrators from the list (or lists, if there 
are two lists) for any reason, including the party's concern that the 
arbitrator may have a conflict of interest. Second, the party ranks 
each arbitrator remaining on the list by assigning the arbitrator a 
different numerical ranking. A ``1'' rank indicates the party's first 
choice, a ``2'' indicates the party's second choice, and so on, until 
all the arbitrators are ranked. When a party receives one list of 
public arbitrators and one list of non-public arbitrators, the party 
must rank arbitrators on each list separately.\38\ As noted above, all 
claimants who file a single claim are treated as one claimant; and 
similar treatment is accorded to all respondents who file one answer. 
Thus, frequently, persons must act jointly to determine which 
arbitrators to strike and how to rank the remaining arbitrators on the 
lists in order for persons who are parties to have their preferences 
for arbitrators weighed appropriately. Moreover, even when all 
claimants do not file a single claim (or all respondents do not file a 
single answer), the party claimants' (or the party respondents') 
rankings will be consolidated prior to the consolidation that occurs of 
claimant and respondent rankings, where the party claimants (or

[[Page 40770]]

party respondents) do not submit one set of rankings.\39\
---------------------------------------------------------------------------

    \38\ Proposed Rule 10308(c)(1).
    \39\ See proposed Rule 10308(c)(1)(D).
---------------------------------------------------------------------------

    Under proposed paragraph (c)(2), each party's lists of arbitrators 
reflecting the party's strikes and rankings must be returned to the 
Director not later than twenty days after the Director's letter 
communicating the lists was sent. If a party does not timely return the 
lists, the Director shall treat the party as having retained all the 
arbitrators on the lists and as having no preferences. If the lists are 
returned but a party fails to rank an arbitrator on a list, the 
Director will assign the arbitrator the next lower ranking after the 
lowest-ranked arbitrator on that list. For example, if a party ranks 
arbitrators on a list containing ten public arbitrators by striking six 
arbitrators and ranking arbitrators A, B, and C, as ``1,'' ``2,'' and 
``3,'' respectively, and fails to rank public arbitrator D, ODR will 
assign arbitrator D a ranking of ``4.''
    If a party fails to rank more than one arbitrator on the same list 
or gives two or more arbitrators on the same list the same numerical 
ranking, then the Director shall rank the multiple, unranked 
arbitrators in the same order of preference that the list originally 
generated by NLSS reflected and transmitted to the parties for their 
ranking. (When NLSS generates a list, the person listed first is ranked 
as high or higher by NLSS selection factors than the person listed 
second, third, and so on. Generally, this NLSS ranking is not relevant 
because the ranking by the parties is the basis for appointing 
arbitrators. NLSS ``ranking'' only becomes relevant when the parties 
fail to rank, or improperly rank multiple arbitrators on a list.) \40\
---------------------------------------------------------------------------

    \40\ In this process, when only the four factors are considered 
in the NLSS-list generation process (e.g., arbitrator 
classification, hearing location code, rotation, and no identified 
conflicts of interest), the person who has taken part in the fewest 
list selection processes (i.e., having a higher rotation number) 
would be placed higher on the NLSS-generated list than a person who 
has participated in more list selection processes. (E.g., P, a 
public arbitrator in Richmond, Virginia who has participated in the 
list selection process six times would be listed more highly by NLSS 
than Z, a public arbitrator from Richmond, Virginia who has 
participated in the list selection process seven times, if both were 
generated for the same list. Therefore, if a party failed to rank 
both P and Z, the Director would refer to the original NLSS-
generated list and rank P more highly than Z). If additional factors 
are introduced, such as subject matter expertise, those persons 
having the greatest cluster of desired factors or characteristics 
would be listed most highly on the NLSS-generated lists and that 
ordering would be used by the Director for the default ``ranking'' 
process list is used only when the parties fail to rank multiple 
arbitrators.
---------------------------------------------------------------------------

