[Federal Register Volume 64, Number 78 (Friday, April 23, 1999)]
[Notices]
[Pages 20036-20043]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-10200]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-41302; File No. SR-NASD-99-07]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the National Association of Securities Dealers, Inc. Creating
a Discovery Guide for Use in NASD Arbitrations
April 16, 1999.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on January 29, 1999, the National Association of Securities Dealers,
Inc. (``NASD'' or ``Association''), through its wholly owned subsidiary
NASD Regulation, Inc. (``NASD 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 NASD Regulation. On March 23, 1999, NASD Regulation submitted
Amendment No 1 to the proposed rule change.\3\ NASD Regulation
submitted Amendment No. 2 to the proposed rule change on April 9,
1999.\4\ The Commission is publishing this notice of the rule change,
as amended, to solicit comments on the proposed rule change from
interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See letter from Alden S. Adkins, Senior vice President and
General Counsel, NASD Regulation, to Katherine A. England, Assistant
Director, Division of Market Regulation, Commission, dated March 23,
1999. In Amendment No. 1, NASD Regulation made minor changes to the
Discovery Guide in response to some of the Commission's concerns
about the Guide (``Amendment No. 1'').
\4\ See letter from S. Alden, Senior Vice President and General
Counsel, NASD Regulation, to Katherine A. England, Assistant
Director, Division of Market Regulation, Commission, dated April 9,
1999. In Amendment No. 2, NASD Regulation made minor changes to
clarify some of the language within the Discovery Guide (``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 has filed with the Commission a proposed Discovery
Guide for use in NASD arbitration proceedings to improve the discovery
process in NASD-sponsored securities arbitrations. Below is the text of
the proposed rule change which would create the Discovery Guide and
Document Production Lists.
* * * * *
Discovery Guide
For NASD arbitrations, the Discovery Guide supplements the
section in The Securities Industry Conference on Arbitration
(``SICA'') publication entitled ``The Arbitrator's Manual,'' and
captioned ``Prehearing Conference,'' found on pages 11 through 16,
regarding public customer cases.
I. The Need for New Discovery Procedures
Discovery disputes have become more numerous and time consuming.
The same discovery issues repeatedly arise. To minimize discovery
disruptions, the NASD Regulation Office of Dispute Resolution has
developed too initiatives to standardize the discovery process:
early appointment of arbitrators to conduct an initial prehearing
conference and document production lists (``Document Production
Lists'').
No requirement under the Discovery Guide supersedes any record
retention requirement of any federal or state law or regulation or
any rule of a self-regulatory organization.
The Discovery Guide and Document Production Lists are designed
for customer disputes with firms and Associated Person(s) \5\ The
Discovery Guide also discusses additional discovery requests,
information requests, depositions, admissibility of evidence, and
sanctions.
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\5\ NASD Regulation may develop separate Document Production
Lists for intra-industry disputes.
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The Discovery Guide, including the Document Production Lists,
will function as a guide for the parties and the arbitrators; it is
not intended to remove flexibility from arbitrators or parties in a
given case. For instance, arbitrators can order the production of
documents not provided for by the Document Production Lists or alter
the production schedule described in the Discovery Guide. Further,
nothing in the Discovery Guide precludes the parties from
voluntarily agreeing to an exchange of documents in a manner
different from that set forth in the Discovery Guide. In fact, the
Office of Dispute Resolution encourages the parties to agree to the
voluntary exchange of documents and information and to stipulate to
various matters. The fact that an item appears on a Document
Production List does not shift the burden of establishing or
defending any aspect of a claim.
II. Document Production Lists.
The Office of Dispute Resolution will provide the parties with
Document Production Lists (attached to the Discovery Guide) at the
time it serves the statement of claim in customer cases. The
arbitrators and the parties should consider the documents described
in Document Production Lists 1 and 2 presumptively discoverable.
Absent a written objection, documents on Document Production Lists 1
and 2 shall be exchanged by the parties within the time frames set
forth below.
The arbitrators and parties also should consider the additional
documents identified in Document Production Lists 3 through 14,
respectively, discoverable, as indicated, for cases alleging the
following causes of action: churning, failure to supervise
misrepresentation/omission, negligence/breach of fiduciary duty,
unauthorized trading, and unsuitability. For the general document
production and for each of these causes of action, there are
separate Document Production Lists for firms/Associated Person(s)
and for customers.
NASD Rule 10321 provides that the parties shall cooperate to the
fullest extent practicable in the voluntary exchange of documents
and information to expedite the arbitration process. As noted,
nothing in the Discovery Guide precludes parties from voluntarily
agreeing to an exchange of documents in a manner different from that
set forth in the Discovery Guide.
A. Time Frames for Document Production and Objections
The parties should produce all required documents listed in the
applicable Document Production Lists not later than thirty days \6\
from the date the answer is due or filed, whichever is earlier. If a
party redacts any portion of a document prior to production, the
redacted pages (or ranges of pages) shall be labeled ``redacted.'' A
party may object to the production of any document, which would include
an objection based upon an established privilege such as the attorney-
client privilege. If any party objects to the production of any
document listed in the relevant Document Production Lists, the party
must file written objections with the Office of Dispute Resolution and
serve all parties not later than thirty days following the date the
answer is due or filed, whichever is earlier. Objections should set
forth the reasons the party objects to producing the documents. An
objection to the production of a document or a category of documents is
not an acceptable reason to delay the production of any document not
covered by the objection. A response to an objection should be served
on all parties within 10 days from service of the written objections.
Objections and responses should be filed with the Office of Dispute
Resolution at the time they are served on the parties. The
arbitrator(s) shall then determine whether the objecting party has
overcome the presumption based upon sufficient reason(s).
