Self Regulatory Organizations; Order Approving Proposed Rule Change by the New York Stock Exchange, Inc. Relating to Arbitration Rules

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40858; File No. SR-NYSE-98-28]

Self Regulatory Organizations; Order Approving Proposed Rule

Change by the New York Stock Exchange, Inc. Relating to Arbitration

Rules

December 29, 1998.

I. Introduction

On September 15, 1998, the New York Stock Exchange, Inc. (``NYSE''

or ``Exchange'') filed with the Securities and Exchange Commission

(``Commission'' or ``SEC'') a proposed rule change pursuant to Section

19(b)(1) of the Securities Exchange Act of 1934 (``Exchange Act'') \1\

and Rule 19b-4 thereunder.\2\ The proposed rule change would amend NYSE

Rules 347 and 600 to exclude claims of employment discrimination,

including sexual harassment, in violation of a statute from arbitration

unless the parties have agreed to arbitrate the claim after it has

arisen. Notice of the proposed rule change, together with the substance

of the proposal, was provided in a Commission release and in the

Federal Register.\3\ The Commission received three comment letters and

a response to those letters from the Exchange. The Commission is

approving the proposed rule change.

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

\2\ 17 CFR 240.19b-4.

\3\ Securities Exchange Act Release No. 40479 (September 24,

1998) 63 FR 52782 (October 1, 1998).

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II. Description

The proposed rule change will modify the current requirement in

NYSE Rule 347 that any employment-related disputes between a registered

representative and a member or member organization be settled by

arbitration. The proposal provides that statutory employment

discrimination claims are eligible for arbitration at the Exchange only

if the parties agree to arbitrate the claims after they arise.

Background

NYSE Rule 347 has been in effect since the late 1950's and requires

that any employment-related disputes between a registered

representative and a member or member organization be settled by

arbitration.\4\ In order to become ``registered'' an individual is

required to sign and file with the Exchange a Form U-4 (Uniform

Application for Securities Registration or Transfer). Form U-4 requires

registered persons to submit to arbitration any claim that must be

arbitrated under the rules of the self-regulatory organizations

(``SROs'') with which they register.

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\4\ NYSE Rule 347 provides ``Any controversy between a

registered representative and any member or member organization

arising out of the employment or termination of employment of such

registered representative by and with such member or member

organization shall be settled by arbitration, at the instance of any

such party, in accordance with the arbitration procedure prescribed

elsewhere in these rules.''

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Until the 1990's, the rule was generally invoked to arbitrate

business and contract disputes, such as wrongful discharge, breach of

contract or claims regarding compensation. In 1991, the Supreme Court

held in Gilmer v. Interstate/Johnson Lane,\5\ that a registered

representative could be compelled to arbitrate his claim under the Age

Discrimantion in Employment Act (``ADEA'') pursuant to Form U-4 and

NYSE Rule 347. Subsequent courts have held that claims alleging

employment discrimation, including sexual harassment claims, may be

compelled to arbitration.\6\

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\5\ 500 U.S. 20 (1991).

\6\ Indeed, they have extended the reasoning of Gilmer to cover

disputes arising under: Title VII of the Civil Rights Act of 1964,

see, e.g., Alford v. Dean Witter Reynolds, Inc., 939 F. 2d 229 (5th

Cir. 1991), Cremin v. Merrill Lynch, Pierce, Fenner & Smith, Inc.,

957 F. Supp. 1460 (N.D. III. 1997), but see Rosenberg v. Merrill

Lynch, Pierce, Fenner & Smith, Inc., 1998 U.S. Dist. Lexis 877 (D.

Mass. 1998)); the Americans with Disabilities Act, (see, e.g.,

Austin v. Owens-Brockway Glass Container, Inc., 78 F. 3d 875, 881

(4th Cir.) cert. denied, 117 S. Ct. 432 (1996); and state statutes

of a similar nature (see, e.g., Kalider v. Shearson Lehman Hutton,

Inc., 789 F. Supp. 179, 180 (W.D. Pa. 1991)).

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In 1994, the General Accounting Office (``GAO'') conducted a study

on the arbitration of employment discrimination disputes in the

securities industry.\7\ The GAO Report did not critize the fairness of

arbitration as a means of resolving employment discrimination disputes,

but did make recommendations for improving the arbitration process.

Despite steps to improve the process, registered representatives and

others continue to oppose arbitration of discrimination claims pursuant

to the Form U-4 and other pre-dispute agreements. In July 1997, the

U.S. Equal Employment Opportunity Commission (``EEOC'') issued a policy

statement that mandatory pre-dispute agreements to arbitrate statutory

employment discrimination claims are consistent with the purpose of the

federal civil rights laws.\8\

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\7\ Employment Discrimination: How Registered Representatives in

Discrimination Disputes (GAO/HEHS-94-17, March 30, 1994).