(ii) Consolidating Parties' Rankings

    After the claimant and respondent have returned their lists to the 
Director, the Director implements the parties' preferences for 
arbitrator selection using the process described in proposed paragraph 
(c)(3) of Rule 10308. Under proposed paragraph (c)(3), the Director, 
using the NLSS, creates a consolidated list of the public arbitrators, 
and, if non-public arbitrators are also ranked, a second consolidated 
list of non-public arbitrators, using a one or two-step consolidation 
process.
    Since generally all parties who file a single claim are treated as 
one claimant and all respondents who file one answer are treated as one 
respondent, in most cases, the Director will consolidate the parties' 
preferences for arbitrators using a one-step process. The Director will 
add the consolidated rankings of the claimant and the respondent to 
produce a single consolidated list for the public arbitrators and, if 
necessary, a second consolidated list for the non-public 
arbitrators.\41\ NLSS performs the consolidation functions.
---------------------------------------------------------------------------

    \41\ Proposed Rule 10308(c)(3).
---------------------------------------------------------------------------

    When there are multiple claimants or respondents, the Director will 
use a two-step consolidation process. First, the Director will 
consolidate all rankings of the multiple claimants or respondents. For 
example, if there are two respondents, R #1 and R #2, the rankings of R 
#1 and R #2 are added together, resulting in one consolidated 
respondent ranking for each listed non-public arbitrator. This first 
step in the two-step consolidation process may be avoided by 
cooperation. The parties may file a list to which the parties have 
jointly agreed.\42\ The first step of the consolidation process, 
consolidating all the preferences of multiple claimants and, 
separately, those of multiple respondents, prevents numerous parties on 
one side of the case from unfairly affecting the selection of the 
arbitrators. By consolidating the rankings of parties on the same side, 
the process ensures that claimants' and respondents' choices will have 
the same weight in the arbitrator selection process. Second, as 
previously described, the NLSS will consolidate the rankings of the 
claimants and the respondents to produce a single consolidated list for 
public arbitrators and, if necessary, a second list for non-public 
arbitrators.\43\
---------------------------------------------------------------------------

    \42\ Proposed Rule 10308(c)(1)(D).
    \43\ Proposed Rule 10308(c)(3). The proposed rule also 
accommodates the interests of a party added to the case if the party 
is added before the Director has consolidated the other parties' 
rankings. Proposed rule 10308(c)(6).
---------------------------------------------------------------------------

    In instances where the Director determines the interests of a 
claimant or a respondent (including a third party respondent) are so 
substantially different from the interests of other claimants or 
respondents, the Director may determine not to consolidate the 
numerical rankings of that party with the numerical rankings of the 
other claimants (or with the other respondents, as the case may 
be).\44\ In those instances, NLSS will not have the capacity to create 
the consolidated list (or lists). Instead, the consolidated list (or 
lists) will be created based upon calculations performed manually by 
the ODR with each party's rankings having an equal weighting (e.g., 
where a claimant, a respondent, and a third party respondent are 
recognized as having substantially different interests, each of the 
parties rankings will have a 33\1/3\% weight in the consolidated list 
or lists).
---------------------------------------------------------------------------

    \44\ Proposed Rule 10308(c)(3)(B).
---------------------------------------------------------------------------

    The following examples illustrate the consolidation process.
    <bullet> If the dispute will be heard by one public arbitrator, the 
NLSS will produce a consolidated list that will contain the names of 
five public arbitrators, ranked 1 through 5, based upon the 
consolidated rankings derived from the parties' rankings.
    <bullet> If the list of public arbitrators sent to both parties 
contained five names and the claimant strikes one name, then the 
consolidated list will rank, numerically, the four names remaining on 
the list. If the claimant strikes one name and the respondent strikes a 
second name, then the consolidated list will contain only the names of 
the three public arbitrators that neither party chose to strike.
    A detailed example is set forth below: \45\
---------------------------------------------------------------------------

    \45\ The example illustrates the process that will be used for 
each list of arbitrators distributed to the parties. Therefore, in 
cases where a panel of one non-public and two public arbitrators 
will be selected, this process will be used to produce two 
consolidated arbitrators lists.

