Opinion ID: 2533812
Heading Depth: 2
Heading Rank: 2

Heading: Preemption by the SEA

Text: The SEA contains no express preemption provision; on the contrary, it contains two savings clauses expressly preserving state law in certain limited areas (15 U.S.C. §§ 77p, 77r). Accordingly, neither express preemption nor field preemption by the SEA is at issue in this case. As the Court of Appeal in this case correctly recognized, and as the parties themselves agree, we are concerned here only with conflict preemption by the SEA. As noted earlier ( ante, 28 Cal.Rptr.3d p. 697, 111 P.3d pp. 963-964), conflict preemption applies in two situations: when it is impossible to comply with both the federal and the state law, and when the state law could prevent or impair accomplishment of the purposes and objectives of the federal law. ( English v. General Electric Co., supra, 496 U.S. at p. 79, 110 S.Ct. 2270.) As a preliminary matter, we must decide whether, as defendants and interveners argue, the provisions of the NASD Code have the force of federal law, so that if the California Standards conflict with the NASD Code, they likewise necessarily conflict with the SEA, and are therefore preempted. Plaintiffs, and the California Attorney General as amicus curiae, argue that the NASD Code does not have the preemptive force of federal law, and, as a consequence, the California Standards may conflict with the NASD Code without necessarily being preempted by the SEA.
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.
Standard 7 sets forth in considerable detail the matters that must be disclosed by a person nominated or appointed as an arbitrator. (Cal. Stds., std. 7, subd. (a).) Standard 8 lists additional matters that an arbitrator must disclose in a consumer arbitration [6] administered by a provider organization. Among other things, the arbitrator must disclose relationships between the provider organization and any of the parties or lawyers in the arbitration. By comparison, the NASD Code contains a relatively concise description of matters that must be disclosed: Each arbitrator shall be required to disclose to the Director of Arbitration any circumstances which might preclude such arbitrator from rendering an objective and impartial determination. Each arbitrator shall disclose: [¶] (1) Any direct or indirect financial or personal interest in the outcome of the arbitration; [¶] (2) Any existing or past financial, business, professional, family, social, or other relationships or circumstances that are likely to affect impartiality or might reasonably create an appearance of partiality or bias. Persons requested to serve as arbitrators must disclose any such relationships or circumstances that they have with any party or its counsel, or with any individual whom [ sic ] they have been told will be a witness. They must also disclose any such relationship or circumstances involving members of their families or their current employers, partners, or business associates. (NASD Code, rule 10312(a).) The NASD Code further provides that arbitrators must make a reasonable effort to inform themselves of any interests, relationships or circumstances that should be disclosed, and that after appointment they have a continuing duty ... to disclose, at any stage of the arbitration, any such interests, relationships, or circumstances that arise, or are recalled or discovered. ( Id., rule 10312(b), (c).) Finally, the Director of Arbitration must advise the parties of any information disclosed by an arbitrator, unless the arbitrator voluntarily withdraws or the director removes the arbitrator. ( Id., rule 10312(e).)
Standard 10(a) provides that an arbitrator is disqualified in these situations: (1) The arbitrator fails to comply with his or her obligation to make disclosures and a party serves a notice of disqualification in the manner and within the time specified in Code of Civil Procedure section 1281.91; (2) The arbitrator complies with his or her obligation to make disclosures within 10 calendar days of service of notice of the proposed nomination or appointment and, based on that disclosure, a party serves a notice of disqualification in the manner and within the time specified in Code of Civil Procedure section 1281.91; (3) The arbitrator makes a required disclosure more than 10 calendar days after service of notice of the proposed nomination or appointment and, based on that disclosure, a party serves a notice of disqualification in the manner and within the time specified in Code of Civil Procedure section 1281.91; (4) A party becomes aware that an arbitrator has made a material omission or material misrepresentation in his or her disclosure and, within 15 days after becoming aware of the omission or misrepresentation and within the time specified in Code of Civil Procedure section 1281.91(c), the party serves a notice of disqualification that clearly describes the material omission or material misrepresentation and how and when the party became aware of this omission or misrepresentation; or (5) If any ground specified in Code of Civil Procedure section 170.1 exists and the party makes a demand that the arbitrator disqualify himself or herself in the manner and within the time specified in Code of Civil Procedure section 1281.91(d). The standard further provides that [n]otwithstanding any contrary request, consent, or waiver by the parties, an arbitrator must disqualify himself or herself if he or she concludes at any time during the arbitration that he or she is not able to conduct the arbitration impartially. (California Standards, std. 10(c).) The NASD Code's arbitrator disqualification provisions differ significantly. The NASD Code provides: After the appointment of an arbitrator and prior to the commencement of the earlier of (A) the first pre-hearing conference or (B) 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. [¶] ... [¶] The Director will grant a party's request to disqualify an arbitrator if it is reasonable to infer, based on information known at the time of the request, that the arbitrator is biased, lacks impartiality, or has an interest in the outcome of the arbitration. The interest or bias must be direct, definite, and capable of reasonable demonstration, rather than remote or speculative. (NASD Code, rule 10308(d); see also, id., rule 10312(d)(3).)
