Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the National Association of Securities Dealers, Inc., Relating to Fees and Hearing Session Deposits for the Arbitration of Claims by Public Investors, Members and Associated Persons

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39346; File No. SR-NASD-97-79]

Self-Regulatory Organizations; Notice of Filing of Proposed Rule

Change by the National Association of Securities Dealers, Inc.,

Relating to Fees and Hearing Session Deposits for the Arbitration of

Claims by Public Investors, Members and Associated Persons

November 21, 1997.

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 October

29, 1997,\1\ the National Association of Securities Dealers, Inc.

(``NASD'' or ``Association'') 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 the self-

regulatory organization. The Commission is publishing this notice to

solicit comments on the proposed rule change from interested persons.

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\1\ The NASD submitted Amendment No. 1 to the proposed rule

filing on November 14, 1997, the substance of which is incorporated

into this notice and the proposed rule filing. See letter from John

M. Ramsay, Deputy General Counsel, NASD Regulation, to Katherine A.

England, Assistant Director, Market Regulation, Commission, dated

November 12, 1997 (``Amendment No. 1'').

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

Substance of the Proposed Rule Change

NASD Regulation is proposing to amend Rules IM-10104, 10205 and

10332 of the NASD's Code of Arbitration Procedure (``Code'') to

increase the arbitrator honoraria and the arbitration filing fees and

hearing session deposits for intra-industry and public investor

arbitrations administered by NASD Regulation. Below is the text of the

proposed rule change. Proposed new language is in italics; proposed

deletions are in brackets.

IM-10104. Arbitrator's Honorarium

All persons [serving on panels of arbitrators pursuant to Rule

10104 of] selected to serve as arbitrators pursuant to the

Association's Code of Arbitration Procedure shall be paid an honorarium

for each hearing session (including a prehearing conference) in which

they participate [while in the performance of said duties].

The honorarium shall be $[150]200 for [a single] each hearing

session [, $225 for a double session], $50 for travel to a canceled

hearing, and $[50]75 per day additional honorarium to the chairperson

of the panel. The honorarium for a case not requiring a hearing [is $75

per case] shall be $125.

10205. Schedule of Fees for Industry and Clearing Controversies

(a) At the time of filing a Claim, Counterclaim, Third Party Claim,

or Cross-Claim in an industry or clearing controversy which is required

to be submitted to arbitration before the Association as set forth in

Rule 10201, above, a party who is a member shall pay a non-refundable

filing fee and shall remit a hearing session deposit to the Association

in the amounts stated in paragraph (k) unless such fee or deposit is

specifically waived by the Director of Arbitration. A party who is an

associated person shall pay a non-refundable filing fee and shall pay a

hearing session deposit in the amounts specified for customer claimants

in Rule 10332. If the associated person is a joint claimant with a

member, the member shall pay a non-refundable filing fee and shall pay

a hearing session deposit in the amounts specified in paragraph (k) of

this Rule. Where multiple hearing sessions are required, the

arbitrator(s) may require any of the parties to make additional hearing

deposits for each additional hearing session. In no event shall the

amount deposited by all parties per hearing session exceed the amount

of the largest initial hearing deposit made by any party under the

paragraph (k) below.

(b) No change.

(c) No change.

(d) No change.

(e) If the dispute, claim, or controversy does not involve,

disclose, or specify a money claim, the non-refundable filing fee

assessed on a party who is a member shall be $500. If the dispute,

claim, or controversy does not involve, disclose, or specify a money

claim, the hearing session deposit to be remitted by a party shall be

$1000 [$600]. These amounts may be adjusted by the Director of

Arbitration or the panel of arbitrators may require the maximum amount

specified in the schedule [$1,000].

(f) No change.

(g) No change.

(h) No change.

(i) If an eligible matter is submitted for arbitration as a large

and complex case, under the procedures set forth in Rule 10334, or

under procedures agreed upon by the parties, following the

Administrative Conference specified in Rule 10334(b), the fees and

deposits for such matter shall be those set forth in the schedule of

fees for claims over $10,000,000 [$5,000,000].

(j) No change.

(k) Schedule of Fees

[[Page 63581]]

Schedule of Fees

----------------------------------------------------------------------------------------------------------------

Deposit for cases Hearing Session Deposit

Amount in dispute (exclusive to be decided on -----------------------------------------

of interest and expenses) Claim filing fee the paper record One

[simplified1] arbitrator1[2] Three arbitrators2[3]

----------------------------------------------------------------------------------------------------------------

$.01-$1,000................... $200 [500] $25 [75] $25 [300] NA

$1,000.01-$2,500.............. $300 [500] $50 [75] $50 [300] NA

$2,500.01-$5,000.............. $400 [500] $125 [75] $125 [300] NA

$5,000.01-$10,000............. $500 $250 [75] $250 [300] NA

$10,000.01-$25,000............ $750 $300 $450 NA

$25,000.01-$30,000............ $1,000 [500] NA $450 [300] $-600

$30,000.01-$50,000............ $1,000 [500] NA $450 [300] $-600

$50,000.01-$100,000........... $1,000 [500] NA $4503[3004] $750 [600]

$100,000.01-$500,000.......... $1,000 [500] NA $4503[3004] $-1,125 [750]

$500.000.01-$1,000,000........ $1,250 NA $4503 $1,200

$1,000,000.01-$5,000,000...... $2,000 [500] NA $4503[3004] $1,200 [1,000]

[Over]$5,000,000.01-$10,000.00 $2,500 [500] NA $4503[3004] $1,200[1,500]

0.00.

Over $10,000,000.............. $5,000 NA $4503 $1,200

----------------------------------------------------------------------------------------------------------------

[\1\ Simplified Arbitration (Without Hearing)]

\1\[2] The dispute is resolved by o[O]ne a[A]rbitrator per hearing session, including pre-hearing conferences.

[(Per hearing session)]

\2\[3] The dispute is resolved by t[T]hree [or more] a[A]rbitrators per hearing session. [(Per hearing session)]

\3\[4] Fee applies only to p[P]re-hearing c[C]onferences [Only] with a single arbitrator.