                              Original List                             
------------------------------------------------------------------------
                                          List                          
              Arb# \46\                 position         Arb name       
------------------------------------------------------------------------
A00001...............................          1  Red.                  
A00100...............................          2  Orange.               
A01000...............................          3  Yellow.               
A10000...............................          4  Green.                
A10001...............................          5  Blue.                 
A00500...............................          6  Indigo.               
A99999...............................          7  Violet.               
A20000...............................          8  Cvan.                 
A00200...............................          9  Magenta.              
A02200...............................         10  Fuchsia.              
------------------------------------------------------------------------


[[Page 40771]]

      
---------------------------------------------------------------------------

    \46\ Each arbitrator in the NLSS is assigned an arbitrator 
identification number as he or she enters the system. For example, a 
person who has been an NASD arbitrator since 1995 has a lower 
arbitration identification number (e.g., A13888) than a person who 
has been an NASD arbitrator since 1997 (e.g., A17050).

                                                                 With Parties' Rankings                                                                 
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                          List                                 Consolidated          Consolidated                                       
                Arb#                    position          Arb name               claimant             respondent               Total          Difference
--------------------------------------------------------------------------------------------------------------------------------------------------------
A00001..............................            1  Red...................  1...................  6...................  7...................            5
A00100..............................            2  Orange................  Strike..............  7...................  N/A.................          N/A
A01000..............................            3  Yellow................  2...................  1...................  3...................            1
A10000..............................            4  Green.................  3...................  5...................  8...................            2
A10001..............................            5  Blue..................  4...................  4...................  8...................            0
A00500..............................            6  Indigo................  5...................  3...................  8...................            2
A99999..............................            7  Violet................  6...................  2...................  8...................            4
A20000..............................            8  Cyan..................  7...................  Strike..............  Strike..............          N/A
A00200..............................            9  Magenta...............  8...................  8...................  16..................            0
A02200..............................           10  Fuchsia...............  9...................  Strike..............  Strike..............          N/A
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                                 System Results                                                 
----------------------------------------------------------------------------------------------------------------
                                    List                                                                        
             Arb#                 position        Arb name      Consolidated rank              Notes            
----------------------------------------------------------------------------------------------------------------
A00001........................            1  Red..............  2................  Total is 7.                  
A00100........................            2  Orange...........  Strike...........  N/A.                         
A01000........................            3  Yellow...........  1................  Total is 3.                  
A10000........................            4  Green............  4................  Total is 8                   
                                                                                   Difference is 2              
                                                                                   List Position is 4.          
A10001........................            5  Blue.............  3................  Total is 8                   
                                                                                   Difference is 0              
                                                                                   List Position is 5.          
A00500........................            6  Indigo...........  5................  Total is 8                   
                                                                                   Difference is 2              
                                                                                   List Position is 6.          
A99999........................            7  Violet...........  6................  Total is 8                   
                                                                                   Difference is 4              
                                                                                   List Position is 7.          
A20000........................            8  Cyan.............  Strike...........  N/A                          
A00200........................            9  Magenta..........  7................  Total is 16                  
A02200........................           10  Fuchsia..........  Strike...........  N/A.                         
----------------------------------------------------------------------------------------------------------------


                                               Rearranged by Rank                                               
----------------------------------------------------------------------------------------------------------------
                                                               Consolidated                                     
                Arb#                          Arb name             rank                     Notes               
----------------------------------------------------------------------------------------------------------------
A01000..............................  Yellow.................             1  Total is 3.                        
A00001..............................  Red....................             2  Total is 7                         
A10001..............................  Blue...................             3  Total is 8                         
                                                                             Difference is 0                    
                                                                             List Position is 7.                
A10000..............................  Green..................             4  Total is 8                         
                                                                             Difference is 2                    
                                                                             List Position is 4.                
A00500..............................  Indigo.................             5  Total is 8                         
                                                                             Difference is 2                    
                                                                             List Position is 6.                
A99999..............................  Violet.................             6  Total is 8                         
                                                                             Difference is 4                    
                                                                             List Position is 7.                
A00200..............................  Magenta................             7  Total is 16.                       
----------------------------------------------------------------------------------------------------------------

    Numerical ties between two or more arbitrators during consolidation 
will be broken by NLSS by the following principles. First, NLSS will 
break a tie during consolidation by preferentially ranking one 
arbitrator above another based upon which of the tied arbitrators has a 
set of rankings, that, when compared, result in the smallest numerical 
difference between the claimant ranking and the respondent ranking. For 
example, in the tabular example above, the consolidated rankings of the 
consolidated claimant and the consolidated respondent have

