Self-Regulatory Organizations; Order Granting Approval to Proposed Rule Change by the National Association of Securities Dealers, Inc. Creating a Discovery Guide for Use in NASD Arbitrations

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41833; File No. SR-NASD-99-07]

Self-Regulatory Organizations; Order Granting Approval to

Proposed Rule Change by the National Association of Securities Dealers,

Inc. Creating a Discovery Guide for Use in NASD Arbitrations

September 2, 1999.

I. Introduction

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 (``SEC'' or ``Commission'') a

proposed rule change pursuant to Section 19(b)(1) of the Securities

Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4 thereunder.\2\ Under

its

[[Page 49257]]

proposal, NASD Regulation seeks to create a discovery guide for use in

NASD arbitrations. Notice of the proposal, as amended by Amendment No.

1 and Amendment No. 2, was published in the Federal Register on April

23, 1999 (``Notice'').\3\ The Commission received eight comment letters

on the filing.\4\

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\1\ 15 U.S.C. 78s(b)(1).

\2\ 17 CFR 240.19b-4.

\3\ See Securities Exchange Act Release No. 41302 (April 16,

1999), 64 FR 20036 (File No. SR-NASD-99-07).

\4\ See letters from Cliff Palefsky, National Employment Lawyers

Association (``NELA''), to Secretary, Commission, dated May 4, 1999

(``NELA Letter''); Barbara Black, Professor of Law, to Secretary,

Commission, dated May 13, 1999 (``Black Letter''); Mark E. Maddox,

Public Investors Arbitration Bar Association (``PIABA''), to

Jonathan G. Katz, Secretary, Commission, dated May 18, 1999 (``PIABA

Letter''); Linda P. Drucker, Charles Schwab & Co. Inc. (``Schwab''),

to Jonathan G. Katz, Secretary, Commission, dated May 14, 1999

(``Schwab Letter''); Stephen G. Sneeringer, Securities Industry

Association (``SIA''), to Jonathan G. Katz, Secretary, Commission,

dated May 14, 1999 (``SIA Letter''); Paul L. Matecki, Raymond James

& Associates, Inc. (``Raymond James''), to Jonathan G. Katz,

Secretary, Commission, dated May 14, 1999 (``Raymond James

Letter''); Norman S. Poser, Professor of Law, to Secretary,

Commission, dated May 13, 1999 (``Poser Letter''); Dan Jamieson, to

Jonathan G. Katz, Secretary, Commission, dated June 1, 1999

(``Jamieson Letter'').

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II. Description of the Proposal

NASD Regulation proposes to create a Discovery Guide to streamline

the discovery process in NASD arbitrations involving customers. The

Discovery Guide, which contains Document Production Lists, provides

parties to an arbitration proceeding guidance on which documents they

should exchange without arbitrator or NASD Regulation staff

intervention. Further, the Discovery Guide provides arbitrators with

guidance in determining which documents should be produced by customers

and member firms or associated persons in customer arbitrations.

The Discovery Guide, which includes the Document Production Lists,

is intended to function as a guide for parties and arbitrators in the

discovery process. It is not intended to bind arbitrators or parties in

a particular case. Further, nothing in the Discovery Guide precludes

parties from voluntarily agreeing to an exchange of documents in a

manner or scope different from that set forth in the Discovery Guide or

Document Production Lists. In addition, any party can make a motion

objecting to the production of particular documents included on the

applicable Document Production List(s) in any arbitration proceeding.

Likewise, any party can request that additional documents, not included

on any of the Document Production Lists, be produced. However, if an

arbitrator directs compliance with the Discovery Guide in connection

with ordering the production of documents, the order, like any other

document production order, is binding on the parties.

Background

The Discovery Guide is a consensus document that was developed over

a two-year period. In January 1996, the Arbitration Policy Task Force

(``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.'' \5\

Based on Task Force recommendations, the NASD's National Arbitration

and Mediation Committee, together with advisors from various diverse

backgrounds, helped to draft the Discovery Guide in an effort to

implement these recommendations. Among those contributing to the

Discovery Guide were persons who are members of the Securities

Industries Conference on Arbitration (``SICA'') \6\, 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.

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\5\ See Securities Arbitration Reform: Report of the Arbitration

Policy Task Force to the Board of Governors of NASD (``Task Force

Report'') at 2.

