Opinion ID: 2533812
Heading Depth: 3
Heading Rank: 1

Heading: The preemptive force of the NASD Code

Text: Federal regulations have no less pre-emptive effect than federal statutes. ( Fidelity Federal Sav. & Loan Assn. v. de la Cuesta (1982) 458 U.S. 141, 153, 102 S.Ct. 3014, 73 L.Ed.2d 664 ( Fidelity ).) To have preemptive effect, however, a federal regulation must be one that Congress authorized the promulgating agency to adopt. ( Id. at p. 154, 102 S.Ct. 3014.) Thus, a federal agency may pre-empt state law only when and if it is acting within the scope of its congressionally delegated authority[,] ... [for] an agency literally has no power to act, let alone pre-empt the validly enacted legislation of a sovereign State, unless and until Congress confers power upon it. ( Louisiana Public Service Comm'n v. FCC (1986) 476 U.S. 355, 374, 106 S.Ct. 1890, 90 L.Ed.2d 369; accord, New York v. F.E.R.C. (2002) 535 U.S. 1, 18, 122 S.Ct. 1012, 152 L.Ed.2d 47.) Here, the relevant questions are whether the SEC intended to preempt the California Standards, and, if so, whether that action is within the scope of the SEC's delegated authority. (See Fidelity, supra, at p. 154, 102 S.Ct. 3014 [the questions upon which resolution of this case rests are whether the Board meant to pre-empt California's due-on-sale law, and, if so, whether that action is within the scope of the Board's delegated authority.].) In 1973, in Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Ware (1973) 414 U.S. 117, 94 S.Ct. 383, 38 L.Ed.2d 348 ( Ware ), the United States Supreme Court considered whether NYSE arbitration rules preempted a California law governing employee wage claims. Merrill Lynch, Pierce, Fenner & Smith, Inc. (Merrill Lynch) had established a profit-sharing plan for its employees under terms providing that an employee who voluntarily terminated employment and competed with Merrill Lynch forfeited all benefits. ( Id. at pp. 119-120, 94 S.Ct. 383.) David Ware, a former employee whose profit-sharing benefits had been forfeited under this provision, brought a class action against Merrill Lynch in California state court, arguing that the forfeiture provision was void under a California law (Bus. & Prof.Code, § 16600) prohibiting contracts that restrained anyone from engaging in a lawful profession, trade, or business. ( Ware, supra, at pp. 120-121, 94 S.Ct. 383.) Merrill Lynch petitioned to compel arbitration, invoking an arbitration provision in Ware's employment agreement and a provision of the NYSE rules requiring that any controversy between a member and the member's employee be settled by arbitration in accordance with NYSE arbitration rules. ( Id. at pp. 121-122, 94 S.Ct. 383.) The trial court denied the petition to compel arbitration, and the Court of Appeal affirmed, reasoning that profit-sharing contributions were a form of wages and that another California law (Labor Code, § 229) permitted an employee to sue for wages without regard to the existence of any private agreement to arbitrate. ( Ware, supra, at pp. 123-125, fn. 7, 94 S.Ct. 383.) The United States Supreme Court granted certiorari to decide the extent to which authority delegated under a federal regulatory statute pre-empts state law. ( Ware, supra, 414 U.S. at p. 125, 94 S.Ct. 383.) The court stated that its guiding principle was that state law should be pre-empted by exchange self-regulation `only to the extent necessary to protect the achievement of the aims of the Securities Exchange Act.' ( Id. at p. 127, 94 S.Ct. 383, quoting Silver v. New York Stock Exchange (1963) 373 U.S. 341, 361, 83 S.Ct. 1246, 10 L.Ed.2d 389.) The SEA embodies Congress's decision to use an approach of supervised self-regulation of the national securities market. ( Ware, supra, at p. 127, 94 S.Ct. 383.) Under the SEA, securities may be traded only on registered exchanges, and an exchange seeking registration must show that it has rules that are `just and adequate to insure fair dealing and to protect investors.' ( Ware, supra, at p. 128, 94 S.Ct. 383, quoting 15 U.S.C. § 78f(d).) The Ware court noted that the SEA gave the SEC authority to alter or supplement an exchange's rules, but only in 12 designated areas; exchange rules outside those areas were not subject to SEC scrutiny. ( Ware, supra, at p. 129, 94 S.Ct. 383.) From this review, the high court concluded that the congressional aim in supervised self-regulation is to insure fair dealing and to protect investors from harmful or unfair trading practices and that any rule or practice not germane to fair dealing or investor protection would not appear to fall under the shadow of the federal umbrella; it is, instead, subject to applicable state law. ( Ware, supra, 414 U.S. at pp. 130-131, 94 S.Ct. 383.) Applying this conclusion to the facts before it, the Ware court noted that nothing in the SEA or in any SEC rule specified