[[Page 40772]]

resulted in four arbitrators, Green, Blue, Indigo, and Violet, each 
receiving a consolidated ranking of 8, resulting in a four-way tie. 
(See table entitled ``With Parties Rankings.'') Of the four tied 
arbitrators, Blue will be assigned a ranking as the most preferred 
arbitrator because the difference between Blue's consolidated 
claimant's ranking and Blue's consolidated respondent's ranking is 0 
(i.e., 4-4=0); conversely, Violet would be given the fourth (or lowest 
or least preferred) ranking of the four arbitrators in the four-way tie 
because of the largest difference in the rankings that the consolidated 
claimant and the consolidated respondent gave Violet, compared to the 
three others (i.e., the consolidated claimant ranked Violet 6 and the 
consolidated respondent ranked Violet 2, resulting in a difference of 4 
(i.e., 6-2=4), whereas the differences in the rankings assigned Blue, 
Green, and Indigo are, respectively, 0,2 and 2.) (See table entitled, 
``Rearranged by Rank'').
    A second principle that governs tie-breaking within NLSS is that, 
given an equal difference in the consolidated ranking, an arbitrator 
who was listed higher (as more preferred) on the list as originally 
generated by the NLSS and transmitted to the parties will be given a 
more preferred or higher ranking in order to break this type of tie. 
Referring to the same example, Green and Indigo both show consolidated 
rankings of 8, resulting in the first type of tie discussed above. In 
addition, Green and Indigo each received rankings from consolidated 
claimants and respondents that are different by only 2. The first 
principle applied to break a tie does not provide any assistance; the 
second principle must be applied. Applying the second principle, during 
the consolidation process NLSS will rank Green as more preferred (or 
higher) than Indigo because, on the original list generated by NLSS, 
Green had a list position of 4, which was higher than Indigo's list 
position of 6. (See table entitled, ``Rearranged by Rank,'' and the 
column entitled ``Notes,'' for the final NLSS consolidated rankings 
taking into account these two tie-breaking principles, and the table 
entitled ``Original List'' for the position of the arbitrators on the 
list as originally generated by NLSS.)

(iii) Appointing Arbitrators

    Proposed Rule 10308(c)(4) sets forth the steps the Director will 
take to appoint arbitrators after consolidation occurs. Assuming that 
the tabular example above is a list of public arbitrators, if the 
arbitration is to be heard by one public arbitrator, the Director 
contacts the public arbitrator ranked highest on the list. Thus, the 
Director would contact Yellow first to determine if Yellow was 
available to serve and, if not disqualified, Yellow would be appointed. 
Using the tabular example above, if the Director were required to 
appoint a three-person arbitration panel, the Director would contact 
Yellow and Red to determine if they were available to serve and, if not 
disqualified, would appoint them. If necessary, due to the 
unavailability or disqualification of one of the two arbitrators, the 
Director would then contact Blue, and invite Blue to serve. The 
Director would refer to a second list, generated according to the same 
principles, to determine which non-public arbitrator should be 
contacted first.
    The contact is to determine if the arbitrator is available and, 
after being provided the issues of the case and the names of the 
parties, if the arbitrator is aware of any conflicts of interest or 
bias or other reason that may preclude the arbitrator from rendering an 
objective and impartial decision. Based upon the information that the 
arbitrator has previously provide, any information provided to the 
Director under Rule 10312,\47\ and any information obtained from any 
other source, the Director shall determine if the arbitrator should be 
disqualified. If the Director determines that the arbitrator should not 
be disqualified and that the arbitrator is available, the Director 
appoints the arbitrator.\48\
---------------------------------------------------------------------------

    \47\ Current Rule 10312, also discussed below, requires an 
arbitrator to disclose, with respect to a particular case and the 
issues, parties, and witnesses in the case, any information which 
might preclude the arbitrator from rendering an objective and 
impartial determination in the case.
    \48\ Proposed Rule 10308(c)(4).
---------------------------------------------------------------------------

    The Director will establish a time frame for ODR's guidance if a 
listed arbitrator is contacted but fails to respond to ODR's inquiries 
regarding availability and disqualification. For example, if an 
arbitrator is telephoned and fails to respond, ODR will eliminate such 
arbitrator and contact the next listed arbitrator after an appropriate, 
but relatively brief, period. ODR must exercise such discretion in 
fairness to all parties who are waiting for their arbitration cases to 
be resolved.