\8\ EEOC Notice No. 915.002, July 10, 1997.

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In support of the EEOC's position, the Ninth Circuit Court of

Appeals held in May 1998, in Duffield v. Robertson Stephens &

Company,\9\ that employers could not compel employees to waive their

right to a judicial forum under Title VII, and therefore plaintiff

could not be compelled to arbitrate her statutory employment

discrimination claims pursuant to Form U-4.\10\ Other federal courts

consistently upheld the arbitration of employment discrimination claims

pursuant to the Form U-4.

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\9\ 1998 WL 227469 (9th Cir.).

\10\ In January 1998, a U.S. District Court in Massachusetts, in

Rosenberg v. Merrill Lynch, 76 FEP 681 (D.Mass 1998), declined to

compel arbitration of plaintiff's Title VII and the ADEA claims

pursuant to the agreement to arbitrate contained in the Form U-4

plaintiff was required to sign as a condition of her employment.

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On June 22, 1998, the Commission approved a proposed rule change by

the National Association of Securities Dealers, Inc. (``NASD'') to

remove the requirement from its rules that registered representatives

must arbitrate statutory employment discrimination claims.\11\ Under

the NASD's rule, an employee could file such a claim in court unless he

or she was obligated to arbitrate pursuant to a separate agreement

entered into either before or after the dispute arose.

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\11\ Exchange Act Release No. 40109 (June 22, 1998) 63 FR 35299

(June 29, 1998).

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The Commission's order approving the NASD rule change noted that

the NASD intends to make changes to its arbitration program to make

arbitration more attractive to parties for the resolution of

discrimination claims.\12\ An NASD ``Working Group'' that includes

attorneys who represent employees, member firms and neutrals

[[Page 1052]]

is developing improvements to the NASD's arbitration procedures for

discrimination cases. A representative of the Exchange is participating

as an observer in the Working Group's discussions.

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\12\ Id.

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The Exchange's proposed rule change will create a narrow exception

to the NYSE rule that requires arbitration of all employment-related

claims of a registered representatives. Paragraph (a) of the proposed

amendment to NYSE Rule 347 adds language indicating that paragraph (b)

contains an exception to the requirement to arbitrate employment

disputes. Paragraph (b) provides that ``a claim alleging employment

discrimination,including any sexual harassment claim, in violation of a

statute shall be eligible for arbitration only where the parties have

agreed to arbitrate the claim after it has arisen.'' \13\

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\13\ Claims ``in violation of a statute'' are not limited to the

federal civil rights laws and include all federal, state and local

anti-discrimination statutes.

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In addition, under the proposal, statutory employment

discrimination claims will not be eligible for arbitration pursuant to

any pre-dispute agreement to arbitrate. The Exchange has stated that

its action brings its arbitration policy into conformity with the

EEOC's ``Policy Statement on Mandatory Binding Arbitration of

Employment Discrimination Disputes as a Condition of Employment.'' \14\

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\14\ EEOC Notice No. 915.002, July 10, 1997.

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In its December 1997 comment letter to the SEC regarding the NASD

proposal, the EEOC stated its position ``that pre-dispute arbitration

agreements, particularly those that mandate binding arbitration of

discrimination claims as a condition of employment, are contrary to the

fundamental principles reflected in this nation's employment

discrimination laws. We recommend therefore, that the proposed rule be

revised to permit arbitration of statutory employment discrimination

claims only under post-dispute arbitration agreements.'' \15\

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\15\ Letter from Gilbert F. Casellas, Chairman, EEOC, to

Jonathan G. Katz, Secretary, SEC, Re: NASD Proposed Rule Change on

Arbitration of Employment Discrimination Claims, December 1997.

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The Exchange has had a general arbitration provision in its

Constitution since 1817. NYSE Rule 600 requires the arbitration of

disputes between customers or non-members and members or member

organizations, pursuant to any written agreement to arbitrate or upon

the demand of the customer or non-member.\16\ The vast majority of

disputes resolved by Exchange arbitration are business disputes arising

out of securities transactions with investors, and contractual disputes

between members and their employees. Since 1992, the year following the

Gilmer decision, the Exchange has received an average of 18

discrimination claims a year.\17\ The Exchange's proposed amendments

will limit the availability of the Exchange's forum for the resolution

of employment discrimination claims to those cases where the parties

have agreed to arbitrate the claim after it has arisen, as recommended

by the EEOC.