10332. Schedule of Fees for Customer Disputes

(a) No change.

(b) No change.

(c) No change.

(d) No change.

(e) If the dispute, claim, or controversy does not involve,

disclose, or specify a money claim, the non-refundable filing fee for a

public customer shall be $250 and the non-refundable filing fee for an

industry party shall be $500[.00]. The hearing session deposit to be

remitted by a party shall be $1000 [$600] or such greater or lesser

amount as the Director of Arbitration or the panel of arbitrators may

require, but shall not exceed the maximum amount specified in the

schedule [$1,000].

(f) No change.

(g) No change.

(h) If an eligible matter is submitted for arbitration as a large

and complex case under the procedures set forth in Rule 10334, or under

procedures agreed upon by the parties, following the Administrative

Conference specified in Rule 10334(b), the fees and deposits for such

matter shall be those set forth in the schedule of fees for claims over

$10,000,000 [$5,000,000].

(i) No change

(j) No change

(k) Schedule of Fees

For purposes of the schedule of fees, the term ``claim'' includes

Claims, Counterclaims, Third Party Claims, and Cross-Claims. Any such

claim made by a customer or associated person is treated as a customer

claim for purposes of the schedule of fees. Any such claim made by a

member [or associated person of a member] is an industry claim.

Customer or Associated Person Claimant

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Deposit for cases Hearing session deposit

Amount in dispute (exclusive to be decided on -----------------------------------------

of interest and expenses) Claim filing fee the paper record One arbitrator Three arbitrators

[simplified \1\] \1\[2] \2\[3]

----------------------------------------------------------------------------------------------------------------

$.01-$1,000................... $ 25 [ 15] $ 25 [15] $ 25 [ 15] NA

$1,000.01-$2,500.............. $ 25 $ 50 [25] $ 50 [ 25] NA

$2,500.01-$5,000.............. $ 50 $125 [75] $125[100] NA

$5,000.01-$10,000............. $ 75 $250 [75] $250 [200] NA

$10,000.01-$25,000............ $125 [100] $300 [NA] $450 NA

$25,000.01-$30,000............ $150 NA $450[300] $ 400

$30,000.01-$50,000............ $175 [120] NA $450[300] $ 600[ 400]

$50,000.01-$100,000........... $225 [150] NA $450 \3\[300 \4\] $ 750[ 500]

$100,000.01-$500,000.......... $300 [200] NA $450 \3\[300 \4\] $1,125[ 750]

$500,000.01-$1,000,000........ $375 [250] NA $450 \3\[300 \4\] $1,200[1,000]

$1,000,000.01-$3,000,000...... $500 NA $450 \3\ $1,200

$3,000,000.01-$5,000,000...... $600 NA $450 \3\ $1,200

[Over]$5,000,000.01-$10,000,00 $600 [300] NA $450 \3\[300 \4\] $1,200[1,500]

0.

Over $10,000,000.............. $600 NA $450 \3\ $1,200

----------------------------------------------------------------------------------------------------------------

[\1\ Simplified Arbitration (Without Hearing)].

\1\[2] The dispute is resolved by o[O]ne a[A]rbitrator per hearing session, including pre-hearing conferences.

[(Per Hearing Session)].

\2\[3] The dispute is resolved by t[T]hree [or more] a[A]rbitrators per hearing session. [(Per hearing

session)].

\3\[4] Fee applies only to p[P]re-hearing c[C]onferences [Only] with a single arbitrator.

[[Page 63582]]

Member [Industry] Claimant

----------------------------------------------------------------------------------------------------------------

Deposit for cases Hearing Session Deposit

Amount in dispute (exclusive to be decided on -----------------------------------------

of interest and expenses) Claim filing fee the paper record Three arbitrator \1\

arbitrators \2\ [3] [simplified \1\] One [2]

----------------------------------------------------------------------------------------------------------------

$.01-$1,000................... $200 [500] $25 [75] $25 [300] NA

$1,000.01-$2,500.............. $300 [500] $50 [75] $50 [300] NA

$2,500.01-$5,000.............. $400 [500] $125 [75] $125 [300] NA

$5,000.01-$10,000............. $500 $250 [75] $250 [300] NA

$10,000.01-$25,000............ $750 $300 $450 NA

$25,000.01-$30,000............ $1,000 [500] NA $450 [300] $600

$30,000.01-$50,000............ $1,000 [500] NA $450 [300] $600

$50,000.01-$100,000........... $1,000 [500] NA $450 \3\[300 \4\] $750 [600]

$100,000.01-$500,000.......... $1,000 [500] NA $450 \3\[300 \4\] $1,125 [750]

$500,000.01-$1,000,000........ $1,250 NA $450 \3\ $1,200

$1,000,000.01-$5,000,000...... $2,000 [500] NA $450 \3\[300 \4\] $1,200 [1,000]

[Over] $5,000,000.01- $2,500 [500] NA $450 [300 \4\] $1,200 [1,500]

$10,000,000.

Over $10,000,000.............. $5,000 NA $450 \3\ $1,200

----------------------------------------------------------------------------------------------------------------

[\1\ Simplified Arbitration (Without Hearing)]

\1\ [\2\] The dispute is resolved by o[O]ne a[A]rbitrator per hearing session, including pre-hearing

conferences. [(Per Hearing Session)]

\2\ [\3\] The dispute is resolved by t[T]hree [or more] a[Arbitrators per hearing session. [(Per hearing

session)]

\3\ [\4\] Fee applies only to p[P]re-hearing c[C]onferences [Only] with a single arbitrator.

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 self-regulatory organization

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. The self-regulatory organization

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

Background and Introduction

NASD Regulation is proposing to amend the NASD's Code of

Arbitration Procedure to increase the filing fees and hearing session

deposits charged to public investors, member firms and associated

persons for arbitrating disputes under the Code. In addition, NASD

Regulation is proposing to increase the honoraria paid to

arbitrators.\2\

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\2\ This rule filing replaces SR-NASD-97-39, in which NASD

Regulation originally proposed the amendments to the filing fees and

hearing session deposits that are contained in this filing. As

discussed below, in this filing NASD Regulation has modified some of

the fee changes proposed in SR-NASD-97-39 to align the fees charged

more closely with the Office of Dispute Resolution's (``Office'')

average costs of administering arbitration proceedings. In addition,

the budget, revenue and cost figures used throughout this filing

reflect the most current information about the arbitration process.