\6\ 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 self-

regulatory organization (``SRO'') forums and participants in those

forums. The membership includes representatives from the SROs with

securities arbitration forums, three or four ``public'' members, and

a representative from the SIA.

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Discovery Guide Features

NASD Regulation proposes that the Discovery Guide 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. SICA members compiled The Arbitrator's Manual as a guide for

arbitrators, and it is designed to supplement and explain the Uniform

Code of Arbitration as developed by SICA. The procedures and policies

set out in both The Arbitrator's Manual and the Discovery Guide are

discretionary and may be changed by the arbitrator(s) so long as they

are consistent with the rules of the forum. 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. The first two lists, one

for firms or associated persons and one for customers, contain

documents that are presumptively discoverable in all customer cases,

unless the arbitrator(s), in the exercise of discretion, determines

that some or all of the documents in the two lists should not be

produced. The next twelve lists, which are dispute specific, contain

additional documents that should be produced by both customers and

firms or associated persons for respectively, claims of churning,

failure to supervise, misrepresentation/omissions, negligence/breach of

fiduciary duty, unauthorized trading, and unsuitability. For example, a

party involved in a churning claim should produce documents from either

List One or Two, which apply to all customer cases, and documents from

List Three or Four, which apply to churning claims.

NASD Regulation's Office of Dispute Resolution (``ODR'') will

provide the parties with the Discovery Guide at the time ODR serves the

statement of claim. If a particular Document Production List is

applicable, the parties should consider those documents to be

presumptively discoverage. Unless the party files a timely objection,

those documents should be produced not later than 30 calendar days from

the date the answer is due or filed, whichever is earlier. Objections

to production of any document on a Document Production List, and any

responses thereto, are to be considered by the arbitrator(s). The

arbitrator(s) then determine whether the objecting party has overcome

the presumption of discoverability based upon sufficient reason(s).

In addition to specific document production requirements, the

Discovery Guide provides general guidance on other issues such as

confidential treatment of documents, additional discovery requests,

depositions, admissibility of evidence, arbitrator participation, and

sanctions. This guidance is discussed below.

Confidential Treatment. The Discovery Guide provides that parties

may stipulate to the confidential treatment of documents.

Alternatively, the arbitrator(s) may issue confidentiality orders.

However, the Discovery Guide further advises that arbitrator(s) should

not issue orders or use confidentiality agreements to require parties

to produce documents

[[Page 49258]]

otherwise protected by established privileges. As discussed more fully

below, a party objecting to discovery on grounds of privilege has the

burden to demonstrate that a particular document is privileged.

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

or service of the objection.

The Discovery Guide also provides a mechanism for a party to seek

to compel production of documents when the adverse party refuses to

produce such documents or offers only to produce alternative documents

that are unacceptable to the requesting party. The Discovery Guide

instructs that the arbitrator(s) carefully consider such motions,

regardless of whether the item requested is on any of the Document

Production Lists.

Depositions. The Discovery Guide discusses the arbitrator(s)'

authority to permit depositions. It suggests depositions be limited to

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) to 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 listed in 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, at the time of the initial prehearing

conference, the exchange of properly requested discovery has not

occurred, the Discovery Guide provides that the arbitrator(s) should

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 \7\ finds that there is

``substantial justification'' for the failure to produce the documents

or information. The Discovery Guide recognizes that panels have wide

discretion to address non-compliance 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

Discovery Guide suggests 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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\7\An arbitration panel's ruling need only be by majority vote;

it need not be unanimous.

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III. Summary of Comments

The Commission received eight comment letters on the proposal.\8\

One commenter urged the adoption of the Discovery Guide as proposed.\9\

Further, none of the commenters opposed the concept of creating a

Discovery Guide for use in customer arbitration.\10\ However, most of

the commenters had particular criticisms about certain aspects of the

Discovery Guide. Additionally, seven of the eight commenters made

suggestions on how to improve the Discovery Guide.\11\ With respect to

several specific criticisms, the comments were evenly distributed on

both sides of the issue.

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\8\ See supra note 4.

\9\ See PIABA Letter.

\10\ Out of the eight commenters, seven stated that they were in

favor of the concept of a Discovery Guide. See PIABA Letter, Black

Letter, Schwab Letter, SIA Letter, Raymond James Letter, Poser

Letter, and Jamieson Letter. The eighth, from NELA, stated that

while the desire to facilitate discovery is appropriate, NELA

believed that the proposed Discovery Guide is problematic in certain

material aspects. See NELA Letter.