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\16\ NYSE Rule 600(a) provides: ``Any dispute, claim or

controversy between a customer or non-member and a member, allied

member, member organization and/or associated person arising in

connection with the business of such member, allied member, member

organization and/or associated person in connection with his

activities as an associated person shall be arbitrated under the

Constitution and Rules of the New York Stock Exchange, Inc. as

provided by any duly executed and enforceable written agreement or

upon the demand of the customer or non-member.''

\17\ Historically, discrimination claims accounted for less than

two percent of the total claims filed at the Exchange, except for

1996 (when discrimination claims accounted for two point six

percent) and the first six months of 1998 where, due to a steady

decline in case filings generally, discrimination claims accounted

for three percent of the cases filed.

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The Exchange is also proposing to amend NYSE Rule 600, adding

paragraph (f) that provides that claims alleging employment

discrimination, including any sexual harassment claim, shall be

eligible for submission to arbitration only where the parties have

agreed to arbitrate the claim after it has arisen. This amendment

excludes from Exchange arbitration statutory employment discrimination

claims of non-registered employees pursuant to pre-dispute arbitration

agreements. NYSE Rule 347 only applies to ``registered'' employees.

The EEOC and several members of Congress have endorsed arbitration

as an effective means of resolving discrimination claims, provided the

parties agree to arbitrate after the claim has arisen. The Exchange's

proposed amendment provides a forum for those employees who choose,

after a claim has arisen, to resolve their statutory employment

discrimination claims through arbitration.

Some employment disputes may contain contract or tort claims as

well as statutory employment discrimination claims. Under amended NYSE

Rule 347 (and NYSE Rule 600 for non-registered employees who have

executed pre-dispute arbitration agreements) these cases may be

bifurcated. The employment discrimination claims may be heard in a

forum other than the Exchange, such as court, while any claims subject

to arbitration may continue to be heard at the Exchange.\18\ However,

NYSE Rule 347 requires arbitration of claims ``at the instance'' of

either party, and therefore may be waived, allowing the entire case to

be heard in court. The parties may also avoid bifurcation by agreeing

to proceed with all claims in a single forum. Given a choice, after a

dispute has arisen, employees in many instances believe that

arbitration is preferable to protracted and expensive litigation and

will willingly make that choice.\19\

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\18\ The bifurcation of securities industry claims is not

unprecedented. Before the Supreme Court's decision in Shearson v.

McMahon, 482 U.S. 220 (1987) (holding that claims under the Exchange

Act could be compelled to arbitration), the Supreme Court decided

Dean Witter Reynolds, Inc. v. Byrd, 105 S. Ct. 1238 (1985). In Byrd,

the dispute involved allegations of federal securities laws

violations and pendent state law claims. The Court compelled the

state law claims to arbitration and held that the federal securities

laws claims could be heard in court.

\19\ See Duffield v. Robertson Stephens & Company, 1998 WL

227469 (9th Cir.).

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III. Summary of Comments

The Commission received three comment letters on the proposed rule

change.\20\ Two of the letters supported the proposal \21\ and the

other oppose it.\22\ The comment letter primarily focused on section

3(f) of the Exchange Act and the Federal Arbitration Act (``FAA''). The

Exchange responded to the comment letters.\23\

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\20\ October 16, 1998 National Employment Lawyers Association

Letter (NELA Letter); October 21, 1998 Securities Industry

Association Letter (SIA Letter); and October 21, 1998 New York State

Attorney General Dennis Vacco (NY Attorney General Letter).

\21\ NELA Letter; and NY Attorney General Letter.

\22\ SIA Letter.

\23\ Letter from James E. Buck, Senior Vice President and

Secretary, NYSE, to Jonathan G. Katz, Secretary, SEC, dated December

2, 1998.

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Overview of the Proposed Rule Change

One commenter that supported the proposal did so because it

believes that it complies with EEOC policy and the letter and spirit of

Tile VII.\24\ A second commenter that supported the proposal did so

because it believes that arbitration may not be well-adapted for

employment discrimination claims, since employees and others have

challenged its fairness in employment-related disputes.\25\ While

supporting the proposal, this commenter suggested that the proposal be

modified to include common law employment-related claims (e.g.,

wrongful termination, defamation) and preserve punitive damages.

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\24\ NELA letter.

\25\ NY Attorney General Letter.

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The one commenter that opposed the proposal said that it is

inconsistent with

[[Page 1053]]

section 3(f) of the Exchange Act and the FAA, and that it will lead to

unnecessary bifurcation of claims, since it differs from the NASD's

recent rule change.\26\ This commenter disagreed with the Exchange's

interpretation of the relevant case law. It also asserted that

arbitration is faster and cheaper than litigation and that plaintiffs

are more likely to win in arbitration than in litigation.