Since SR-NASD-97-39 was filed, the NASD has completed its 1998

budget process. The Office's revised 1998 revenue and expense

figures from the 1998 Budget (set forth in Table 1) reflect

significant savings resulting from the NASD's ``Reinvesting for Our

Future'' program. This program required NASD departments to identify

areas within their operations where savings could be achieved. In

addition, the Office's 1997 revenue and cost experience through the

end of September 1997, and including the new member surcharges

implemented on July 1, 1997, caused NASD Regulation to revise the

Office's projected 1998 revenues and costs. The revised revenue and

cost projections are reflected in this rule filing.

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In support of the proposed rule change, below is a discussion of

NASD Regulation's arbitration program operating costs and revenue, new

initiatives for improving the arbitration program, and a general

description of filing fees, hearing session deposits and forum fees

charged in arbitration proceedings. In addition, the development of the

proposed fee increases is described. Finally, a narrative description

of the proposed rule change is provided.

Operating Costs and Revenue. NASD Regulation's Office of Dispute

Resolution (``Office''), and its predecessors, have been administering

arbitrations for the Association since 1969. Since 1972 NASD Members

have been required to submit disputes to arbitration upon the request

of a customer, another member or an associated person. Submission of

claims to arbitration by public investors was largely voluntary until

1987 and, as a result, the program handled a relatively small number of

cases each year. Following the United States Supreme Court's 1987

decision in Shearson/American Express, Inc. v. McMahon, 482 U.S. 220,

96 L.Ed.2d 185, 107 S.Ct. 2332, affirming the enforceability of

customer predispute arbitration agreements, the arbitration caseload

grew rapidly and the program now handles more than 6,000 cases

annually.

The Office's operating costs have been funded from filing fees

(charged to any party filing a claim in arbitration), forum fees

(charged for each hearing session held in an arbitration and allocated

by the arbitrators in the award to the parties), and, more recently,

member surcharges (charged to any member named in a claim and to any

member when an employee of the member is named in a claim). The

difference between the revenue collected in fees and the cost of

administering the program has been made up from the general member

assessment revenue collected by the Association from all of its

members. As the number of cases has grown, and the cost and complexity

of administering arbitration proceedings have increased, NASD

Regulation has sought to increase the fees in order to shift the costs

of the program primarily to its member users. In 1994, for example,

NASD Regulation began charging members a non-refundable fee if the

member or an associated person of the member was named in an

arbitration proceeding--the ``member surcharge.''

In spite of the effort to shift the costs to service users, the

Office is not collecting sufficient user revenue to cover its costs.

For example, as the table below illustrates, in 1996 the cost of the

dispute resolution program exceeded fee

[[Page 63583]]

revenue by $11.3 million. For 1997, even with the implementation of

substantial increases in the member surcharge and an increase in

revenue due to increases in the arbitration caseload, the cost will

exceed revenue by $16 million. For 1998, even if the proposed changes

are approved and implemented, the cost of the program will exceed

revenue by $6.1 million.

Table 1.--Revenues vs. Expenses

[In thousands of dollars]

----------------------------------------------------------------------------------------------------------------

1998

Projected

(includes 1998

1997 member Projected

Projected surcharge (with member

(with member and surcharge,

1995 Actual 1996 Actual surcharge arbitrator arbitrator

increase honorarium honorarium

effective 7/ increase, increase and

1/97) but without fee

fee increases)

increase)

----------------------------------------------------------------------------------------------------------------

Revenue................................... $9,664 $13,275 $16,000 $23,110 $29,100

Expenses.................................. $17,826 $24,617 $31,988 $35,128 $35,158

Net....................................... ($8,162) ($11,342) ($15,988) ($12,058) ($6,058)

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The revenue shortfall in the program is currently made up from

general assessment revenue; however, NASD Regulation is developing

further increases in the member-user fees to close the budget gap.

There will not be any further increases in fees charged to public

investors in the foreseeable future.

New Initiatives to Improve the Arbitration Program. In January

1996, the NASD's Arbitration Policy Task Force (``Task Force'')

released its report on Securities Arbitration Reform. The Task Force's

report made numerous recommendations to improve the arbitration

process. Some of the recommendations, such as early appointment of

arbitrators, have been implemented. Other recommendations, such as

selecting arbitrators by a list selection method, involve significant

technological changes and changes in the way the Office administers

arbitration cases. And still others, like increasing arbitrator

honoraria to attract and retain qualified arbitrators, involve

permanent increases in the NASD's costs of operating the program.

Since the report was released, NASD Regulation has been engaged in

a major effort to implement the numerous Task Force recommendations.

The Office also has other initiatives underway to improve the

arbitrator process. These include improving case processing and

administration by, among other things, upgrading the computerized case

tracking system and hiring additional staff. Some of the changes, such

as increasing arbitrator honoraria and implementing list selection of

arbitrators, will result in permanent increases in the cost to the NASD

of administering the dispute resolution program, while others, such as

improving case tracking, should result in savings. Implementing these

changes will substantially improve the fairness and efficiency of the

arbitration process. Finally, the growth rate in NASD Regulation's

arbitration case load over the last ten years, and the increasing

length and complexity of arbitration cases, are generating additional

cost pressures on the Office in its continuing efforts to meet the

needs of users of the dispute resolution services.\3\

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\3\ The number of cases filed with NASD Regulation's Office of

Dispute Resolution in the first five months of 1997 is up 16 percent

over the same period in 1996. The number of cases filed annually has

risen from 2,886 in 1987 to an estimated 6,247 in 1997 based on the

number of cases filed in the first nine months of 1997, a 116

percent increase. NASD Regulation projects that over 6,900 cases

will be filed in 1998, an increase of 139 percent over 1987.