\11\See NELA Letter, Black Letter, Schwab Letter, SIA Letter,

Raymond James Letter, Poser Letter, and Jamieson Letter.

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Discovery Guide as a Proposed Rule Change

Three commenters assert that the Discovery Guide should not be

filed with the Commission as a proposed rule change.\12\ They content

that arbitration relies on the flexibility of arbitrators, and adopting

the Discovery Guide as a rule would limit arbitrator(s)' discretion. In

addition, they argue that because the Discovery Guide will be part of

The Arbitrator's Manual, which is not a rule, and will only be a

``guide,'' it should not be submitted as a rule under the rule filing

process. Finally, the commenters maintain that adopting the Discovery

Guide as a rule will give it more importance than what was intended by

its drafters. In contrast, another commenter contends that, because the

Discovery Guide contains guidelines and not mandates, whether it is

issued as a rule is immaterial.\13\ Further, that commenter commends

the Commission for allowing the public to comment on the guidelines

through the formal rulemaking process.

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\12\ See Schwab Letter, SIA Letter, and Raymond James Letter.

\13\See Jamieson Letter.

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Customer Personal Financial Information

Three commenters contend that producing certain documents

reflecting personal financial information infringes on customers'

privacy rights.\14\ In particular, these commenters argue that the

production of tax returns and other financial information, such as

business ownership records, should be limited to certain types of

claims, not be required at all, or the firm should have the burden of

establishing the relevance of these documents in specific cases. One of

these commenters asserts that a customer's right to privacy can only be

waived by the customer, and not by the committees who created the

Discovery Guide or by the securities industry as a condition of the

industry complying with its legal obligation to provide relevant

information in an arbitration.\15\ The commenter argues that decisions

affecting important rights of individual customers (i.e., forced

disclosure of personal and private information) should be made on a

case-by-case basis, and the information should not be subject to

routine disclosure. In addition, another commenter states that the

production of statements concerning a customer's net worth is unfair

because most customers would have to create these statements.\16\

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\14\ See NELA Letter, Black Letter, and Poser Letter.

\15\ See NELA Letter.

\16\ See Jamieson Letter.

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On the other hand, three industry commenters argue that customer

tax returns and other financial information are crucial in all types of

customer/

[[Page 49259]]

broker disputes.\17\ According to one of these commenters, tax returns

and information about net worth are often the only pertinent

documentation that a customer has.\18\ Further, they assert that a

customer's entire tax return (not only the portions listed in the

Discovery Guide) and the customer items in List 8, such as a resume,

should be produced in every case. These commenters believe that this

information is relevant in every dispute.

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\17\ See Schwab Letter, SIA Letter, and Raymond James Letter.

\18\ See Schwab Letter.

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Production Burden on Firms

The three industry commenters argue that the use of documents

dealing with an associated person's disciplinary history violates a

basic premise of the Federal Rules of Evidence.\19\ They maintain that

evidence of prior bad acts, such as records of disciplinary history or

information reported on Forms U-4 and U-5, should not be used in

arbitration to demonstrate an alleged bad act. In response to these

comments, another commenter states that production of these records is

not prejudicial since an associated person's disciplinary history is

already publicly available through the NASD's Public Disclosure

Program.\20\

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\19\ See Schwab Letter, SIA Letter, and Raymond James Letter.

\20\ See Jamieson Letter.

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Additionally, one industry commenter argues that the production of

disciplinary history documents would be particularly burdensome for

discount and on-line brokers.\21\ The commenter contends that because a

customer of a discount broker deals with many associated persons, a

firm's production burden would be tremendous for many types of

disputes. In response to this problem, the commenter suggests limiting

the production of documents to those concerning an associated person

who is regularly and permanently assigned to the account, if any. On

the other hand, another commenter notes that the materials to be

produced by firms under the Discovery Guide are kept in the normal

course of a firm's business pursuant to industry recordkeeping

requirements.\22\

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\21\ See Schwab Letter.

\22\ See Jamieson Letter.

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The three industry commenters also argue that firms should not have

to produce internal audit reports in failure to supervise claims.\23\

They maintain that since failure to supervise can be alleged in almost

all claims, internal audit reports will have to be produced in every

case. Moreover, these commenters assert that production might affect

the vitality and candor of internal audit reports, and thus harm the

``self-policing'' obligation of firms.\24\ Another commenter, however,

argues that any increased exposure of internal audit reports will help

ensure that the reports' recommendations are followed internally, and

that self-policing will thereby by improved.\25\ Furthermore, one

commenter agrees with the Discovery Guide that internal audit reports

are likely to be relevant in a failure to supervise case, regardless of

whether they focus on a particular associated person.\26\

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\23\ See Schwab Letter, SIA Letter, and Raymond James Letter.