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\26\ SIA Letter.

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Comments Concerning Section 3(f) of the Exchange Act

The SIA said that the proposal, which provides the Exchange as an

arbitration forum only for post-dispute arbitration agreements, is

inconsistent with section 3(f) of the Exchange Act \27\ because it

differs from the recent NASD rule change, which does not affect pre-

dispute arbitration agreements. The SIA claimed that this would create

a system of inconsistent regulations that would eliminate the efficacy

of arbitration agreements and create disparate treatment for similarly

situated cases at different SROs. It also argued that this would result

in bifurcation of claims and an unwarranted increase in litigation.

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\27\ Section 3(f) of the Exchange Act provides that when the

Commission reviews a proposed rule change from an SRO, it must

``consider or determine whether an action is necessary or

appropriate in the public interest * * * (and) consider, in addition

to the protection of investors, whether the action will promote

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

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The Exchange stated in its response letter that section 3(f) does

not require that SROs have precisely the same rules. It noted that its

proposal is substantially similar to the NASD's recent rule change,

since both leave parties' substantive rights and remedies largely

unchanged.\28\ Further, the Exchange said that bifurcation would only

occur if a prospective plaintiff chose to bifurcate his or her claims.

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\28\ In its response to the comment letters, the Exchange noted

that its rule change is ``similar to the recently approved NASD

rules in that they exclude claims of statutory employment

discrimination from the Exchange's requirement that all employment

disputes between a registered representative and a member or member

organization be arbitrated.''

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In its letter, the SIA offers a hypothetical case in which a

registered representative signs a Form U-4 and an agreement to

arbitrate all disputes, including statutory employment discrimination

claims. The SIA concludes that under the Exchange's proposal, only the

economic claims can be arbitrated. The Exchange interpreted its

proposal differently. The Exchange stated that under the NASD's rules,

the entire dispute in the SIA's hypothetical would be eligible for

arbitration at the NASD or another forum provided for in the Form U-4

or arbitration agreement.

The Exchange also noted that after a dispute has arisen, the

parties can agree to proceed with all claims in arbitration or in

court. The Exchange recognized that there is some potential for

bifurcation, but believes that in most instances parties will, in their

own best interests, agree to proceed in a single forum. The Exchange

also disagreed with the SIA's argument that the proposal will lead to

motion practice or forum shopping.

The Exchange also noted that it has received relatively few claims

alleging employment discrimination and only 126 since 1992 (or about

two each month). The NASD, in contrast, received 139 such claims in

1997 alone. Nevertheless, the Exchange stated that it will monitor its

actual experience under the porposal, including bifurcation, and

consider appropriate action in the future if warranted.

The Exchange further stated that its proposal represents a policy

decision not to adopt identical procedures because it receives

relatively few employment-discrimination claims. The Exchange stated

that its decision would not significantly harm securities industry

arbitration. The Exchange also noted that even though most Exchange

members and member organizations are also NASD members, the few

Exchange members that are not may still proceed with arbitration of

employment discrimination claims in another forum, such as the American

Arbitration Association.

Comments Concerning the FAA

The SIA disagreed with the Exchange's analysis of the case law

interpreting the FAA, stating that the Exchange's proposal violates the

FAA. The SIA argued that for member firms that have pre-dispute

arbitration agreements, the proposal would vitiate an otherwise valid

arbitration agreement. The Exchange disagreed. The Exchange stated that

the FAA does not mandate arbitration of all claims, but merely the

enforcement, upon motion of a party, of privately megotiated

arbitration agreements. The Exchange also noted that the FAA does not

require an arbitration provider such as the Exchange to make its forum

available to hear particular types of cases.

The Exchange also noted that the proposal would not prevent parties

with pre-dispute arbitration agreements from agreeing to arbitrate

after the dispute arises. Further, as discussed above, the Exchange

noted that the proposal neither invalidates pre-disputes arbitration

agreements nor forces parties to litigate statutory employment

discrimination claims--it merely removes the Exchange as an arbitration

forum for such claims.

Comments Concerning Other Issues

The SIA also argued that arbitration is better for plaintiffs in

employment dispute cases than litigation in Fedral court, cliting its

own study in support.\29\ The SIA said that, among other things, in

arbitration: plaintiffs prevail more frequently; claims are resolved

more quickly; and arbitration is less expensive. In its response, the

Exchange neither agreed with nor disputed these SIA statements, stating

that its proposal allows plaintiffs to choose the forum they believe is

better for them. The Exchange stated that under its proposal, statutory

employment discrimination claims are eligible for arbitration at the

Exchange if the parties agree to arbitrate after the dispute arises.