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\6\ All time periods referenced herein are calendar days.
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[[Page 20037]]
B. Confidentiality \7\
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\7\ Section II. B. is also applicable to additional discovery
requests and information requests (see sections IV. and V.).
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If a party objects to document production on grounds of privacy or
confidentiality, the arbitrator(s) or one of the parties may suggest a
stipulation between the parties that the document(s) in question will
not be disclosed or used in any manner outside of the arbitration of
the particular case, or the arbitrator(s) may issue a confidentiality
order. The arbitrator(s) shall not issue an order or use a
confidentiality agreement to require parties to produce documents
otherwise subject to an established privilege. Objections to the
production of documents, based on an established privilege, should be
raised in accordance with the time frame for objections set forth
above.
C. Affirmation in The Event That There Are No Responsive Documents or
Information
If a party responds that no responsive information or documents
exist, the customer or the appropriate person in the brokerage firm who
has personal knowledge (i.e., the person who has conducted a physical
search), upon the request of the requesting party, must: (1) State in
writing that he/she conducted a good faith search for the requested
information or documents; (2) describe the extent of the search; and
(3) state that based on the search, no such information or documents
exist.
III. The Initial Prehearing Conference
To maximize the efficient administration of a case by the
arbitration panel,\8\ the Office of Dispute Resolution staff will
schedule an initial prehearing conference in which the arbitrator(s)
usually participates.\9\ The initial prehearing conference gives the
arbitrator(s) and the parties an opportunity to organize the management
of the case, set a discovery cut-off date,\10\ identify dispositive or
other potential motions, schedule hearing dates, determine whether
mediation is desirable, and resolve any other preliminary issues.\11\
During the initial prehearing conference, the arbitrator(s) and the
parties should schedule hearing dates for the earliest available time,
consistent with the parties' need to prepare adequately for the
hearing.
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\8\ The panel consists of three arbitrators in most cases.
Claims between $25,000 and $50,000 may proceed with a single
arbitrator. Claims under $25,000 are decided by a single arbitrator,
generally on the pleadings.
\9\ In some instances, the parties may opt out of the initial
prehearing conference. To opt out, parties must supply the following
information to the Office of Dispute Resolution by the specified
deadline:
(1) A minimum of four sets of mutually agreeable hearing dates;
(2) A discovery cut-off date;
(3) A list of all anticipated motions with the motion due dates,
opposition due dates, and reply due dates provided;
(4) A minimum of four dates and times for any proposed
prehearing conferences to hear motions; and
(5) A determination whether briefs will be submitted and, if so,
the due date for submission.
\10\ The Office of Dispute Resolution recommends that the panel
set a cut-off date during the initial prehearing conference for
service of discovery requests, giving due consideration to time
frames that permit timely resolution of objections and disputes
prior to the scheduled exchange of hearing exhibits pursuant to the
NASD Code of Arbitration Procedure.
\11\ The arbitrators should direct one of the parties to prepare
and forward to the Office of Dispute Resolution, within 48 hours, a
written order memorializing the results of the prehearing
conference, approved as to form and content by the other parties.
When motions are heard at the initial prehearing conference, the
panel may order the parties to submit the order with a stipulation
as to form and content from all parties.
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Prior to the initial prehearing conference, each arbitrator should
become familiar with the claims and defenses asserted in the pleadings
filled by the parties. At the initial prehearing conference, the
arbitrator(s) should order time limits for discovery that will allow
the scheduling of hearing dates within a reasonable time and address
all outstanding discovery disputes. If the exchange of properly
requested documents has not occurred, the arbitrator(s) should order
the production of all required documents, including those outlined in
the Document Production List (see section II. above), within 30 days
following the conference.
IV. Additional Discovery Requests
The parties may request documents in addition to those identified
in the Document Production Lists pursuant to Rule 10321(b). Unless a
longer period is allowed by the requesting party, requests should be
satisfied or objected to within 30 days from the date of service of the
document request. A response to an objection should be served on all
parties within 10 days from service of the written objections.
Requests, objections, and responses should be filed with the Office of
Dispute Resolution at the time they are served on the parties.
A party may move to compel production of documents when the adverse
party (a) refuses to produce such documents or (b) offers only to
produce alternative documents that are unacceptable to the requesting
party. The Office of Dispute Resolution will provide the chairperson of
the panel with the motion, opposition, and reply, along with the
underlying discovery documents the parties have attached to their
pleadings. The chairperson should determine whether to decide the
matter on the papers or to convene a prehearing conference (usually via
telephone). In considering motions to compel, particularly where non-
production is based upon an argument asserting an established
privilege, such as the attorney-client privilege, the arbitrator(s)
should always give consideration to the arguments set forth by both
sides, particularly as to the relevancy of the documents or
information. The arbitrator(s) should carefully consider such motions,
regardless of whether item requested is on any of the Document
Production Lists. If in doubt, the arbitrator(s) should ask the
requesting party what specific documents it is trying to obtain and
what it seeks to prove with the documents.
V. Information Requests
Like requests for documents, parties may serve requests for
information pursuant to Rule 10321(b). Requests for information are
generally limited to identification of individuals, entities, and time
periods related to the dispute; such requests should be reasonable in
number and not require exhaustive answers or fact finding. Standard
interrogatories, as utilized in state and federal courts, are generally
not permitted in arbitration.
Unless a longer period is allowed by the requesting party,
information requests should be satisfied or objected to within 30 days
from the date of service of the requests. A response to an objection
should be served on all parties within 10 days from service of the
written objections. Requests, objections, and responses should be filed
with the Office of Dispute Resolution at the time they are served on
the parties.