\24\ Notwithstanding these comments, the Commission reminds all

regulated entities and persons that nothing in the Discovery Guide

or Document Production Lists changes or reduces their obligations to

monitor compliance with the federal securities laws or rules of

self-regulatory organizations.

\25\ See Jamieson Letter.

\26\ See Poser Letter.

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Miscellaneous

Most of the commenters make suggestions on how to improve the

Discovery Guide and, in particular, the Document Production Lists. For

example, one commenter suggests that the first two lists, which apply

to all customer cases, be ``pruned'' to avoid placing an unreasonable

burden on the parties.\27\ In addition, another commenter suggests that

confidentiality orders or stipulations be used sparingly because

investors already have little information about the arbitration

process.\28\ Another commenter expressed concern that the Discovery

Guide's recognition of ``privacy'' and ``confidentiality'' as valid

objections to document production may encourage parties to make

objections to delay the discovery process.\29\

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\27\ See Poser Letter.

\28\ See Jamieson Letter.

\29\ See Black Letter.

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Several commenters addressed privilege issues. Four commenters

contend that the Discovery Guide should not contain a list of

privileges because privileges are traditionally governed by state

law.\30\ Similarly, three of these commenters state that because most

privileges would only be available to customers, a list of applicable

privileges should not be included in the Discovery Guide.\31\ In

addition, one commenter recommends that the Discovery Guide contain a

requirement that parties produce a privilege log to identify documents

not produced as a result of the assertion of a privilege.\32\ The

commenter believes this will help protect parties from the improper

assertion of a privilege.

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\30\ See Schwab Letter, SIA Letter, Raymond James Letter, and

Jamieson Letter.

\31\ See Schwab Letter, SIA Letter, and Raymond James Letter.

\32\ See NELA Letter.

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In addition, one commenter argues that arbitrators should be given

more power to sanction parties for non-production of documents.\33\ The

commenter states that with the current proposal, an arbitrator first

needs an order for production before the arbitrator can issue

sanctions. The commenter believes that the Discovery Guide should be

amended so that if a party fails to produce a listed document, the

party should be sanctioned unless the party can provide a substantial

justification for not producing the document. Similarly, another

commenter contends that the documents on the lists should not be

presumptively discoverable, but automatically produced.\34\ The

commenter believes this will help streamline the arbitration process.

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\33\ See Poser Letter.

\34\ See Black Letter.

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IV. Discussion

One commenter states that the Commission should give deference to

this proposal because it was reached through compromise by

organizations who represent opposing interests.\35\ The Discovery Guide

reflects a compromise between the various interests of the drafters.

The Discovery Guide was drafted over a two-year period with the input

of organizations who represent different interests within the

securities industry. 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.

Similarly, the comment letters received by the Commission reflect the

views of a cross section of the securities industry, plaintiff

representatives, academicians, and others involved in the arbitration

process. The Discovery Guide, when considered as a whole, provides

useful guidance to arbitrators, claimants, and industry participants in

customer arbitrations and fairly balances their respective interests.

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\35\ See PIABA Letter.

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As noted above, several commenters assert that the Discovery Guide

should not be filed with the Commission as a proposed rule change

because arbitration relies on the flexibility of arbitrators, and

adopting the Discovery Guide as a rule would limit arbitrators'

[[Page 49260]]

discretion.\36\ In addition, one commenter notes the Discovery Guide

states that an arbitration panel should issue sanctions if a party

fails to produce documents or information required by a written order,

not for non-compliance with the Discovery Guide itself.\37\ That

commenter, therefore, argues that arbitrators should be given more

power to sanction parties for non-compliance with the Discovery Guide.

Further, another commenter asserts that instead of being presumptively

discoverable as they are under the Discovery Guide, the Documents on

the document Production Lists should be automatically produced.\38\

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\36\ See Schwab Letter, SIA Letter, and Raymond James Letter.

\37\ See Poser Letter.

\38\ See Black Letter.