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The amendments to the fee schedules proposed in this rule change

will serve to close some of the user revenue gap that currently exists

in funding the Office's direct costs of providing arbitration services.

However, the revenue from the proposed fee increases on public

investors will not be used to fund the development of new systems or

the implementation of the Task Force's recommendations. The exception

to this is the early appointment of arbitrators, a Task Force

recommendation that has already been implemented, and the proposed

increases in arbitrator honoraria, which will be an increase in the

Office's direct cost of administering arbitrations. Both of these

initiatives directly benefit public investors, the first by improving

the efficiency of arbitration, the second by attracting and retaining a

higher caliber of willing, committed arbitrators.

General Description of Filing Fees, Hearing Session Deposits and

Forum Fees. The fees and deposits for arbitration proceedings fall into

three categories: (1) filing fees (including member surcharges); \4\

(2) hearing session deposits; and (3) forum fees.

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\4\ Member surcharges imposed pursuant to Rule 10333, are

intended to shift some of the costs of the dispute resolution

program to the members who are actually named in cases and,

therefore, are the primary users of the program.

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Filing fees are submitted by the party filing a claim. Filing fees

are required for all claims, including cross-claims, counterclaims and

third party claims. For example, if a public investor files a claim

against two members, the investor pays a filing fee specified in Rule

10332 for public investor claimants based on the aggregate amount

claimed. If one member then files a counterclaim against the public

investor, the member pays the filing fee specified in Rule 10332 for

industry claimants based on the aggregate amount claimed in the

counterclaim. If the member then files a cross-claim against the other

member firm respondent or a third party claim against another member,

the member pays another filing fee as specified in Rule 10332 for

industry claimants based on the aggregate amount claimed in the cross-

claim and the member who is a third party respondent pays a member

surcharge based on the aggregate amount claimed in the third party

claim. The members each pay one member surcharge when they are brought

into the case, whether through a claim, counter-claim, cross-claim or

third party claim.

A hearing session deposit is required for arbitrations where

hearings will be held and is intended as an advance payment for the

Office's cost of conducting one hearing session. If the arbitrators

determine that several

[[Page 63584]]

hearing sessions may be necessary, Rule 10332(a) permits them to order

the parties to make additional hearing session deposits. The cost of

conducting a hearing session includes arbitrator compensation and

travel expenses, hearing conference rooms, and staff work and expenses.

All parties are required to pay the hearing session deposits specified

in Rules 10205 and 10332. Any member firm filing a cross-claim,

counterclaim, or third party claim against a public investor must pay

the hearing session deposits specified for industry claimants in Rule

10332. In addition, if a case is settled or withdrawn more than eight

days before a hearing is held, the hearing session deposit is refunded;

in the Office's experience this occurs two-thirds of the time.

Forum fees are NASD Regulation's charges that are assessed by the

arbitrators to the parties for conducting hearings where evidence and

testimony is presented. The fees are based on the number of hearing

sessions scheduled and conducted. Thus, forum fees can be assessed even

if there is no final award. Forum fees assessed by the arbitrators are

paid to NASD Regulation, not to the arbitrators, and the arbitrators'

compensation is not affected by the amount of forum fees assessed or

collected. The arbitrators can assess forum fees for each hearing

session up to the maximum hearing session deposit that the party is

required to pay under Rule 10332. For example, under the proposed rule

change, the hearing session deposit for a public investor with a

$100,000 claim is $750. Therefore, if an arbitration took four hearing

sessions (two full days), the arbitrators could assess a maximum of

$3,000 in forum fees.\5\ The arbitrators can assess the forum fees

evenly between the parties, or apportion the fees in any other manner,

including assessing all forum fees against one party. The arbitrators

can also determine to assess only part of the forum fees against one

party (the respondent, for example) and not assess any forum fees

against another party (the claimant, for example). Any forum fee

assessed against any party is reduced by the amount of hearing session

deposits already paid by the party.

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\5\ Arbitrators assess forum fees in the award. The Office keeps

track of the number of hearing sessions held, the hearing session

charge to be applied and any other fees paid or incurred (such as

filing or postponement fees and hearing session deposits) and

advises the arbitrators. The arbitrators then determine how much of

the fees, if any, each party will be responsible for paying,

sometimes setting forth liability for the fees in percentages and

specifying individual or joint and several liability for the fees.

Finally, the award will set forth the specific amounts of fees owed

by each party.

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Development of Proposed Fee Increases

As a result of the continuing growth of the program and the current

and projected operating revenue shortfalls, NASD Regulation determined

that changes to the funding mechanisms were necessary. Moreover, as

discussed below, the fees collected under the current schedule do not

come close to covering the NASD's costs of providing the arbitration

service. In order to ensure that the changes were appropriate to the

goals of the program and fair to its users, NASD Regulations

established guidelines for fee increases and analyzed the program to

identify the cost of each service.\6\ In addition, NASD Regulation

identified the member users of the program.

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\6\ The NASD Regulation Board of Directors formed a Subcommittee

on Arbitration Fees to examine the current revenue, cost and fee

structure, and to recommend changes. The Subcommittee was composed

of three public members (James E. Burton, CalPERS; Bonnie Guiton

Hill, Times-Mirror Corp.; and William S. Lapp, Esq., Lapp, Laurie,

Libra, Abramson & Thomson, board member of the Public Investors

Arbitration Bar Association and member of NASD Regulation's National

Arbitration and Mediation Committee (NAMC)) and three securities

industry members (Raymond E. Wooldridge, Southwest Securities Group,

Inc., NAMC member and Chairman of NAMC's Finance Subcommittee, and

former Vice-Chairman of NASD Regulation's Board of Directors; Philip

S. Cottone, Rutherford, Brown & Catherwood, Inc., Chairman of NAMC

and former member of NASD Regulation's Board of Directors; and O.

Ray Vass, Merrill, Lynch, Pierce, Fenner & Smith, Inc., member of

NASD Regulation's Membership Committee).