A party may move to compel responses to requests for information
that the adverse party refuses to provide. The Office of Dispute
Resolution will provide the chairperson of the panel with the motion,
opposition, and reply, along with the underlying discovery documents
the parties have attached to their pleadings. The chairperson should
determine whether to decide the matter on the papers or to convene a
prehearing conference (usually via telephone).
VI. Depositions
Depositions are strongly discouraged in arbitration. Upon request
of a party, the arbitrator(s) may permit depositions, but only under
very limited circumstances, such as: (1) To preserve
[[Page 20038]]
the testimony of ill or dying witnesses; (2) to accommodate essential
witnesses who are unable or unwilling to travel long distances for a
hearing and may not otherwise be required to participate in the
hearing; (3) to expedite large or complex cases; and (4) to address
unusual situations where the arbitrator(s) determines that
circumstances warrant departure from the general rule. Balanced against
the authority of the arbitrator(s) to permit depositions, however, is
the traditional reservation about the overuse of depositions in
arbitration.
VII. Admissibility
Production of documents in discovery does NOT create a presumption
that the documents are admissible at the hearing. A party may state
objections to the introduction of any document as evidence at the
hearing to the same extent that any other objection may be raised in
arbitration.
VIII. Sanctions
The arbitration panel should issue sanctions if any party fails to
produce documents or information required by a written order, unless
the panel \12\ finds that there is ``substantial justification'' for
the failure to produce the documents or information. The panel has wide
discretion to address noncompliance with discovery orders. For example,
the panel may make an adverse inference against a party or assess
adjournment fees, forum fees, costs and expenses, and/or attorneys'
fees caused by noncompliance. In extraordinary cases, the panel may
initiate a disciplinary referral against a registered entity or person
who is a party or witness in the proceeding or may, pursuant to Rule
10305(b), dismiss a claim, defense, or proceeding with prejudice as a
sanction for intentional failure to comply with an order of the
arbitrator(s) if lesser sanctions have proven ineffective.
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\12\ As with other rulings, an arbitration panel's ruling need
only be by majority vote; it need not be unanimous.
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* * * * *
Document Production Lists
* * * * *
List 1
Documents to be Produced in all Customer Cases \13\
Firm/Associated Persons(s)
(1) All agreements with the customer, including, but not limited
to, account opening documents, cash, margin, and option agreements,
trading authorizations, powers of attorney, or discretionary
authorization agreements, and new account forms.
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\13\ Only named parties must produce documents pursuant to the
guidelines set forth herein. However, non-parties may be required to
produce documents pursuant to a subpoena or an arbitration panel
order to direct the production of documents (see Rule 10322). In
addition, the arbitration chairperson may use the Document
Production Lists as guidance for discovery issues involving non-
parties.
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(2) All account statements for the customer's account(s) during
the time period and/or relating to the transaction(s) at issue.
(3) All confirmations for the customer's transaction(s) at
issue. As an alternative, the firm/Associated Person(s) should
ascertain from the claimant and produce those confirmations that are
at issue and are not within claimant's possession, custody, or
control
(4) All ``holding (posting) pages'' for the customer's
account(s) at issue or, if not available, any electronic equivalent.
(5) All correspondence between the customer and the firm/
Associated Person(s) relating to transaction(s) at issue
(6) All notes by the firm/Associated Person(s) or on his/her
behalf, including entries in any diary or calendar, relating to the
customer's account(s) at issue.
(7) all recordings and notes of telephone calls or conversations
about the customer's account(s) at issue that occurred between the
Associated Persons(s) and the customer (and any person purporting to
act on behalf of the customer), and/or between the firm and the
Associated Person(s).
(8) All Forms RE-3, U-4, and U-5, including all amendments, all
customer complaints identified in such forms and all customer
complaints of a similar nature against the Associated Person(s)
handling the account(s) at issue.
(9) All sections of the firm's Compliance Manual(s) related to
the claims alleged in the statement of claim, including any separate
or supplemental manuals governing the duties and responsibilities of
the Associated Person(s) and supervisors, any bulletins (or similar
notices) issued by the compliance department, and the entire table
of contents index to each such Manual.
(10) All analyses and reconciliations of the customer's
account(s) during the time period and/or relating to the
transaction(s) at issue.
(11) All records of the firm/Associated Person(s) relating to
the customer's account(s) at issue, such as, but not limited to,
internal reviews and exception and activity reports which reference
the customer's account(s) at issue.
(12) Records of disciplinary action taken against the Associated
Person(s) by any regulator or employer for all sales practices or
conduct similar to the conduct alleged to be at issue.
* * * * *
LIST 2
Documents to be Produced in All Customer Cases
CUSTOMER
(1) All customer and customer-owned business (including
partnership or corporate federal income tax returns, limited to
pages 1 and 2 of Form 1040, Schedules B, D, and E, or the equivalent
for any other type of return, for the three years prior to the first
transaction at issue in the statement of claim through the date of
the statement of claim was filed.
(2) Financial statements or similar statements of the customer's
assets, liabilities and/or net worth for the period(s) covering the
three years prior to the first transaction at issue in the statement
of claim through the date the statement of claim was filed.
(3) Copies of all documents the customer received from the firm/
Associated Person(s) and from any entities in which the customer
invested through the firm/Associated Person(s), including monthly
statements, opening account forms, confirmations, prospectuses,
annual and periodic reports, and correspondence.
(4) Account statements and confirmations for accounts maintained
at securities firms other than the respondent firm for the three
years prior to the first transaction at issue in the statement of
claim through the date the statement or claim filed.
(5) All agreements, forms, information, or documents relating to
the account(s) at issue signed by or provided by the customer to the
firm/Associated Person(s).