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By its terms, the Discovery Guide provides for arbitrator(s) to

exercise discretion in tailoring the Discovery Guide to particular

cases.\39\ Arbitrator(s) can change any Provision of the Discovery

Guide. Further, nothing in the Discovery Guide shifts the burden of

proof a party bears in arbitration, and the mere fact that a document

is contained in a Document Production List does not make the document

automatically admissible in any arbitration proceeding.

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\39\ Under Rule 19b-4, a stated policy, practice, or

interpretation of the self-regulatory organization shall be deemed

to be a proposed rule change unless (1) it is reasonably and fairly

implied by an existing rule of the self-regulatory organization or

(2) it is concerned solely with the administration of the self-

regulatory organization and is not a stated policy, practice, or

interpretation with respect to meaning, administration, or

enforcement of an existing rule of the self-regulatory organization.

17 CFR 240.19b-4(c). Proposed rule changes submitted under Section

19 of the Act and Rule 19b-4 are subject to a notice and comment

period. The Discovery Guide falls within Rule 19b-4.

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As stated in the Discovery Guide and the Purpose section of NASD

Regulation's filing with the Commission, the Discovery Guide (including

the Document Production Lists) is intended to function as a guide for

arbitrators and parties in the discovery process and is not intended to

bind arbitrators or parties in a particular case. While parties should

consider the documents on the lists to be presumptively discoverable,

the Discovery Guide specifically notes that all of the documents on

each list are not required to be produced in every case. Nothing in the

Discovery Guide prevents parties from voluntarily agreeing to an

exchange of documents in a manner or scope different from that set

forth in the Discovery Guide.

Furthermore, parties may also object to the production of any

particular document, or seek the production of additional documents not

on any of the Document Production Lists. The arbitrator(s) then makes a

determination whether production is required. To the extent that an

arbitrator uses the Discovery Guide in connection with ordering the

production of documents, the order is binding on the parties. The

failure to comply with the Discovery Guide itself does not

automatically result in sanctions; rather, sanctions are imposed only

after a party has failed to comply with an arbitrator's order. Thus,

arbitrators retain their discretion under the Discovery Guide to manage

arbitrations as they deem appropriate.

Some commenters objected to the burden on customers to produce

certain documents in all customer arbitrations. For example, three

commenters contend that producing certain documents infringes on

customers' privacy rights.\40\ Conversely, other commenters object to

firms' production burdens under the Discovery Guide.\41\ The Discovery

Guide reflects a fair compromise between the interests of the drafters

and will benefit arbitrators in handling document production. Further,

we note that the Document Production Lists were drafted to provide

parties with information that is reasonably calculated to lead to the

discovery of admissible evidence in arbitrations.\42\ Arbitrator(s)

should use their discretion to consider whether in a particular case,

the documents on the Document Production Lists will lead to the

discovery of admissible evidence. Nothing in the Discovery Guide

affects a party's ability to object to the production of any particular

document or class of documents, or to request additional documents.

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\40\See NELA Letter, Black Letter, and Poser Letter.

\41\See Schwab Letter, SIA Letter, and Raymond James Letter.

\42\See e.g., Fed. R. Civ. P. 26(b)(1).

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Three commenters also assert that firms should not have to produce

documents about an associated person's disciplinary history because

production would be burdensome and the documents would be

inadmissible.\43\ As one commenter noted, some disciplinary information

about firms and associated persons is already available to the public

through the NASD's Public Disclosure Program. Furthermore, as stated in

the Discovery Guide, the production of documents in discovery under the

Discovery Guide does not create a presumption that the documents are

admissible in the arbitration proceeding.

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\43\See Schwab Letter, SIA Letter, and Raymond James Letter.

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In addition, three commenters argue that firms should not have to

produce internal audit reports in failure to supervise claims because

production might affect the vitality and candor of these reports.

Another commenter, however, takes the opposite view--the commenter

believes the production of these reports will result in better self-

policing. The Discovery Guide is narrowly focused in that it only calls

for the production of internal audit reports, if they exist, in failure

to supervise claims. In addition, internal audit reports may help a

firm defend a failure to supervise claim. Nothing in the Discovery

Guide or the Document Production Lists changes firms' obligations to

monitor compliance with the federal securities laws or rules of self-

regulatory organizations. To the extent a firm objects to the

production of such internal audit reports in any particular claim,

nothing in the Discovery Guide precludes a firm from filing an

objection with the arbitrator(s). In addition, whether such a report is

admissible is a decision for the arbitrator(s).