(iv) Selecting a Chairperson

    The Director notifies the parties of the appointments and requests 
that the parties appoint a chairperson. The parties may jointly select 
one of the arbitrators (including the non-public arbitrator) to be the 
chairperson of the panel.\49\ If the parties fail to appoint a 
chairperson by mutual agreement within 15 days, the Director will 
appoint the chairperson. If the Director appoints the chairperson, the 
chairperson will be one of the public arbitrators, but one who is not 
an attorney or other professional who has devoted 50% or more of his or 
her professional or business activities, within the past two years, to 
representing or advising public customers in adversarial proceedings 
concerning disputed securities or commodities transactions or related 
matters.\50\ This provision also excludes a person who is employed by a 
person engaged in the listed professional activities from being 
appointed as chairperson.
---------------------------------------------------------------------------

    \49\ Proposed Rule 10308(c)(5).
    \50\ Specifically, proposed paragraph (c)(5) of Rule 10308 
prohibits the Director from appointing as the chairperson a public 
arbitrator who:
    (A) is an attorney, accountant, or other professional, and
    (B) has devoted 50% or more of his or her professional or 
business activities, within the last two years, to representing or 
advising public customers in matters relating to disputed securities 
or commodities transactions or similar matters.
---------------------------------------------------------------------------

(v) When the Consolidated List Is Insufficient

    Under proposed Rule 10308(c)(4), if the Director is not able to 
appoint the number of arbitrators needed for the panel using the 
consolidated list, the Director may appoint other arbitrators from the 
NLSS roster as necessary. If the Director is required to appoint a non-
public arbitrator, the Director may not appoint a non-public arbitrator 
who meets the criteria set forth in paragraph (a)(4)(B) or (a)(4)(C), 
unless the parties otherwise agree. A non-public arbitrator in proposed 
paragraph (a)(4)(B) is one who is retired form the securities or 
commodities industry; proposed paragraph (a)(4)(C) describes a non-
public arbitrator who is a professional who devotes 20 percent or more 
of his or her professional time to clients who are engaged in any of 
the securities or commodities business activities described in 
subparagraph (a)(4).\51\ When the Director appoints a non-public 
arbitrator in this state of the proceeding, the parties no longer have 
the ability to strike. Thus, the rule requires that the Director choose 
a non-public arbitrator who is active and fully involved in the 
securities or

[[Page 40773]]

commodities industry or related industry.
---------------------------------------------------------------------------

    \51\ Although a party does not have the right to strike an 
arbitrator appointed under the process described in proposed 
paragraph (c)(4)(B), a party retains the right to request that the 
Director consider disqualifying an arbitrator appointed pursuant to 
proposed Rule 10308(c)(4)(B).
---------------------------------------------------------------------------

Arbitrator Disclosures and Removing Arbitrators--Paragraph (d)

    Proposed Rule 10308(d)(1) provides a mechanism for the Director to 
disqualify an arbitrator after the arbitrator has been appointed by the 
Director under proposed paragraph (c)(4). As noted previously, during 
the period that a party is reviewing and ranking the lists of 
arbitrators (see paragraphs (c)(1) and (2)), a party has an unlimited 
right to eliminate a listed arbitrator by striking the arbitrator from 
the list, and may do so to eliminate an arbitrator who the party 
believes may not be impartial or fair, among other reasons. Thus, prior 
to sending the party's rankings to the Director for consolidation, the 
party has an unlimited right to strike any potential arbitrator as to 
whom the party suspects bias. Proposed paragraph (d)(1) applies after 
the parties has exercised this unlimited right to strike, the 
arbitrator lists have been consolidated, the arbitrators have made 
initial disclosures to the Director under Rule 10312 about concerns 
regarding the specific parties, issues and witnesses in the case as 
discussed below, and the arbitrators have been appointed.\52\
---------------------------------------------------------------------------

