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NASD Drops ‘Controversial’ Approach to Arbitration Motions

ADR World

The National Association of Securities Dealers has decided to back away from an approach to motions to dismiss for extraordinary circumstances in arbitration after meeting with opposition from stakeholders who criticized its explanation of what those circumstances would be.

NASD said in a July 21 filing with the Securities and Exchange Commission that its commentary on what constitutes extraordinary circumstances for the purposes of granting a dispositive motion generated “substantial controversy,” and the organization is proposing to rely instead on regulatory language developed with public input.

NASD is developing new rules on dispositive motions — which can substantially end a case — for its consumer and industry arbitration codes. At issue is commentary to the proposal saying that for the purposes of those rules, “if a party demonstrates affirmatively the legal defenses of, for example, accord and satisfaction, arbitration and award, settlement and release, or the running of an applicable statute of repose, the panel may consider these defenses to be extraordinary circumstances.”

Critics of the commentary said it could increase the costs of arbitration by requiring investors to defend those motions and eliminate the core reasons for arbitration: “cost effectiveness and expediency,” NASD said in its SEC filing.

The filing essentially resubmits the proposed rule without the controversial commentary, using the provisions in the rule to guide arbitral panels.

NASD said it “believes that the rule strikes the appropriate balance between allowing the dismissal of claims in limited, extraordinary circumstances and reinforcing the general principle that parties are entitled to a hearing in arbitration.”

It added that the proposal was developed over several years with input from industry and public members of its National Arbitration and Mediation Committee, saying it “will provide necessary guidance to parties and arbitrators, and make the administration of arbitrations more uniform and transparent.”

Jill I. Gross, an associate professor and director of the Pace University School of Law Investor Rights Project, said she is pleased with the withdrawal of the language.

“We were concerned the language was overly broad and could have resulted in arbitrators dismissing claims too often when a party was entitled to a hearing,” Gross explained. “We support the language that dispositive motions should only be granted in extraordinary circumstances,” she added.

However, any proposed rule on dispositive motions rule should include a “catch-all phrase” that would authorize arbitrators to deny a dispositive motion whenever a “panel believes a hearing is necessary in the interests of justice,” Gross said.

The message from NASD to arbitral panels should be that “arbitrators are encouraged to conduct a hearing” as they are necessary to the “fundamental fairness” of the process, she said.

Philip M. Aidikoff, an attorney with Aidikoff, Uhl & Bakhtiari in Beverly Hills, CA, said “the use of the words extraordinary circumstances is fine but the commentary language, which could achieve the status of legislative history, is unsatisfactory.”

The commentary “used very complex legal terms and could have opened the wrong doors” leading to arbitral panels granting dispositive motions when a hearing should have been conducted, he suggested.

According to Aidikoff, many investors represent themselves in securities arbitrations or are represented by inexperienced attorneys. When faced with motions to dismiss, those parties may be unable to respond properly and if a motion is granted would be denied a hearing, “to which I believe they are guaranteed by the NASD arbitration code,” he added.

Phil Cutler, an attorney with Cutler Nylander & Hayton in Seattle, said “although experienced arbitrators are conversant with the standards to be applied in summary judgment motions in a judicial forum, the terminology chosen by NASD, extraordinary circumstances, is foreign and doesn’t give either parties or arbitrators any real guidance.”

“While the proposed NASD rules attempt to strike a reasonable balance, the rules’ provision that dispositive motions may only be granted in extraordinary circumstances and the decision to jettison commentary that explains what circumstances qualify as extraordinary may well lead to litigation,” he suggested.

According to Cutler, there may be litigation “over whether whatever circumstances the arbitrators relied on in granting a dispositive motion were extraordinary enough to justify their ruling, or cause arbitrators to routinely deny such motions to spare the parties the expense of follow-on litigation.”

The language in NASD’s proposed Customer Code Rule 12504 and Industry Code Rule 13504 says “motions to decide a claim before a hearing are discouraged and may only be granted in extraordinary circumstances.”

Under the rules, motions must be made in writing and served as least 60 days prior to a scheduled hearing, and parties have 45 days to respond to the motion. Dispositive motions would be decided by a full panel, and a “panel may not grant a motion under this rule unless a prehearing conference on the motion is held, or waived by the parties.”

In addition, a panel may issue sanctions under Rule 12212 if it determines that a party filed a motion in bad faith.