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In 1996, case volume for the entire program (public investor and

intra-industry arbitration) was analyzed to obtain a profile of the

users of arbitration services and to project the impact of future fee

changes upon member firms.\7\ This analysis revealed that only 753

firms (14 percent) out of approximately 5,500 NASD member firms had

been parties to arbitration cases. Of these 753 firms, 88 firms (12

percent) accounted for over 50 percent of the case volume. Each of

these 88 firms reported revenues in excess of $100 million on their

FOCUS filings.\8\ In contrast, firms that reported revenues of less

than $500,000 accounted for only 9 percent of NASD member firms and

less than 3 percent of the total projected case load. Thus, a small

number of large firms are involved in more than 50 percent of all

arbitration cases. NASD Regulation considers these firms to be the

primary and most frequent member users of the service and, therefore,

believes it is appropriate for any fee changes to shift member costs to

these member users. The proposed rule changes, including the changes to

the member surcharge adopted in July 1997, largely accomplish this

goal. In addition, any future changes to the fee structure will

transfer any additional costs to these primary users of the program.

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\7\ See Table 3, infra, for a summary of the analysis.

\8\ FOCUS Reports (Financial and Operational Combined Uniform

Single Reports) are submitted to the NASD pursuant to SEC Rule 17a-5

by member firms to report on the member's net capital and general

financial position.

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The Office has analyzed the overall flow of revenue from users of

the arbitration services for the twelve months ending August 31, 1997.

After calculating filing and other fees with forum fees actually paid

by public investors and refunds received by public investors, the data

show that public investors currently are assessed approximately $3.5

million of $15.3 million in fee revenue collected from users. This is

23 percent of the total fee revenue. Although the time periods are not

directly comparable, the revenue contribution of public investors over

the twelve months ended August 31, 1997 is less than 12 percent of the

$29.8 million calendar year 1997 projected total cost of running the

dispute resolution program. Public investors, however, file

approximately 80 percent of the new claims filed with the Office each

year. Moreover, even though some of these revenue contribution figures

will vary because of differences in case volume, forum fee allocations

and other factors, NASD Regulation believes that the total relative

revenue contributions of public investors and members will not change

substantially after the proposed fee changes are approved.

Overall, NASD Regulation expects that the fee changes proposed in

this rule filing and the member surcharge changes implemented earlier

in 1997 will generate approximately $11.5 million in additional

revenue. The combination of increases in fees (filing fees, member

surcharges and hearing session deposits) charged to members will

generate $8.4 million in additional revenues (73 percent of total

additional revenues to be generated by the fee changes). Even with this

additional revenue, the Office will continue to incur operating

shortfalls of more than $6.1 million.

Guidelines for Proposed Fee Increases. In developing the proposed

rule change, NASD Regulation identified several important principles to

guide its decisions on the appropriate fees for the arbitration service

it provides:

The current ratio of public investor fees to member fees

should not change. Currently public investors pay approximately 23

percent of the

[[Page 63585]]

arbitration service fees and members pay 77 percent.

The fees should not create a financial barrier to prevent

a public investor from seeking arbitration. The maximum fee charged to

public investors should not exceed the direct costs of providing the

service and public investors should be permitted to ask the Office to

waive the fees in circumstances of financial hardship.

The fees for a public investor to file a case in

arbitration (the filing fee plus hearing session deposit) must be less

or no more than the initial fee charged to the member named in the

aribration (the member surcharge).

The revenue contribution plan should, to the extent

possible, impose costs on the member firms that use the program.

Any fee increases for public investors should be allocated

to reduce the revenue shortfall for direct arbitration services alone.

Additional fee increases to cover revenue shortfalls for other dispute

resolution programs and indirect operating costs would be assessed to

member users of the dispute resolution programs.

Activity-Based Cost Analysis. In order to understand better the

costs of administering the dispute resolution program, NASD Regulation,

assisted by the accounting firm of Coopers & Lybrand, conducted an

activity-based costing study to identify more accurately the Office's

current costs and link specific activity costs to the services

provided. This study identified fifty-two separate arbitration service

activities and determined the total direct cost of performing each

activity.

In addition to providing the Office with a better understanding of

particular activities and costs, the study also provided a program-wide

perspective of the raw average costs and average fees collected in both

simplified and standard arbitration cases. The study showed, on a per

occurrence basis, the costs associated with activities such as: (1)

receiving and processing claims; (2) analyzing and serving claims; (3)

selecting arbitrators; (4) scheduling hearings; and (5) conducting

hearing sessions. The analysis has permitted the Office to extrapolate

its likely costs for 1998 and compare them to the revenue expected.

This ``Break-Even Analysis'' is attached to this filing as Exhibit 2

and is discussed below.

The raw average costs for particular activities have been

identified by breaking down the work of the Office into discrete

functions, such as ``Receiving Claims.'' The cost of performing these

discrete functions is then identified by totaling the staff hours and

other expenses devoted to the function. The number of occurrences of

the function are then identified and counted. The number of times the

receiving claims function occurs matches the number of claims filed

with the Office each year. The number of occurrences of the function is

then divided into the total cost to derive the per occurrence cost of

the function, or the raw average cost. The average cost of each

function can be multiplied by the number of times it occurs in each

case and added to all of the other functional costs of a case to

produce the average cost of a hypothetical case.

The costs associated with particular cases, however, fall along a

wide spectrum depending on the nature of the case. Cases that are

settled shortly after being filed usually cost little to administer.

Cases that involve numerous and complex issues, numerous pre-hearing

rulings and conferences with the arbitrators, lengthy hearings and,

finally, an award are more costly to administer than other cases. The

Office has also found that the larger the amount in dispute, the more

costly the case is to administer because there are usually more parties

involved (which makes communication more costly and time consuming),

there are more motions and other disputes to resolve, and prehearing

conference and hearing logistics are more complicated. This wide

spectrum of costs is the reason that the Office imposes graduated fees

in two stages: filing fees and forum fees (the latter are partly

prepaid through hearing session deposits).