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\29\ Atached to the SIA Letter was its General Counsel's

Congressional testimony, which described the SIA study.

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Finally, one commenter suggested that voluntary post-dispute

arbitration agreements should only be encouraged if they preserve the

substantive protections and remedies afforded by statutes. The Exchange

responded that the commenter's concern was unwarranted in the post-

dispute context. It argued that any disparity in bargaining power

between the parties that exists before a dispute arises is missing

after the dispute arises, and the employee may freely agree that he or

she is better off arbitrating statutory employment discrimination

claims. The Exchange also noted that the EEOC supports post-dispute

agreements.

IV. Discussion

Under the Act, SROs like the Exchange are assigned rulemaking and

enforcement responsibilities to perform their role in regulating the

securities industry for the protection of investors and other related

purposes. Pursuant to section 19(b)(2) of the Act, the Commission is

required to approve an SRO rule change like the Exchange's if it

determines that the proposal is consistent with applicable statutory

standards.\30\ These standards include section 6(b)(5) of the Act,

which

[[Page 1054]]

provides that the Exchange's rules must be designed to, among other

things, ``promote just and equitable principles of trade'' and

``protect investors and the public interest.'' Section 6(b)(5) also

provides that the Exchange's rules may not be designed to ``regulate .

. . matters not related to the purposes of the (Exchange Act) or the

administration of the (Exchange).''

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\30\ The Commission oversees the arbitration programs of the

SROs, including the Exchange's, through inspections of the SRO

facilities and the review of SRO arbitration rules. Inspections are

conducted to identify areas where procedures should be strengthened,

and to encourage remedial steps either through changes in

administration or through the development of rule changes.

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By changing its rules, the NYSE proposal provides that statutory

employment discrimination claims are eligible for submission to

arbitration at the Exchange only if the parties agree to arbitrate the

claims after they arise. This narrow amendment to the NYSE's rules

affects only the arbitration of employment discrimination claims

between NYSE members and their employees.\31\ This proposal is

consistent with the applicable statutory standards.\32\ The statutory

employment anti-discrimination provisions reflect an express intention

that employees receive special protection from discriminatory conduct

by employers. Such statutory rights are an important part of this

country's efforts to prevent discrimination. It is reasonable for the

NYSE to make a policy determination that in this unique area it will

not, as an SRO, require or permit arbitration unless there is a post-

dispute agreement. It is also proper under the Exchange Act for one

SRO's policy determination to differ from that of another.

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\31\ The amendment in no way affects the obligation, under NYSE

rules, of Exchange members or their employees to arbitrate claims

brought by customers against them.

\32\ U.S.C. 78o-3(b)(6).

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Section 3(f), raised by one commenter, addresses issues concerning

efficiency, competition, and capital formation. The Exchange's proposal

fosters competition by providing different approaches for dispute

resolution among markets and among brokers and dealers.

The benefits of the Exchange's proposal to employees with

employment discrimination claims and to the employer/employee

relationship are clear. The Exchange's provision of an arbitration

forum for employment discrimination disputes where the parties choose

arbitration after the dispute arises is consistent with section 3(f).

With respect to the bifurcation issue raised by the commenters, the

Supreme Court, in Dean Witter Reynolds, Inc. v. Byrd, 470 U.S. 213, 217

(1985), acknowledged the appropriateness of bifurcation between federal

statutory and pendant state law claims. The Exchange noted in its

response that there is a potential for bifurcation in some cases.

However, in many instances it is likely that parties will agree to

proceed in a single forum. The Commission notes that the Exchange

stated that it will monitor its actual experience under the proposal,

including bifurcation, and consider appropriate action in the future if

warranted.

The proposal is not, as one commenter suggested, inconsistent with

the FAA. The FAA does not mandate that all claims be arbitrated. The

FAA provides that privately negotiated arbitration agreements should be

enforced, upon motion of a party. Further, the FAA does not require an

arbitration provider such as the Exchange to make its forum available

to hear particular types of cases.

With respect to other comments that suggested that the NYSE should

enact other rules concerning employer/employee arbitration agreements

or extend this rule to other causes of action, these issues are left to

the NYSE to consider in the first instance.

V. Conclusion

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

Exchange Act,\33\ that the proposal, SR-NYSE-98-28 be and hereby is

approved.

\33\ 15 U.S.C. 78s(b)(2).

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For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\34\

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\34\ 17 CFR 200.30-3(a)(12).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 99-299 Filed 1-6-99; 8:45 am]

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