    \52\ As noted above, disqualification issues that arise after 
the Director, using NLSS, has begun consolidating parties' preferred 
arbitrators, may be addressed by the Director directly as part of 
the appointment process described in paragraph (c)(4).
---------------------------------------------------------------------------

    An arbitrator has a continuing obligation under Rule 10312 of the 
Code to disclose to the Director any circumstances that might preclude 
the arbitrator from rendering an objective and impartial determination 
in an arbitration, including a direct or indirect financial or personal 
interest in the outcome of the arbitration, or any existing or past 
financial, business, professional, family or social relationships with 
a party, counsel, or representative (or, when later identified, a 
witness) that might affect impartiality or might reasonably create an 
appearance of partiality or bias. Generally, the ODR, in turn, must 
disclose to the parties any information the arbitrators provide.
    Under paragraph (d)(1), a party or the Director may raise a 
disqualification issue. However, the decision to disqualify an 
arbitrator already appointed lies solely with the Director. The 
Director may not make any decision to disqualify an arbitrator, 
however, after the commencement of the earlier of two events: (i) The 
first prehearing conference or (ii) the first hearing.\53\ At that 
point or thereafter, if a party believes that an arbitrator should be 
disqualified, the matter must be raised before the arbitration panel. 
Vacancies created as a result of a disqualification under proposed 
paragraph (d)(1) are filled by the Director by referring to the 
appropriate consolidated list from which the panelists were originally 
obtained (proposed Rule 10308(d)(3)) or, if there are no persons 
remaining on the consolidated list, by a person the Director selects 
under proposed Rule 10308(c)(4)(B).
---------------------------------------------------------------------------

    \53\ Proposed Rule 10308(d)(2).
---------------------------------------------------------------------------

Discretionary Authority--Paragraph (e)

    Under paragraph (e) of Rule 10308, the Director's authority to 
exercise discretionary authority is stated explicitly. In paragraph 
(e), the Director has authority to resolve a problem that arises 
relating to the appointment of arbitrators or any other procedure under 
the rule if (i) the rule does not have an applicable provision, or (ii) 
the application of a specific provision in the rule would not result in 
a resolution of the underlying problem because the facts and 
circumstances are unanticipated or unusual.

Miscellaneous Related Proposed Rule Changes

Proposed Conforming Amendments

    NASD Regulation is proposing conforming amendments to Rules 10104, 
10309, 10310, 10311, 10312, and 10313.
    NASD Regulations proposes to make parallel amendments to Rule 10104 
and Rule 10309. NASD Regulation proposes to amend Rule 10104 to reflect 
that the specific provisions of proposed Rule 10308, rather than the 
general provisions of Rule 10104, regarding the composition and 
appointment or arbitrators panels, will apply to arbitrations involving 
public customers. Rule 10104 would not apply to a question regarding 
the composition and appointment of such arbitrator panels unless none 
of the specific provisions in proposed Rule 10308 would be 
applicable.\54\ NASD Regulation proposes the same types of amendment to 
Rule 10309, a similarly general provision relating to the composition 
of arbitrator panels.
---------------------------------------------------------------------------

    \54\ Rule 10104 and certain other rules in the Rule 10000 Series 
may be amended further or rescinded when a list of selection rule 
applicable to intra-industry arbitration proceedings is approved. 
NASD Regulation plans to file a rule shortly so that NLSS may be 
used for panel selection in intra-industry arbitrations, as well as 
in customer arbitrations.
---------------------------------------------------------------------------