(6) All account analyses and reconciliations prepared by or for
the customer relating to the account(s) at issue.
(7) All notes, including entries in diaries or calendars,
relating to the account(s) at issue.
(8) All recordings and notes of telephone calls or conversations
about the customer's account(s) at issue that occurred between the
Associated Person(s) and the customer (any person purporting to act
on behalf of the customer).
(9) All correspondence between the customer (and any person
acting on behalf of the customer) and the firm/Associated Person(s)
relating to the account(s) at issue.
(10) Previously prepared written statements by persons with
knowledge of the facts and circumstances related to the account(s)
at issue, including those by accountants, tax advisors, financial
planners, other Associated Person(s), and any other third party.
(11) All prior complaints by or on behalf of the customer
involving securities matters and the firm's/Associated Person(s')
response(s).
(12) Complaints/Statements of Claim and Answers filed in all
civil actions involving securities matters and securities
arbitration proceedings in which the customer has been a party, and
all final decisions and awards entered in these matters.
(13) All documents showing action taken by the customer to limit
losses in the transaction(s) at issue.
* * * * *
List 3
Churning
Firm/Associated Person(s)
(1) All commission runs relating to the customer's account(s) at
issue or, in the alternative, a consolidated commission report
relating to the customer's account(s) at issue.
(2) All documents reflecting compensation of any kind, including
commissions, from all sources generated by the Associated
[[Page 20039]]
Person(s) assigned to the customer's account(s) for the two months
preceding through the two months following the transaction(s) at
issue, or up to 12 months, whichever is longer. The firm may redact
all information identifying customers who are not parties to the
action, except that the firm/Associated Person(s) shall provide at
least the least four digits of the non-party customer account number
for each transaction.
(3) Documents sufficient to describe or set forth the basis upon
which the Associated Person(s) was compensated during the years in
which the transaction(s) or occurrence(s) in question occurred,
including: (a) any bonus or incentive programs; and (b) all
compensation and commission schedules showing compensation received
or to be received based upon volume, type of product sold, nature of
trade (e.g., agency v. principal), etc.
* * * * *
List 4
Churning
Customer
No additional documents identified.
* * * * *
List 5
Failure to Supervise
Firm/Associated Person(s)
(1) All commission runs and other reports showing compensation
of any kind relating to the customer's account(s) at issue or, in
the alternative, a consolidated commission report relating to the
customer's account(s) at issue.
(2) All exception reports and supervisory activity reviews
relating to the Associated person(s) and/or the customer's
account(s) that were generated not earlier than one year before or
not later than one year after the transaction(s) at issue, and all
other documents reflecting supervision of the Associated Person(s)
and the customer's account(s) at issue.
(3) Those portions of internal audit reports at the branch in
which the customer maintained his/her account(s) that: (a) focused
on the Associated Person(s) or the transaction(s) at issue; and (b)
were generated not earlier than one year before or not later than
one year after the transaction(s) at issue and discussed alleged
improper behavior in the branch against other individuals similar to
the improper conduct alleged in the statement of claim.
(4) Those portions of examination reports or similar reports
following an examination or an inspection conducted by a state or
federal agency or a self-regulatory organization that focused on the
Associated Person(s) or the transaction(s) at issue or that
discussed alleged improper behavior in the branch against other
individuals similar to the improper conduct alleged in the statement
of claim.
* * * * *
List 6
Failure to Supervise
Customer
No additional documented identified.
* * * * *
List 7
Misrepresentation/Omissions
Firm/Associated Person(s)
Copies of all materials prepared or used by the firm/Associated
Person(s) relating to the transactions or products at issue,
including research reports, prospectuses, and other offering
documents, including documents intended or identified as being ``for
internal use only,'' and worksheets or notes indicating the
Associated Person(s) reviewed or read such documents. As an
alternative, the firm/Associated Person(s) may produce a list of
such documents that contains sufficient detail for the claimant to
identify each document listed. Upon further request by a party, the
firm/Associated Person(s) must provide any documents identified on
the list.
* * * * *
List 8
Misrepresentation/Omissions
Customer
(1) Documents sufficient to show the customer's ownership in or
control over any business entity, including general and limited
partnerships and closely held corporations.
(2) Copy of the customer's resume.
(3) Documents sufficient to show the customer's complete
educational and employment background or, in the alternative, a
description of the customer's educational and employment background
if not set forth in a resume produced under item 2.
* * * * *
List 9
Negligence/Breach of Fiduciary Duty
Firm/Associated Person(s)
Copies of all materials prepared or used by the firm/Associated
Person(s) relating to the transactions or products at issue,
including research reports, prospectuses, and other offering
documents, including documents intended or identified as being ``for
internal use only,'' and worksheets or notes indicating the
Associated Person(s) reviewed or read such documents. As an
alternative, the firm/Associated Person(s) may produce a list of
such documents that contains sufficient detail for the claimant to
identify each document listed. Upon further request by a party, the
firm/Associated Person(s) must provide any documents identified on
the list.
* * * * *
List 10
Negligence/Breach of Fiduciary Duty
Customer
(1) Documents sufficient to show the customer's ownership in or
control over any business entity, including general and limited
partnerships and closely held corporations.
(2) Copy of the customer's resume.
(3) Documents sufficient to show the customer's complete
educational and employment background or, in the alternative, a
description of the customers educational and employment background
if not set forth in a resume produced under item 2.
* * * * *
List 11
Unauthorized Trading
Firm/Associated Person(s)
(1) Order tickets for the customer's transaction(s) at issue.
(2) Copies of all telephone records, including telephone logs,
evidencing telephone contact between the customer and the firm/
Associated Person(s).