Finally, NASD Regulation notes that the activity-based cost

analysis is a useful analytical tool for budgeting and planning;

however, it should not be relied upon to produce guaranteed cost

figures. The actual costs of providing the services can and will vary

due to factors that are unpredictable and beyond NASD Regulation's

ability to control.

Proposed Rule Changes

In view of the foregoing, NASD Regulation is proposing to amend the

schedules of fees (including hearing session deposits) for both intra-

industry and public investor disputes to support the improvement of the

arbitration service administered by the Office and to shift the cost of

administering the service to the users.

The filing fee and hearing session deposit changes proposed in this

rule filing are discussed in four separate categories: (1) filing fees

for claims by public investors against members (``Public Investor-

Member Disputes''); (2) filing fees for claims by members against

public customers (``Member-Public Investor Disputes'') or other members

or associated persons (``Intra-industry Disputes''); \9\ (3) hearing

session deposits in all cases between public investors and members, and

in intra-industry cases; and, (4) miscellaneous changes. Also discussed

are NASD Regulation's proposed changes to the arbitrator honorarium

schedule. NASD Regulation believes the changes, taken together, will

maintain the current ratio of funding of the arbitration service

between public investors and members.\10\

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\9\ The proposed rule change treats associated persons of

members like public customers for purposes of fees. See discussion,

infra.

\10\ For the twelve month period ending August 31, 1997, the net

revenue contribution of public investors was approximately $3.5

million. (Net revenue contribution is calculated by identifying the

fees paid, including hearing session deposits and postponement fees,

less the refunds and reallocations through assessment of costs, such

as forum fees.) The net revenue contribution of members was $11.8

million. NASD Regulation is projecting that the combined additional

revenue generated by the proposed fee increases in this rule filing

and the increased member surcharge already in effect will be

approximately $11.6 million. While it is not possible to predict

accurately the 1998 net revenue contributions of public investors

and members, NASD Regulation intends for the proposed increases to

maintain the same ratio of public investor/member net revenue

contributions.

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Filing Fees: Public Investor-Member Disputes. NASD Regulation is

proposing to amend Rule 10332 to increase the filing fee for disputes

between a public investor claimant and a member respondent by an

average of 50 percent in most brackets (fees are based on the amount in

dispute, and a range of amounts in dispute (e.g., $50,000.01 to

$100,000) to which a particular fee applies is referred to as a

bracket) and add three new brackets to graduate further the fee

schedule. For example, the old bracket of fees for claims of $10,000.01

to $30,000 has been divided into two brackets; one from $10,000.01 to

$25,000 with a new filing fee of $125 (versus $100 for the old

bracket), and another from $25,000.01 to $30,000 with a new filing fee

of $150. The old bracket was divided to take into account the new

ceiling for simplified arbitration cases, which was raised from $10,000

to $25,000.\11\ The largest filing fee increases are for the largest

cases; the filing fee for claims of more than $10,000,000 is being

raised 100 percent from $300 to $600.\12\

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\11\ See note 1, supra.

\12\ See Table 2, infra.

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Using the costs identified in the activity-based costing study,

NASD Regulation believes that in 1998 the average direct cost

associated with processing a simplified arbitration case

[[Page 63586]]

from beginning to end will be approximately $412. For a standard case

the cost from filing through all activities up to the prehearing

conference will range from $353 through at least $630. The activity

categories used to calculate average claim processing costs were: (i)

receipt/assignment of cases; (ii) check processing; (iii) analyzing

claims; (iv) serving claims; (v) processing answers; (vi) processing

motions; (vii) processing counterclaims; and (viii) conducting

discovery (except for prehearing conferences to resolve discovery

issues). Activity costs that were not included, among others, were; (i)

recruiting and training of arbitrators; (ii) qualifying arbitrators;

(iii) mediation; and (iv) NASD corporate oversight and transfer pricing

of services from other departments.

For a simplified arbitration case the proposed customer filing fee

for a $10,000 claim is $75, plus a proposed $250 simplified arbitration

fee, for a total of $325, versus average costs for simplified cases of

$412. Because there are no hearings in such cases, much of the Office's

cost is associated with activities from processing the claim up through

presenting it to the arbitrator for a decision. By contrast, in cases

where hearings are conducted, the hearings constitute by far the

largest portion of the cost.

NASD Regulation is proposing filing fees designed to cover as much

of the actual costs of the arbitration process from filing up to the

prehearing conference as is possible without erecting barriers to entry

into arbitration. For a standard case in which more than $100,000 is in

dispute and three arbitrators are appointed, the proposed customer

filing fee is $300, while the Office's average expenses for

administering the case from filing up to the pre-hearing conference

will be at least $477. The margins for large bracket cases are smaller,

but the proposed fees do not exceed the actual average cost to provide

the service.

NASD Regulation's ``Break-even Analysis'' (attached as Exhibit 2)

illustrates how the Office's costs of administering an arbitration

correlate to the revenues obtained through filing fees and hearing

session deposits using 1998 figures and the proposed fee increases.\13\

The analysis uses the activity categories identified in the activity-

based costing study. For each type of activity the Office's total cost

of performing the activity (serving claims, for example) is divided by

the number of times the particular activity occurs to produce an

approximate average cost for each occurrence of the activity. These

activities and their costs are then charted sequentially as they would

likely occur in a case to produce a hypothetical cumulative cost at

each major stage of a case. This average cost is charted against the

fee revenue received in a case. As noted above, however, NASD

Regulation does not regard the analysis as a guarantee that in each

case each step in the process will cost no more than the average

predicted by the analysis.

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\13\ Exhibit 2 to the proposed rule filing presents examples of

how the proposed filing fees and forum fees would apply in

particular types of cases and the Office's average costs of

administering arbitration proceedings in such cases. The figures in

the line ``Net of revenues--cost'' show the loss the Office will

incur in the example when the Office's costs are subtracted from the

revenues collected. Similarly, the final figure in each example

shows how much the Office would lose in such cases after the

Office's total costs are subtracted from the revenues collected,

including forum fees. In addition, for comparison purposes, Exhibit

2 includes the current forum fees that would be charged for the type

of case in each example. Because the cost figures set forth in

Exhibit 2 are averages, parties should not regard them as predictive

of the actual cost of administering their case.

