Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by National Association of Securities Dealers, Inc. Relating to the Referral of Matters by Arbitrators for Disciplinary Investigation

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-34146; File No. SR-NASD-93-75]

Self-Regulatory Organizations; Notice of Filing of Proposed Rule

Change by National Association of Securities Dealers, Inc. Relating to

the Referral of Matters by Arbitrators for Disciplinary Investigation

Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934

(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on December

16, 1993, the National Association of Securities Dealers, Inc.

(``NASD'' or ``Association'') filed with the Securities and Exchange

Commission (``SEC'' or ``Commission''), and amended on May 25, 1994,\1\

the proposed rule change as described in Items I, II, and III below,

which Items have been prepared by the NASD. The Commission is

publishing this notice to solicit comments on the proposed rule change

from interested persons.

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\1\Amendment No. 1 amended to NASD's Statement of the Purpose

of, and Statutory Basis for, the Proposed Rule Change.

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I. Self-Regulatory Organization's Statement of the Terms of Substance

of the Proposed Rule Change

The NSAD is proposing to amend section 5 of the Code of Arbitration

Procedure (``Code'')\2\ to specify that arbitrators, at the conclusion

of a proceeding, may refer matters arising or discovered during the

course of an arbitration proceeding for disciplinary investigation.

Below is the text of the proposed rule change. Proposed new language is

italicized.

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\2\NASD Manual, Code of Arbitration Procedure, part I, section

5, (CCH) 3705.

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Code of Arbitration Procedure

Non-Waiver of Association Objects and Purposes

Sec. 5. The submission of any matter to arbitration under this Code

shall in no way limit or preclude any right, action or determination by

the Association which it would otherwise be authorized to adopt,

administer or enforce. If any matter comes to the attention of an

arbitrator during and in connection with the arbitrator's participation

in a proceeding, either from the record of the proceeding or from

material or communications related to the proceeding, that the

arbitrator has reason to believe may constitute a violation of the

Association's rules or the federal securities laws, the arbitrator may

initiate a referral of the matter to the Association for disciplinary

investigation; provided, however, that any such referral should only be

initiated by an arbitrator after the matter before him has been settled

or otherwise disposed of, or after an award finally disposing of the

matter has been rendered pursuant to section 41 of the Code.

II. Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

In its filing with the Commission, the NASD 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 place specified in Item

IV below. The NASD 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

The NASD is proposing to amend section 5 of the Code of Arbitration

Procedure to specify that arbitrators, at the conclusion of a

proceeding, may refer to disciplinary investigation matters which come

to their attention during the course of an arbitration proceeding.

The NASD believes that potential violations uncovered during

arbitration hearings should be investigated by the NASD as part of its

comprehensive regulatory program. The NASD is aware, however, that

while customers who suffer a financial loss as a result of misconduct

by their registered representative may bring arbitration actions, they

often do not pursue formal complaints with a self-regulatory

organization (``SRO'') necessary to trigger an investigation of the

potential violation. Further, while the filing of an arbitration

complaint will alert an SRO to the existence of a potential

violation,\3\ because customer complaints in arbitration often do not

allege or disclose sufficient information to indicate obvious

misconduct on the part of a respondent, they may not trigger a

disciplinary investigation. Indeed, in such cases, violations of the

securities laws or the NASD's rules are not apparent until an

arbitration hearing occurs and the parties testify and introduce

evidence about the relevant events. Thus, in some cases, the NASD never

is made aware of securities law violations or violations of the NASD's

rules, notwithstanding the fact that the financial injury to the

customer resulting from the violations is the subject of an arbitration

proceeding.

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\3\The filing of a customer-initiated arbitration complaint

against an associated person alleging damages of $10,000 or more

triggers a requirement of the member or associated person to amend

the associated person's Form U-4 or U-5, as appropriate. Information

supplied pursuant to such an amendment will be entered into the

Central Registration Depository and will also be forwarded to the

appropriate NASD District office for preliminary investigation.

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The NASD also has observed that arbitrators seldom refer for

disciplinary investigation matters which come to their attention during

the course of an arbitration proceeding. Because the NASD believes that

arbitration matters, and the evidentiary material related to or

produced in such matters, constitute a valuable source of information

concerning potential violations of the NASD's rules and the federal

securities laws, bringing such information to the attention of the

Association's regulatory staff should improve the efficacy of the

NASD's regulatory function. Accordingly, the NASD believes that

specifying a mechanism in the Code for arbitrators to bring such

information to the attention of the NASD's regulatory staff for

investigation will serve the public interest by ensuring that potential

violations of the NASD's rules and the federal securities laws are not

overlooked.

In addition, the NASD believes that it is important for arbitrators

to understand that the arbitration process is for the resolution of

disputes between the securities industry and others, and that there is

also a regulatory apparatus separate from the arbitration process which

is designed to address misconduct which affects the public interest and

the integrity of the financial markets. Thus, to the extent arbitrators

are aware that they may refer matters, in addition to or in lieu of

awarding punitive damages as part of awards,\4\ the fairness of the

arbitration process will be enhanced.

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\4\The NASD, in connection with this rule filing, is not

expressing any official position with respect to the ability of

arbitrators to award punitive damages.

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The proposed amendment to section 5 specifies that if any matter

comes to the attention of an arbitrator during the course of a

proceeding the arbitrator may initiate a referral of the matter to the

Association for disciplinary investigation. The proposed amendment also

specifies, however, that any such referral should be initiated by an

arbitrator only after final disposition of the matter through

settlement or award. Although the NASD is not setting forth a specific

procedure for such referrals, the NASD contemplates that arbitrators

will direct referrals to the Association through the Arbitration

Department staff and the Director of Arbitration.

The NASD believes that the proposed rule change is consistent with

the provisions of section 15A(b)(6)\5\ of the Act is that specifying a

mechanism in the Code for arbitrators to bring information concerning

potential violations of the Association's rules and the federal

securities laws to the attention of the NASD's regulatory staff for

investigation will serve the public interest by ensuring that such

potential violations are not overlooked.

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\5\15 U.S.C. 78o-3.

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(B) Self-Regulatory Organization's Statement on Burden on Competition

The NASD does not believe that the proposed rule change 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

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. Persons making written submissions

should file six copies thereof with the Secretary, Securities and

Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549.

Copies of the submission, all subsequent amendments, all written

statements with respect to the proposed rule change that are filed with

the Commission, and all written communications relating to the proposed

rule change between the Commission and any person, other than those

that may be withheld from the public in accordance with the provisions

of 5 U.S.C. 552, will be available for inspection any 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-94-75 and should

be submitted by June 29, 1994.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority, 17 CFR 200.30-3(a)(12).

Jonathan G. Katz,

Secretary.

[FR Doc. 94-13876 Filed 6-7-94; 8:45 am]

BILLING CODE 8010-01-M