(3) All documents relied upon by the firm/Associated Person(s)
to establish that the customer authorized the transaction(s) at
issue.
* * * * *
List 12
Unauthorized Trading
Customer
1. Copies of all telephone records, including telephone logs,
evidencing telephone contact between the customer and the firm/
Associated Person(s).
2. All documents relied upon by the customer to show that the
transaction(s) at issue was made without his/her knowledge or
consent.
* * * * *
List 13
Unsuitability
Firm/Associated Person(s)
(1) Copies of all materials prepared, used, or reviewed by the
firm/Associated Person(s) related to the transactions or products at
issue, including but not limited to research reports, prospectuses,
other offering documents, including documents intended or identified
as being ``for internal use only,'' and worksheets or notes
indicating the Associated Person(s) reviewed or read such documents.
As an alternative, the firm/Associated Person(s) may produce a list
of such documents. Upon further request by a party, the firm/
Associated Person(s) must provide any documents identified on the
list.
(2) Documents sufficient to describe or set forth the basis upon
which the Associated Person(s) was compensated in any manner during
the years in which the transaction(s) or occurrence(s) in question
occurred, including, but not limited to: (a) any bonus or incentive
program: and (b) all compensation and commission schedules showing
compensation received or to be received based upon volume, type of
product sold, nature of trade (e.g., agency v. principal), etc.
* * * * *
[[Page 20040]]
List 14
Unsuitability
Customer
(1) Documents sufficient to show the customer's ownership in or
control over any business entity, including general and limited
partnerships and closely held corporations.
(2) Written documents relied upon by the customer in making the
investment decision(s) at issue.
(3) Copy of the customer's resume.
(4) Documents sufficient to show the customer's complete
educational and employment background or, in the alternative, a
description of the customer's educational and employment background
if not set forth in a resume produced under item 3.
* * * * *
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, NASD Regulation 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. NASD Regulation has prepared summaries, set
forth in Sections A, B, and C below, of the most significant aspects of
such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
The Discovery Guide, which includes Document Production Lists,
provides guidance to parties on which documents they should exchange
without arbitrator or staff intervention, and to arbitrators in
determining which documents customers and member firms or associated
persons are presumptively required to produce in customer arbitrations.
The NASD developed the Discovery Guide because parties and their
attorneys often do not comply or do not comply fully with discovery
requests in NASD arbitrations. The proposal will streamline discovery
in arbitrations in several ways, including reducing the number and
scope of document productions and other discovery disputes, thereby
reducing staff, arbitrator and party resources required to resolve such
disputes. The Discovery Guide is a consensus document. It was developed
over more than a two-year period, and reflects the view of many
arbitration experts, experienced practitioners, and self-regulatory
organization (``SRO'') arbitration staff.
The Discovery Guide and Document Production Lists will function as
a guide for the parties and the arbitrators; they are not intended to
bind arbitrators in a given case or to bind parties. For instance,
arbitrators can order the production of documents not provided for by
the Document Production Lists or alter the production schedule
described in the Discovery Guide. Further, nothing in the Discovery
Guide precludes the parties from voluntarily agreeing to an exchange of
documents in a manner different from that set forth in the Discovery
Guide or in the Document Production Lists. In fact, the Office of
Dispute Resolution (``ODR'') of NASD Regulation encourages the parties
to agree to the voluntary exchange of documents and information and to
stipulate to various matters. However, the Discovery Guide is binding
on parties to the extent it is used by arbitrators to order the
exchange of documents.
Background
In January 1996, 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''), made a number of broad recommendations to the NASD Board of
Governors to improve the securities arbitration process administered by
the NASD Board of Governors to improve the securities arbitration
process administered by the NASD. One of these recommendations states
that: ``Automatic production of essential documents should be required
for all parties, and arbitrators should play a much greater role in
directing discovery and resolving discovery disputes.''\14\ The Task
Force reported that parties and their attorneys routinely failed to
comply with discovery requests or only complied partially. In addition,
the Task Force noted that existing NASD rules did not provide guidance
to an arbitrator as to the proper scope of discovery and, thus,
discovery disputes were resolved largely according to the standards of
individual arbitrators.\15\ According to the Task Force, some
arbitrators had experience in civil litigation, but others had little
knowledge or training that would enable them to resolve a dispute
according to any uniform standard or rules. \16\
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\14\ Task Force Report at 2.
\15\ Id. at 79.
\16\ Id.
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After the work of the Task Force was completed, several groups were
formed to work on the discovery issue. Each group was composed of
persons offering diverse perspectives, and all made a substantial
contribution to the process. The proposed Discovery Guide is the
product resulting from these groups' efforts which were composed of
arbitration experts, experienced practitioners, and SRO arbitration
staff. Among those contributing to the Discovery Guide were persons who
are members of the Securities Industries Conference on Arbitration
(``SICA'') \17\, members of the Securities Industry Association
(``SIA''), directors of the Public Investors Arbitration Bar
Association (``PIABA''), industry representatives from major broker-
dealers, counsel for claimants, and counsel for the industry. The
Discovery Guide represents a compromise reached over more than two
years among a variety of securities industry and investor
representatives and their counsel. Most of the contributors believe the
proposal represents an opportunity to improve discovery in arbitration.
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\17\ SICA was formed to develop and maintain a Uniform Code of
Arbitration and to provide a forum for the discussion of new
developments in securities arbitration among arbitration SRO forums
and participants in those forums. The membership includes
representatives from the SRO's with securities arbitration forums,
three of four ``public'' members, and a representative from the SIA.