    NASD Regulations proposes to amend Rule 10310 and 10311 to make 
both of them inapplicable to proceedings subject to Rule 10308. Under 
Rule 10310, NASD Regulation notifies parties of arbitrators appointed, 
and under Rule 10311, parties have the right to a peremptory challenge 
of an arbitrator. Because proposed Rule 10308 deals with both types of 
procedures, NASD Regulations proposes to amend Rules 10310 and Rule 
10311 so that neither will apply to arbitration proceedings involving 
public customers.
    NASD Regulation is proposing to amend Rule 10312 to make it 
consistent with proposed Rule 10308. Both Rules contain provisions 
regarding an arbitrator's obligation to disclose information to the 
Director and disqualification based upon such disclosure. The proposed 
changes to Rule 10312 state explicitly when the Director's authority to 
disqualify an arbitrator terminates, and provide an arbitrator the 
option to withdraw from an arbitration panel prior to disclosure of 
arbitrator information to the parties. A final change in Rule 10312 
makes the timing of a disclosure consistent with the parallel provision 
in proposed Rule 10308.
    The proposed changes to Rule 10313 are necessary because Rule 10313 
incorporates by reference certain procedures in Rule 10311, and that 
rule, if amended, will not apply to arbitrations involving public 
customers. Specifically, NASD Regulation proposes to amend the last 
sentence of current Rule 10313 so that, for arbitration proceedings 
involving public customers, a party may exercise the right to challenge 
a replacement arbitrator within the time remaining prior to the next 
scheduled hearing session by notifying the Director in writing of the 
challenge arbitrator's name and the basis for such challenge.

Proposed Amendments to Rule 10315

    In the past, the first formal meeting of the arbitration panel and 
the parties generally was the first hearing. As the arbitration process 
has evolved, NASD Regulation has encouraged most arbitration panels to 
hold prehearing conferences. For most arbitrations currently, the first 
formal meeting of the arbitration panel and the parties is a prehearing 
telephone conference. NASD Regulation proposes to amend Rule 10315 
regarding the scheduling of the first meeting to reflect the current 
practice.
    NASD Regulation also proposes to amend from eight business days to 
15 business days the period that NASD has for giving notice of the 
first meeting to the parties and the arbitrators. The period is being 
amended to conform to the 15 business day period set forth in Rule 
10310, which formerly also was a period of only eight business days.

[[Page 40774]]

Proposed Amendments to Various Rules To Correctly Identify Committee 
Name

    The committee of NASD Regulation that addresses arbitration matters 
is the National Arbitration and Mediation Committee. NASD Regulation 
proposes to amend each rule in which the outdated term ``National 
Arbitration Committee'' is used by replacing the outdated term with the 
current committee name, the ``National Arbitration and Mediation 
Committee.'' \55\
---------------------------------------------------------------------------

    \55\ See e.g., Rule 10102, Rule 10103, Rule 10104 referenced 
specifically above, Rule 10301, and Rule 10401.
---------------------------------------------------------------------------

Request for Comments on Specific Topic

    NASD Regulation proposes to allow parties to have the right to 
strike an unlimited number of arbitrators from lists under proposed 
Rule 10308(c)(1)(A). NASD Regulation specifically requests comment on 
whether parties should have an unlimited number of strikes, or whether 
the right to strike should be limited. If a claimant, for example, 
strikes every arbitrator listed, all the listed arbitrators are 
ineligible, the respondent's preferences are nullified, and the 
Director appoints arbitrators who are not listed. Thus, the unlimited 
right to strike any be too broad to accomplish the purposes intended by 
the rule proposal.
    NASD Regulation is requesting that the proposed rule change be 
effective within 45 days of SEC approval.
2. Statutory Basis
    NASD Regulation believes that the proposed rule change is 
consistent with the provisions of Section 15A(b)(6) of the Act,\56\ 
which requires, among other things, that the Association's rules must 
be designed to prevent fraudulent and manipulative acts and practices, 
to promote just and equitable principles of trade, and, in general, to 
protect investors and the public interest.
---------------------------------------------------------------------------

    \56\ 15 U.S.C. 78o-3.
---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden on Competition

    The NASD does not believe that the proposed rule change will impose 
any inappropriate burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    No written comments were either solicited or received.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the publication of this notice in the Federal 
Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) by order approve the proposed rule change, or
    (B) institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying at the 
Commission's Public Reference Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
NASD. All submissions should refer to File No. SR-NASD-98-48 and should 
be submitted by August 20, 1998.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\57\
---------------------------------------------------------------------------

    \57\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-20364 Filed 7-29-98; 8:45 am]
BILLING CODE 8010-01-M