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The analysis shows that well before a preheating conference is held

the claim filing fee revenue has been used up and, after an award is

rendered following a hearing, all of the fee filing revenue and forum

fees that could be collected in a case have been expended. The analysis

takes into account that some activities (processing motions, for

example) will occur several times in a case. In addition, the costs of

some activities (notably, holding hearings) vary greatly so that,

although it is possible to establish an average cost for the activity,

the cost of the activity in a particular case could be substantially

higher or lower than the average. Finally, in the Office's experience,

the cost of some activities tends to vary by the amount in dispute,

with larger cases tending to cost more to administer at certain stages

than smaller cases. The Office believes that the cost variance may

result from the increased contentiousness of the litigants when there

are significant damages in dispute and there are sometimes larger

numbers of parties involved in cases where large amounts are in

dispute.

While the proposed increases in filing fees and hearing session

deposits are expected to generate $3.1 million in additional revenue

from public investors, the increase will be spread over more than 5,000

cases and should not discourage claimants from seeking relief. For

example, in cases where more than $50,000 is in dispute (approximately

16 percent of the public investor cases filed with the Office), the

filing fee is increasing $75 from $150 to $225. The increase of $75

represents less than 2/10 of 1 percent of the amount in dispute.\14\

The filing fee increases in other brackets are similarly small relative

to the amount in dispute:

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\14\ By contrast, the filing fees of the American Arbitration

Association (``AAA'') range from $300 to $4,000, depending on the

amount in dispute. In addition, the AAA's rules require the parties

to pay arbitrator honorariums and other costs of an arbitration

proceeding.

[[Page 63587]]

Table 2.--Percentage Increase in Customer Filing Fees

----------------------------------------------------------------------------------------------------------------

Increase as

Old filing Proposed Dollar Percent percent of

fee new filing amount of increase amount in

fee increase dispute

----------------------------------------------------------------------------------------------------------------

$.01-1,000.00.................................. $15 $25 $10 66.67 1.000

$1,000.01-2,500................................ 25 25 0 0.00 0.000

$2,500.01-5,000................................ 50 50 0.000 0 0.000

$5,000.01-10,000............................... 75 75 0 0.00 0.000

$10,000.01-25,000.............................. 100 125 25 25.00 0.250

$25,000.01-30,000.............................. 100 150 50 50.00 0.200

$30,000.01-50,000.............................. 120 175 55 45.83 0.183

$50,000.01-100,000............................. 150 225 75 50.00 0.150

$100,000.01-500,000............................ 200 300 100 50.00 0.100

$1,000,000.01-3,000,000........................ 250 500 250 100.00 0.025

$500,000.01-3,000,000.......................... 250 375 125 50.00 0.025

$3,000.01-5,000,000............................ 250 600 350 140.00 0.012

$5,000.01-10,000,000........................... 300 600 300 100.00 0.005

Over $10,000.000............................... 300 600 300 100.00 0.005

----------------------------------------------------------------------------------------------------------------

Filing Fees: Member-Public Investor Disputes and Intra-Industry

Disputes. NASD Regulation also is proposing to amend Rule 10332 to

increase the filing fees where a member files a claim against a public

investor. The current filing fee is $500 for all brackets. NASD

Regulation is proposing to substitute a graduated filing fee beginning

at $200 for claims of $1,000 or less up to $5,000 for claims over

$10,000,000. By graduating the fee schedule, the filing fees are

assessed proportionately on the members based on the size of the claim.

Thus, while the filing fees for large claims would increase

substantially, the filing fees for small claims would actually

decrease. The fairness of the fee schedule to members with small claims

is enhanced by decreasing fees for claims of $5,000 or less.

NASD Regulation also is proposing to amend Rule 10205 to increase

and graduate the filing fees for intra-industry disputes. Currently,

the filing fees are $500 regardless of the amount in dispute. NASD

Regulation is proposing to graduate the filing fee from $200 for claims

of $1,000 or less up to $5,000 for claims exceeding $10,000,000 in

order to make the filing fee fairer to claimants with small claims.

As noted above, in addition to the filing fee and hearing session

deposit increases proposed in this rule filing, NASD Regulation has

increased substantially the surcharge on members named as respondents

in an arbitration proceeding.\15\ Taken together, the surcharges and

proposed fee increases on members in both public-investor and intra-

industry cases are expected to generate $8.4 million in additional

revenue, or 73 percent of the total revenue generated. The specific

impact on members is shown below:

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\15\ Rule filing SR-NASD-97-40, filed for immediate

effectiveness on June 12, 1997, and effective July 1, 1997, steeply

graduated and increased the surcharge on members from a maximum of

$500 under the old schedule to $3,600 under the new schedule.

Table 3.--Impact of Fee Increases (Including Surcharges) on Member Firms

----------------------------------------------------------------------------------------------------------------

Number of Estimated

Capitalization of firm Number of cases (est. Percent of impact Impact per

firms 1998) total (1998) firm

----------------------------------------------------------------------------------------------------------------

$1 Billion +................................... 19 2495 36.18 $3,000,000 $157,895

$100 Million-$1 Billion........................ 69 1062 15.40 1,300,000 18,841

$50 Million-$100 Million....................... 48 531 7.70 650,000 13,542

$25 Million-$50 Million........................ 83 751 10.90 900,000 10,843

$10 Million-$25 Million........................ 117 766 11.11 950,000 8,120

$1 Million-$5 Million.......................... 303 1069 15.50 1,300,000 4,290

$500,000-$1 Million............................ 49 111 1.61 150,000 3,061

Less Than $500,000............................. 65 111 1.61 150,000 2,308

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Total.................................... 753 6896 100.00 8,400,000 11,155

----------------------------------------------------------------------------------------------------------------

The average increase in cost to member firms for each case will be

$1,218.