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The approval of the Discovery Guide would result in the
implementation of key recommendations of the Task Force by establishing
the practice in customer arbitrations that essential documents will be
produced, and requiring that arbitrators play a greater role in
directing the discovery process and resolving discovery disputes. The
Discovery Guide follows the Task Force's recommendation in all but one
respect. Although the Task Force recommended that any proposed
arbitration rule or guideline require that documents be produced
automatically, the Discovery Guide is drafted so that the documents are
presumptively discoverable instead to give the arbitrators more
discretion in managing the discovery process and to provide more
flexibility to the process.
Features of the Discovery Guide
The Discovery Guide will be used as a supplement or an addendum to
the guidance regarding discovery set forth in The Arbitrator's Manual,
published by SICA, and particularly the provisions in the section
entitled, ``Prehearing Conference,'' at pages 11-16. The Arbitrator's
Manual is compiled by members of SICA as a guide for arbitrators, and
is designed to
[[Page 20041]]
supplement and explain the Uniform Code of Arbitration as developed by
SICA. By the terms of The Arbitrator's Manual, the procedures and
policies contained therein are discretionary and may be changed by the
arbitrators. Further, nothing in the Discovery Guide, including The
Document Production Lists, precludes the parties from voluntarily
agreeing to an exchange of documents in a manner different from that
set forth in the Discovery Guide.
The Discovery Guide consists of introductory and instructional
text, and fourteen Document Production Lists. It is intended for use by
arbitrators in customer arbitrations only. These lists include the
following (parenthetical references refer to the party from whom
documents are sought):
List 1: Documents To Be Produced In All Customer Cases (Firm/
Associated Person(s))
List 2: Documents To Be Produced In All Customer Cases (Customer)
List 3: Churning (Firm/Associated Person(s))
List 4: Churning (Customer)
List 5: Failure To Supervise (Firm/Associated Person(s))
List 6: Failure To Supervise (Customer)
List 7: Misrepresentation/Omission (Firm/Associated Person(s))
List 8: Misrepresentation/Omission (Customer)
List 9: Negligence/Breach Of Fiduciary Duty (Firm/Associated
Person(s))
List 10: Negligence/Breach Of Fiduciary Duty (Customer)
List 11: Unauthorized Trading (Firm/Associated Person(s))
List 12: Unauthorized Trading (Customer)
List 13: Unsuitability (Firm/Associated Person(s))
List 14: Unsuitability (Customer).
The ODR will provide the parties with the Discovery Guide including
the Document Production Lists at the time ODR serves the statement of
claim. The document production requirements in the first two Document
Production Lists, ``List 1, Documents To Be Produced In All Customer
Cases: (Firm/Associated Person(s)),'' and ``List 2, Documents To Be
Produced In All Customer Cases: Customer,'' would apply in virtually
all cases involving member-customer or associated person-customer
disputes, unless the arbitrator(s), in the exercise of discretion,
determines that some or all of the documents in the relevant Document
Production Lists should not be produced. For cases in which allegations
of churning, failure to supervise, misrepresentation/omission,
negligence/breach of fiduciary duty, unauthorized trading, or
unsuitability are stated, additional Document Production Lists (e.g.,
Document Production Lists 3 and 4--Churning) provide additional
guidance. If a Document Production List is applicable, the Discovery
Guide is drafted to guide the arbitrator(s) to order production, unless
in the exercise of discretion, the arbitrator(s) believes that there is
good cause not to order production.
In addition to specific document production requirements, the
Discovery Guide also discusses other topics such as confidential
treatment of documents, additional discovery requests, depositions,
admissibility of evidence, arbitrator participation, and sanctions.
These general instructions are discussed below.
Confidential Treatment. Under the Discovery Guide, parties may
stipulate that private or confidential document(s) will not be
disclosed or used in any manner outside of the arbitration of the
particular case. Alternatively, the arbitrator(s) may issue
confidentiality orders. The Discovery Guide further provides that
arbitration panels shall not issue orders or use confidentiality
agreements to require parties to produce documents otherwise protected
by established privileges.
Additional Discovery Requests. The Discovery Guide states that
parties may request documents in addition to those identified in the
Document Production Lists, and it provides guidance regarding the
timing of such requests. Unless a longer period is allowed by the
requesting party, requests should be satisfied or objected to within 30
days from the date of service of the document request. Any response to
objections to a request should be served on all parties within 10 days
of service of the objection.
The Discovery Guide provides a mechanism for a party to seek to
compel production of documents when the adverse party (a) refuses to
produce such documents or (b) offers only to produce alternative
documents that are unacceptable to the requesting party. The Discovery
Guide directs the arbitrator(s) to carefully consider such motions,
regardless of whether the item requested is on any of the Document
Production Lists.
Depositions. The Discovery Guide enables the arbitrator(s) to allow
depositions, but only under very limited circumstances, such as: (a) to
preserve the testimony of ill or dying witnesses; (b) to accommodate
essential witnesses who are unable or unwilling to travel long
distances for a hearing and may not otherwise be required to
participate in the hearing; (c) expedite large or complex cases; and
(d) to address unusual situations where the arbitrator(s) determines
that circumstances warrant departure from the general guidance.
Admissibility. Production of documents pursuant to the Discovery
Guide does not create a presumption that the documents are admissible
at the arbitration hearing. Nothing in the Discovery Guide prevents a
party from objecting to the introduction of any document as evidence at
the hearing to the same extent that any other objection may be raised
in arbitration.
Arbitrator Participation. Under the Discovery Guide, the NASD
arbitrator(s) will participate in the initial and subsequent prehearing
conferences to organize the management of the case, set a discovery
cut-off date, identify dispositive or other potential motions, schedule
hearing dates, determine whether mediation is desirable, and resolve
any other preliminary issues. If the exchange of properly requested
discovery has not occurred, the Discovery Guide provides that the
arbitrator(s) may order the production of all required documents
subject to production.