Many of the commenters made specific suggestions on how to improve

the Discovery Guide and, in particular, the Document Production Lists.

For example, one commenter suggests that confidentiality orders or

stipulations be used sparingly because investors already have little

information on the arbitration process.\44\ The Discovery Guide does

not change current features of the arbitration process. Stipulations

are, by definition, made by agreement of the parties and

confidentiality orders can only be issued by arbitrator(s) after they

fully consider the issue. While a confidentiality order may prevent the

public dissemination of particular documents or information, it should

not affect the arbitration process. The same commenter also asserts

that the production of statements concerning a customer's net worth is

unfair because most customers would have to create these statements.

Nothing in the Discovery Guide requires customers to create documents

that do not otherwise exist. Indeed, the Discovery Guide provides that,

if a party has no responsive documents to any document request, the

party should provide an affirmation to that effect.

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\44\See Jamieson Letter.

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In addition, many of the commenters made specific suggestions to

modify one or more aspects of the Document Production Lists. Many of

these suggestions may have considerable merit in particular cases. For

example, one commenter suggests that the first

[[Page 49261]]

two Document Production Lists be ``pruned'' to avoid placing an

unreasonable burden on the parties. In this regard, if production of a

particular document or class of documents called for under an

applicable Document Production List is unduly burdensome to a party,

that party may object to production on that or any other grounds. The

arbitrator(s) retains the ability to modify any request in order to

protect against discovery abuses. Furthermore, there is nothing in the

Discovery Guide that prevents a party from asking for additional

documents such as those suggested by some commenters. We recognize the

commenters' intentions to improve the Discovery Guide and the discovery

process in general. However, the Discovery Guide reflects a compromise,

which was obtained after a long period of negotiation, between various

interests of the drafters. For each item that one commenter thought

would be burdensome for a customer, another commenter believed a

different item would be burdensome to a firm. As adopted, the Discovery

Guide will benefit arbitrators and parties in handling document

production.

One commenter suggests that parties produce a privilege log to

identify documents not produced as a result of the assertion of a

privilege. NASD Rule IM-10100 states that ``[i]t may be deemed conduct

inconsistent with just and equitable principles of trade and a

violation of Rule 2110 for a member of a person associated with a

member to * * * fail to appear or to produce any document in his

possession or control as directed pursuant to provisions of the NASD

Code of Arbitration Procedure * * *'' All parties should act in good

faith and carefully consider the relevant case law when asserting a

privilege, and arbitrators should consider whether a privilege log is

necessary to help facilitate the discovery process.\45\ It is expected

that the NASD Regulation will take appropriate action against members

and registered persons who do not act in good faith or otherwise

violate IM-10100.

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\45\ The Commission agrees with several commenters that

applicable privileges, which are usually a matter of state law,

should not be specified in the Discovery Guide.

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The Discovery Guide will streamline the discovery process. By

creating lists of documents that should be produced in all customer

arbitrations as well as particular types of cases, the Discovery Guide

will help expedite the discovery process and reduce the number of

discovery disputes between parties, which in turn should help lower the

cost of the arbitration discovery process. Further, nothing in the

Discovery Guide changes the burden of establishing or defending any

aspect of a claim. When considered as a whole, the Discovery Guide

provides useful guidance to parties and arbitrators in NASD-sponsored

customer arbitrations.

In addition, the Commission finds that the proposal is consistent

with the requirements of Section 15A of the Act \46\ and the rules and

regulations thereunder that govern the NASD.\47\ In particular, the

Commission finds that the proposal is consistent with Section 15A(b)(6)

of the Act \48\ which requires, among other things, that the rules of

an association 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; and are not

designed to permit unfair discrimination among customers, issuers,

brokers, or dealers.

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\46\ 15 U.S.C. 78o-3.

\47\ In addition, pursuant to Section 3(f) of the Act, the

Commission has considered the proposed rule's impact on efficiency,

competition, and capital formation. 15 U.S.C. 78c(f).

\48\ 15 U.S.C. 78o-3(b)(6).

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It is therefore ordered, pursuant to Section 19(b)(2) of the

Act,\49\ that the proposed rule change (SR-NASD-99-07), as amended, is

hereby approved.

\49\ 15 U.S.C. 78s(b)(2).

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\50\

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\50\ 17 CFR 200.30-3(a)(12).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 99-23610 Filed 9-9-99; 8:45 am]

BILLING CODE 8010-01-M