arbitration as the favored means of resolving employer-employee disputes, and that the NYSE rule requiring arbitration of those disputes was not within any of the areas subject to SEC scrutiny. The court further noted that arbitration of employer-employee disputes was not essential to protect investor confidence in the market, contrasting the NYSE's arbitration rule with other exchange rules providing for direct effective disciplinary action against any abusive exchange practice. ( Ware, supra, at p. 136, 94 S.Ct. 383.) Rules of that kind designed to insure fair dealing and to protect investors, are of the kind directly related to the Act's purposes and ordinarily would not be expected to yield to provisions of state law. ( Ibid. ) The high court in Ware rejected the NYSE's argument that federal preemption was necessary to allow national uniformity in the resolution of wage claims between exchange members and their employees. Convenience in exchange management may be desirable, but it does not support a plea for uniform application when the rule to be applied is not necessary for the achievement of the national policy objectives reflected in the Act. ( Ware, supra, 414 U.S. at p. 136, 94 S.Ct. 383.) The court added: In effect, we are asked to sacrifice the individual's expectation of uniform treatment in the State of his residence for uniformity of application of the effect of an exchange's rules. We decline to do so because we believe that Congress intended that those elements of the old regime of complete self-regulation, that is, those elements not related to the federal objectives, be subject to state law and to established conflicts principles when their application out of State comes into controversy. ( Id. at p. 138, 94 S.Ct. 383.) The United States Supreme Court thus concluded that the NYSE rule requiring arbitration of employer-employee wages disputes did not preempt California law. [5] Making a significant change, Congress in 1975 amended section 19 of the SEA (15 U.S.C. § 78s) to grant the SEC broad authority to oversee and to regulate the rules adopted by the SROs relating to customer disputes, including the power to mandate the adoption of any rules it deems necessary to ensure that arbitration procedures adequately protect statutory rights. ( McMahon, supra, 482 U.S. at pp. 233-234, 107 S.Ct. 2332.) As a result of the 1975 amendments of the SEA, the SEC must approve any NASD rule before it can be implemented. (See 15 U.S.C. § 78s(b).) To approve a rule, the SEC must determine that the rule is consistent with the requirements and goals of the SEA to protect investors and the public interest. (15 U.S.C. § 78o-3(b)(6); see McMahon, supra, at p. 233, 107 S.Ct. 2332.) Although Congress's 1975 amendment of the SEA substantially altered the statutory scheme that the high court had earlier construed in Ware, supra, 414 U.S. 117, 94 S.Ct. 383, 38 L.Ed.2d 348, the precise impact of the amendment on the continuing validity of Ware 's reasoning is unclear. Ware implied that because Congress had given the SEC authority to review SRO rules in certain defined areas, it was reasonable to infer that all rules within the designated areas were germane to the primary purposes of the SEA  fair dealing and investor protection  and that all rules outside those areas were not germane to those purposes. Interveners the NASDDR and the NYSE here appear to argue that because the SEC now reviews all SRO rules, courts must infer that all SRO rules are germane to the SEA's purposes and thus have the preemptive force of federal law. Absent guidance from the United States Supreme Court, we are unwilling to go that far. Rather, we conclude that because the SEC now reviews all SRO rules, any of those rules may be germane to the SEA's goals of fair dealing and investor protection. Whether a particular rule is germane to the congressional purposes is a matter to be determined by careful examination of the rule's contents and consideration of any public pronouncements by the SEC concerning the rule's purpose and effect. As the federal agency entrusted with enforcement of the SEA, the SEC's approval of an NASD rule is an expression of federal policy that may have preemptive effect. (See Dowhal v. SmithKline Beecham Consumer Healthcare, supra, 32 Cal.4th at p. 928, 12 Cal.Rptr.3d 262, 88 P.3d 1.) SEC approval will have preemptive effect if the SEC intended that the rule prevail over conflicting state law and if the SEC's decision was not arbitrary or in excess of its statutory authority. (See Fidelity, supra, 458 U.S. at pp. 153-154, 102 S.Ct. 3014.) The Court of Appeal here concluded that three of the California Standards  standards 7 and 8, concerning disclosure, and standard 10, concerning disqualification  conflict with the NASD Code, and thus also with the SEA. We begin with standards 7 and 8 and then examine standard 10.