Sanctions. The Discovery Guide instructs arbitration panels to
issue sanctions if any party fails to produce documents or information
required by a written order, unless the panel \18\ finds that there is
``substantial justification'' for the failure to produce the documents
or information. The Discovery Guide gives wide discretion to address
noncompliance with discovery orders. For example,the panel may make an
adverse inference against a party or assess adjournment fees, forum
fees, cost and expenses, and/or attorney's fees caused by
noncompliance. In extraordinary cases, the Discovery Guide permits the
panel to initiate a disciplinary referral against a registered entity
or person who is a party or witness in the proceeding or may, pursuant
to Rule 10305(b), dismiss a claim, defense, or proceeding with
prejudice as a sanction for intentional failure to comply with an order
of the arbitrator(s) if lesser sanctions have proven ineffective.
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\18\ An arbitration panel's ruling need only be by majority
vote; if need not be unanimous.
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The Discovery Guide Is a Guideline
As noted, the Discovery Guide will function as a guide for the
parties and the arbitrator(s), and is intended to supplement The
Arbitrator's Manual, which does not create any binding regulatory
obligations. Further, the policies set forth in the Discovery Guide are
discretionary and may be changed by the arbitrator(s). Moreover, the
parties may agree to a voluntary exchange of documents in a manner that
[[Page 20042]]
is different from that set forth in the Discovery Guide.
2. Statutory Basis
NASD Regulation believes that the proposed Discovery Guide is
consistent with the provisions of Section 15A(b)(6) of the Act, 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. The NASD believes that the
Discovery Guide will reduce the number and limit the scope of disputes
involving document productions and other matters, thereby improving the
arbitration process for the benefit of public investors, broker/dealer
members, and associated persons who are the users of the process.
B. Self-Regulatory Organization's Statement on Burden on Competition
NASD Regulation does not believe that the proposed Discovery Guide
will result in any burden on competition that is not necessary or
appropriate in furtherance of the purposes of the Act, as amended.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
Written comments were neither solicited nor received.
III. Date of Effectiveness of the Proposed Rule Change and Timing
for Commission Action
Within 35 days of the date of 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 such 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 utilizing the
Discovery Guide, as amended, is consistent with the Act. In addition to
any other issues that the public may wish to address, the Commission
specifically requests comments on the following aspects of the
Discovery Guide:
A. The Discovery Guide as a Compromise Document
The Discovery Guide provides guidance to parties on which documents
they should exchange without arbitrator or staff intervention in NASD-
sponsored arbitrations, and to arbitrators in determining which
documents customers and member firms or associated persons are
presumptively required to produce in customer arbitrations. In January
1996, the Arbitration Policy Task Force chaired by former Commission
Chairman David Ruder recommended that ``[a]utomatic production of
essential documents should be required for all parties, and arbitrators
should play a much greater role in directing discovery and resolving
discovery disputes.'' Task Force Report (January 1996), at 2.
The NASD's National Arbitration and Mediation Committee, together
with advisors from various diverse backgrounds, helped to draft the
Discovery Guide over a period of two years in an effort to implement
this recommendation. Among those contributing to the Discovery Guide
were persons who are members of SICA, members of SIA, directors of
PIABA, industry representatives, representatives from major broker-
dealers, counsel for claimants, and counsel for the industry. The
Discovery Guide reflects a compromise between the various interests of
the drafters.
The Commission seeks comment on whether the Discovery Guide's
document discovery lists, when considered as a whole, reflect a
balanced compromise between the various interests of the drafters.
The Commission seeks comment on whether the Discovery Guides
document discovery lists, when considered as a whole, reflect a
balanced compromise between the production needs of, and burdens on,
both claimants and industry defendants in customer arbitrations. For
example, while some may believe production of a particular class of
documents on one of the industry production lists is burdensome, there
may be an equally burdensome production requirement on the
corresponding customer production list. Comments should provide
specific examples to support their views of whether the Discovery Guide
is a balanced effort to make both sides in an arbitration produce more
relevant documents more quickly. Comments should take into account
that, as noted in the Discovery Guide, parties are not precluded from
seeking additional classes of documents either by agreement or by order
of the arbitrators in any particular case.
B. Customer Personal Financial Information
Under List 2 of the Discovery Guide, claimants in all cases are
asked to produce a significant amount of personal financial
information. For example, claimants are asked to produce portions of
all customer and customer-owned business federal income tax returns
(List 2, Item 1), financial statements or similar statements of the
customer's assets, liabilities and or net worth (List 2, Item 2), and
account statements and confirmations for accounts maintained at a
securities firm other than the respondent firm (List 2, Item 4) for a
period of at least three years and as many as six years.\19\
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\19\ These requests seek documents covering the period from 3
years prior to the transaction(s) in issue through the time the
claim is filed. Since most arbitration claims must be brought within
3 years from the date of the transaction under applicable statutes
of limitations, depending on when a claim is filed, a claimant may
have to produce 6 years' worth of personal financial information.
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The Commission seeks comment on whether the scope of these requests
on List 2 is reasonable in all customer cases. For example, should
these requests be limited to a lesser amount of personal financial and
tax information (e.g., either tax returns or financial statements), or
to a shorter period of coverage (e.g., financial information covering a
year before the transactions at issue until the date the claim is
made)? Should federal income tax returns be made presumptively
discoverable in only certain types of cases where the information
contained in those documents may be more relevant (such as
unsuitability cases (List 14)), than in other types of cases (such as
churning claims)?