As noted earlier ( ante, at p. 15), conflict preemption applies in two situations: when it is impossible to comply with both the federal and the state law, and when the state law could prevent or impair accomplishment of the purposes and objectives of the federal law. ( English v. General Electric Co., supra, 496 U.S. at pp. 78-79, 110 S.Ct. 2270.) We consider first the California Standards' disclosure requirements, then their disqualification requirements. It is not impossible to comply with both the disclosure requirements of the California Standards and the NASD Code. Assuming that the matters required to be disclosed differ somewhat under each, the arbitrator need only disclose all matters required by both codes. For matters required to be disclosed by the California Standards, the arbitrator would make the disclosure directly to the parties, as the California Standards require. For matters required to be disclosed by the NASD Code, the arbitrator would make the disclosure to the Director of Arbitration, as the NASD Code requires. The remaining question is whether the detailed disclosure requirements of the California Standards in any significant way impede or impair accomplishment of the goals of the NASD Code, and thereby the goals of the SEA. The SEC has expressed its opinion that the California Standards' disclosure requirements will adversely affect NASD arbitrations in three ways: by increasing administrative costs associated with the more detailed disclosure requirements, [7] by reducing the number of available arbitrators (because many will be unwilling to comply with standard 7's requirements), and by reducing the nationwide uniformity and consistency of NASD arbitrations by imposing special disclosure requirements applicable in only one state. The SEC first expressed these views in July 2002 in a letter addressed to the leadership of the California Legislature. In that letter, the SEC's Director stated: [T]he burdens associated with complying with some of the disclosure requirements may have a deleterious effect on SRO arbitration programs by causing some arbitrators to resign rather than comply. Finally, adjudicating a national program to the specific requirements of any state or every state will unnecessarily burden the administration of SRO arbitration programs to the detriment of investors. The SEC again expressed these views in October 2002 when it approved rule IM-10100 of the NASD Code, requiring waiver of the California Standards. Announcing its approval of the rule, the SEC recited the concerns expressed by the NASDDR: The California Standards put extreme and unnecessary disclosure burdens on individuals who serve on NASD arbitration panels and already meet stringent disclosure rules. The extensive record-keeping requirements for arbitrators, coupled with potential liability for even inadvertent violations of the California Standards, led the NASD to conclude that, if the NASD were required to implement the California rules, investors and other parties would be saddled with higher costs, a less efficient and streamlined process, and a much smaller arbitrator roster from which to select the panelists who will decide their cases. (67 Fed.Reg. 62086-62087.) The SEC concluded that the proposed rule change was consistent with the SEA and that accelerated approval of the rule change was necessary to protect investors in that the rules are designed to help address the backlog of cases created by the confusion over the new California standards, are designed to provide them with a mechanism to help resolve their disputes with broker-dealers in a more expedited manner, and are designed to help ensure the certainty and finality of arbitration awards. ( Id. at p. 62088.) The SEC next expressed these views in January 2003 in an amicus curiae brief submitted to the federal district court in Mayo v. Dean Witter Reynolds, Inc. (2003) 258 F.Supp.2d 1097 ( Mayo ). (See Auer v. Robbins (1997) 519 U.S. 452, 462, 117 S.Ct. 905, 137 L.Ed.2d 79 [administrative agency's interpretation of federal law in a legal brief is worthy of deference when it reflects the agency's fair and considered judgment on the matter in question].) In that brief, the SEC stated: The Commission is of the view that in light of the Commission's comprehensive oversight under federal law of the SROs, only the Commission can decide what disclosure and disqualification standards are appropriate for the protection of investors in SRO arbitration, and can insure that those standards are part of an effective national system. The California Standards, to the extent they apply to the SROs, are preempted by virtue of this scheme of federal regulation. The federal district court gave great weight to the SEC's views ( Mayo, supra, at p. 1109, fn. 15), and it concluded that the SEA preempted the California Standards for SRO-administered arbitrations ( id. at p. 1112). Finally, the SEC expressed these views in an amicus curiae brief submitted to the Court of Appeal in this very case. The SEC stated that the California Standards for disclosure and disqualification are preempted by federal law for arbitrations conducted by the NASDDR. The SEC attached a copy of the brief it had submitted in Mayo, supra, 258 F.Supp.2d 1097, and it reiterated its position that only the Commission can decide what disclosure and disqualification standards are appropriate for the protection of investors or employees in SRO arbitration, for the furtherance of market efficiency and regulation of national securities associations and exchanges, and can insure that those standards are part of an effective national system. In deciding whether a state law conflicts with a federal law by hindering the complete accomplishment of the federal law's objective, we give considerable weight to the views of the federal agency charged with administering the federal law. ( Geier v. American Honda Motor Co., Inc. (2000) 529 U.S. 861, 883, 120 S.Ct. 1913, 146 L.Ed.2d 914.) Accordingly, based on the views of the SEC discussed above, we conclude that the SEA preempts the California Standards' rules on arbitrator disclosure. The case for SEA preemption is even more compelling as to the California Standards' disqualification