NASD Regulation is proposing increases in member-user contributions

to the dispute resolution process because member firms have indicated

that arbitration is their preferred forum for resolving public

investor-member disputes through the predispute arbitration agreements

that are typical of broker-customer business relationships.

Accordingly, the proposed fee increases assess the costs on the actual

users of the program.

Hearing Session Deposits. NASD Regulation also is proposing to

amend Rules 10205 and 10332 to increase the hearing session deposits

\16\ for all cases by no more than 50 percent in most brackets (in the

lowest brackets increases from $15 to $25, and $25 to $50, represent 67

and 100 percent

[[Page 63588]]

increases, respectively) and to add three new brackets to graduate

further the hearing session deposit schedule. For example, the old

bracket of fees for claims of $10,000.01 to $30,000 has been divided

into two brackets, one from $10,000.01 to $25,000 with a new hearing

session deposit of $450 \17\ (compared to $300 for the old bracket) for

a single arbitrator, and another from $25,000.01 to $30,000 with a new

hearing session deposit of $450. In the $25,000.01 to $30,000 bracket

the hearing session deposit for three arbitrators will be $600

(compared to $300 for the old bracket). The hearing session deposit for

claims of $5,000,000.01 or more is being reduced to $1,200.

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\16\ Hearing session deposits are required before NASD

Regulation will schedule a hearing unless waived by the Director due

to financial hardship. The amount deposited is offset against the

actual hearing costs incurred. If a case is settled, dismissed, or

withdrawn more than eight business days before a hearing was

scheduled to occur, the hearing session deposit is refunded.

\17\ Under the new ceilings for single arbitrator claims without

a hearing, claims up to $25,000 may be resolved by a single

arbitrator on the pleadings alone. In such cases, a hearing session

deposit is not required. Thus, the new $450 hearing session deposit

for such cases only applies in the event the claimant requests a

hearing.

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The proposed new hearing session deposits are based on the results

of the activity-based costing study which showed that, for cases

requiring hearings, NASD Regulation's projected average cost to provide

hearings in 1998 will be approximately $1,200 per hearing session. The

activities used in computing this cost include arbitrator expenses and

compensation, hearing room expenses, taping expenses, and staff work

and expenses. The Office's experience also shows, however, that the

costs of conducting hearings varies significantly with the amount in

dispute and the number of parties involved. This is because staff

attorneys may need to attend some or all of the hearing sessions, staff

coordination of logistics may be more difficult and complicated, and

staff communication with the parties may be more involved and time-

consuming. Moreover, the hearing session deposits have been graduated

from a relatively low level for cases in lower brackets up to the

actual average cost of conducting hearings because NASD Regulation

believes that charging claimants the full cost of conducting hearings

in relatively small cases could discourage some public investors from

seeking relief.

In addition, the proposed rule change makes the hearing session

deposits for particular brackets the same among all types of cases;

public investor vs. member, member vs. public investor and intra-

industry. This is being done because NASD Regulation believes the

hearing session deposit, and by extension the forum fees, should not

exceed the Office's actual costs, and such costs are, on average,

approximately the same for all types of cases, even if they may vary by

the amount in dispute or the number of parties involved. As a result of

this change, the hearing session deposit will be the same without

regard to whether a public investor or a member filed the initial

claim.

Miscellaneous Changes. NASD Regulation is proposing to amend Rule

10205(a) to provide that if the claimant is an associated person, he or

she will pay the filing fee and hearing session deposit specified for

public customers. However, if the associated person is a joint claimant

with a member, the member will pay the filing fee and hearing session

deposit specified for industry claimants. NASD regulation is also

proposing to amend Rules 10205(e) and 10332(e) to increase the hearing

session deposit from $600 to $1000, or an amount specified by the

Director or the arbitrators not exceeding the maximum hearing session

deposit specified in the rules, for claims where the amount in dispute

is not disclosed by the claimant in the Statement of Claim.\18\

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\18\ In cases where the claimant is seeking a remedy other than

damages (recision, for example) and does not specify damages, the

staff will attempt to establish the market value of the securities

which are the subject matter of the claim before resorting to the

default fee specified in paragraph (e) of the two rules.

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Finally, Rules 10205(i) and 10332(h) are proposed to be amended to

provide that the filing fees and hearing session deposits for large and

complex cases brought under Rule 10334 \19\ will be those specified for

cases exceeding $10,000,000. There are a few significant and distinct

costs associated with such cases, including the Administrative

Conference, the number of hearing sessions, pre-hearing issues to be

resolved and customized arbitration procedures that may be requested by

the parties.

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\19\ Rule 10334 (the rule for large and complex cases) has been

extended for five years and the use of the procedures is now

entirely voluntary. See Securities Exchange Act Release No. 39024

(September 5, 1997), 62 FR 47856 (September 11, 1997).

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Arbitrator Honoraria. NASD Regulation is proposing to amend IM-

10104 to increase the honoraria paid to arbitrators. The honorarium

will be increased from $150 to $200 for each hearing session, with an

additional $75 per day for the chairman of the panel. Thus, the

Office's honorarium cost for a panel of three arbitrators for one

hearing session is $675. The honorarium for a prehearing conference

will be $200. The honorarium for a case not requiring a hearing will be

$125.

2. Statutory Basis

NASD Regulation believes that the proposed rule change is

consistent with the provisions of Section 15A(b)(5) of the Act \20\ in

that the proposed rule change provides for the equitable allocation of

reasonable charges among members and other persons using the

Association's arbitration facility because it further graduates the fee

schedules and requires users, especially member firm users, to absorb a

reasonable share of the costs of operating the arbitration program.

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\20\ 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 impose

any inappropriate burden on competition.

C. Self-Regulatory Organization's Statement on Comments on the Proposed

Rule Change Received from Members, Participants, or Others

No written comments were either solicited or received.

III. Date of Effectiveness of the Proposed Rule Change and Timing

for Commission Action

Within 35 days of the 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 the 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 and copying at

[[Page 63589]]

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-97-79 and should

be submitted by December 22, 1997.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc 97-31392 Filed 11-28-97; 8:45 am]

BILLING CODE 8010-01-M