The Commission also seeks comment on whether the relative
production burden is reasonably equivalent for both claimants and
respondents in an arbitration proceeding. The drafters of the Discovery
Guide sought to effect a compromise between competing interests, with
each party being required to give up certain types of information in
order to receive other types of information on a regular and timely
basis. For example, does requiring customers to produce personal
financial information (List 2, Items 1, 2, and 4) balance the
respondent's obligation to produce records of customer complaints and
disciplinary action, without time limitation (List 1, Items 8 and 12).
\20\
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Commenters should provide specific examples to support their opinions
where possible.
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\20\ List 1, Item 8 requires firms/associated persons to produce
``[a]ll Forms RE-3, U-4, and U-5s, including all amendments, all
customer complaints identified in such forms, and all customer
complaints of a similar nature against the Associated Person(s)
handling the account(s) at issue.'' List 1, Item 12 calls for
production of ``[r]ecords of disciplinary action taken against the
Associated Person(s) by any regulator or employer for all sales
practices or conduct similar to the conduct alleged to be at
issue,'' in all cases.
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C. Privilege Issues
The Discovery Guide states in Part II.B. that ``[t]he arbitrator(s)
shall not issue an order or use a confidentiality agreement to require
parties to produce documents otherwise subject to an established
privilege.'' Those privileges that would be deemed ``established,''
however, are not listed in the Guide. While the attorney-client
privilege would clearly be an example of an established privilege,
would it be helpful to parties and arbitrators to identify if other
privileges also could be claimed? Do securities firms intend to assert
any other types of privileges? Is the absence of specificity an
invitation to argument about whether a privilege has been
``established''?
As the NASD has stressed, the Lists of presumptively discoverable
documents were the result of significant compromise between
representatives of the industry, the plaintiffs' bar, and other
interested persons. Each group agreed to include certain types of
documents in the Lists that it could otherwise object to producing
because it would receive other types of documents in return. Is the
term ``established privilege'' sufficiently limited to assure that the
balance between competing interests that the NASD sought to achieve
through the Discovery Guide will not be upset?
The Commission therefore seeks comment on the privileges that
should be considered ``established'' for purposes of the Discovery
Guide. Should the only privilege recognized as ``established'' be the
attorney/client privilege (and the related work product doctrine)? In
light of the compromises reached in fashioning the Discovery Guide,
should a party be precluded from asserting a blanket privilege to keep
from producing an entire category of documents contained on one of the
discovery Lists?
D. Internal Audit Reports
List 5, Item 3(a) calls for the production of those portions of
internal audit reports that ``focused on'' the associated person(s) or
transaction(s) at issue. There may be instances where an internal audit
report does not ``focus on'' a particular person or transaction, but
may nonetheless relate to a claim made in arbitration. For example, an
internal report that addresses a particular practice of the firm or
branch office may be relevant to the customer's claim even if it does
not ``focus on'' the associated person named in the customer's
complaint.
Therefore, the Commission would like comment on whether the
internal audit reports subject to production under List 5, Item 3(a)
should be limited to those that ``focus on'' the associated person(s)
or transaction(s) at issue in the claim, or whether the class of
internal audit reports should be expanded to include those that
``concern'' or ``relate to'' the claims made in the arbitration. Is the
limitation in List 5, Item 3(a) to reports that ``focus on'' the
associated person(s) and transaction(s) at issue necessary to prevent
production of audit reports that are unrelated to the claims in a
particular arbitration, or does the limitation exclude particular types
of reports that will almost always be relevant?
List 5, Item 3(b) requires production of those portions of internal
audit reports that ``were generated not earlier than one year before or
not later than one year after the transaction(s) at issue and discussed
alleged improper behavior in the branch against other individuals
similar to the improper conduct alleged in the statement of claim.''
Does this provision help ensure that all portions of internal audit
reports that may be relevant to the claims asserted in an arbitration
will be produced by firms? Would an expansion of the documents called
for in List 5, Item 3(a) upset the balance strived for by the members
of the NASD's drafting committee?
E. Particular Types of Claims
Lists 1 and 2 set forth documents to be produced in all customer
cases by firms/associated persons and customers, respectively. Lists 3
through 14 call for the production of additional classes of documents
in particular types of cases, including churning (Lists 3 and 4),
failure to supervise (Lists 5 and 6), misrepresentation/omission (Lists
7 and 8), negligence/breach of fiduciary duty (Lists 9 and 10),
unauthorized trading (Lists 11 and 12) and unsuitability (Lists 13 and
14). Are there other types of specific claims that should be included
in particular lists in the Discovery Guide? For instance, claims
alleging failure to obtain best execution on particular trades do not
have individualized production lists. Because of the nature of best
execution claims, the documents called for in List 11 may be relevant
in those cases. Should List 11 also apply to best execution claims as
well as unauthorized trading claims? When commenting, commenters should
take into account that recently best execution has become a topic of
significant interest.\21\
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\21\ See, e.g., Newton v. Merrill Lynch, Pierce, Fenner & Smith
Incorporated, et al., 135 F.3d 266 (3d Cir. 1998); Order Execution
Obligations, Exchange Act Release No. 37619A, 61 FR 48290 (Sept. 12,
1996) (duty of best execution requires broker-dealer to seek the
most favorable terms reasonably available under the circumstances of
the customer's transaction).
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Person making written submissions should file six copies thereof
with the Secretary, Securities and Exchange Commission, 450 Fifth
Street, N.W., Washington, D.C. 20549-0690. 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 in 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-99-07 and should be
submitted by May 14, 1999.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\22\
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\22\ 17 CFR 200.30-3(a)(12)
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-10200 Filed 4-22-99; 8:45 am]
BILLING CODE 8010-01-M