rules. Standard 10 of the California Standards conflicts with rule 10308 of the NASD Code insofar as it deprives the Director of Arbitration of authority to determine whether, after an arbitrator has been appointed, that arbitrator should be disqualified on the ground of bias or interest. Under standard 10, disqualification is automatic if a party timely serves a notice of disqualification in any of the circumstances described in the standard, some of which may occur after an arbitrator has been selected and appointed. Under the NASD Code, after an arbitrator is appointed, a party may seek disqualification of the arbitrator by making an objection, but it is the Director of Arbitration who makes the disqualification determination. This may often require the exercise of judgment to determine whether information that the arbitrator disclosed after appointment, or failed to disclose before appointment, sufficiently demonstrates a disqualifying bias or interest. These different systems of arbitrator disqualification are fundamentally irreconcilable because application of standard 10 could require disqualification of an arbitrator who could not be disqualified under the NASD rules because the Director of Arbitration had determined that the arbitrator did not have a disqualifying bias or interest. (See Mayo, supra, 258 F.Supp.2d at p. 1107 [Application of the California standards thus would greatly reduce, if not eliminate in practice, the role of the Director of Arbitration in the disqualification process.].) In October 2002, when it approved rule IM-10100 of the NASD Code, requiring waiver of the California Standards, the SEC relied on the existence of this conflict: Under the California Standards, even inadvertent non-disclosure of immaterial relationships is a basis for removal of an arbitrator and vacatur of an award. The California Standards remove from the alternative dispute resolution administrator the power to decide contested challenges to arbitrators, instead vesting this authority unilaterally in any party to the arbitration. As currently drafted, the California Standards would allow a party unilaterally to challenge and remove one arbitrator after another, thus destroying any notion of arbitral finality and closure. (67 Fed.Reg. 62087 (Oct. 3, 2002).) In adopting a rule designed to prevent implementation of the California Standards in NASD arbitrations, the SEC made a finding that the NASD rule was consistent with Section 15A(b)(6) of the Act, which requires that the rules be designed to promote just and equitable principles of trade, as well as to remove impediments to and perfect the mechanism of a free and open market, and, in general, to protect investors and the public interest. (67 Fed.Reg. 62088 (Oct. 3, 2002), fn. omitted.) The SEC has expressed its view that the California Standards' disqualification provision, standard 10, conflicts with the NASD Code in a way that threatens to frustrate the congressional goals and objectives underlying the SEA. In its brief in Mayo, the SEC stated: [T]he California standards for disqualification conflict with the SRO rules in that they require arbitrator disqualification in circumstances where the SRO rules do not permit it. While the SRO rules provide that an arbitrator may, prior to the hearing, be disqualified by the Director of Arbitration based upon the information disclosed under SRO rules, and the NASD allows removal based on previously unknown disqualifying information after the hearing begins, the California statute mandates that an arbitrator `shall be disqualified,' upon notice from either party, for failure to comply with California disclosure requirements. The SEC further noted: This conflict cannot be resolved by the SROs simply by interpreting their existing rules more broadly to accommodate the California standards. All interpretations of rules that are not reasonably and fairly implied in the rule are classified as proposed rule changes and subject to Commission review. [U]nilateral imposition of the state's regulations would impair the balance that the Commission has struck in approving existing disclosure and disqualification rules, as well as its obligation to consider and strike a balance in any revision of those rules. As noted, serious concerns have been raised by the Commission staff that the added opportunities under the California system for disqualification and vacature of arbitral decisions may increase the complexity, cost, and uncertainty of the arbitration process. If so, this would serve the interests of well-financed brokerage firms, while the average investor would suffer from protracted and costly proceedings. The Commission must have an opportunity to consider these factors and make its own determination where to strike the appropriate balance. It appears that application of the California Standards' disqualification provisions would allow a party to disqualify any arbitrator in an NASDDR-administered arbitration. Standard 8(b)(1)(A) requires the arbitrator to disclose any party's membership in the provider organization. Because an NASDDR-administered arbitration always includes one party  the broker/dealer  who is an NASD member, every arbitrator would have to make this disclosure. Under standard 10(a)(2), a party may serve a notice of disqualification based on any disclosure that the arbitrator has made. If the notice is timely served, in the proper form, standard 10 provides that the arbitrator is disqualified. Thus, in an NASDDR-administered arbitration between a broker/dealer and a customer, the customer may disqualify every potential arbitrator based on the arbitrator's required disclosure that the broker/dealer is an NASD member. The SEC's approval of rule IM-10100 of the NASD Code, and its pronouncements quoted above, reflect its determination that the NASD Code's provisions governing arbitrator selection should prevail over conflicting state law, and this determination is neither arbitrary nor in excess of its statutory authority. Therefore, we conclude that the SEA, through the SEC's approval of the NASD Code, preempts the California Standards dealing with disclosure and disqualification, including standards 7, 8, and 10.