Self-Regulatory Organizations; National Association of Securities Dealers, Inc.; Order Granting Approval to Proposed Rule Change 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. 34-41056; File No. SR-NASD-97-79]

Self-Regulatory Organizations; National Association of Securities

Dealers, Inc.; Order Granting Approval to Proposed Rule Change Relating

to Fees and Hearing Session Deposits for the Arbitration of Claims by

Public Investors, Members and Associated Persons

February 16, 1999.

I. Introduction

On October 29, 1997, the National Association of Securities

Dealers, Inc. (``NASD'' or ``Association''), through its wholly-owned

subsidiary NASD Regulation, Inc. (``NASD Regulation'') filed with the

Securities and Exchange Commission (``Commission''), pursuant to

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

and Rule 19b-4 thereunder,\2\ a proposed rule change to amend Rules IM-

10104, 10205 and 10332 of the NASD's Code of Arbitration Procedure

(``Code'') to increase the arbitration filing fees, hearing session

deposits, and arbitrator honoraria for intra-industry and public

investor arbitrations administered by NASD Regulation.\3\

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

\2\ 17 CFR 240.19b-4.

\3\ This rule filing replaced SR-NASD-97-39, in which NASD

Regulation originally proposed amendments to the filing fees and

hearing session deposits.

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

the proposal, was published for comment in Securities Exchange Act

Release No.

[[Page 10042]]

39346 (November 21, 1997), 62 FR 63580 (December 1, 1997). Forty-three

comment letters were received on the proposal.\4\ The NASD responded to

comments on February 12, 1998, February 24, 1998 and March 31, 1998.\5\

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\4\ See letters from Daniel A. Ball, Lewis, Goldberg & Ball, to

Margaret H. McFarland, Deputy Secretary, Commission, dated December

3, 1997 (``Letter 1''); Erwin Cohn, Cohn & Cohn, to Margaret H.

McFarland, Deputy Secretary, Commission, dated December 3, 1997

(``Letter 2''); J. Boyd Page, Page & Bacek, to Margaret H.

McFarland, Deputy Secretary, Commission, dated December 11, 1997

(``Letter 3''); Diane A. Nygaard, The Nygaard Law Firm, to Margaret

H. McFarland, Deputy Secretary, Commission, dated December 10, 1997

(``Letter 4''); Gary M. Berne, Stoll, Stoll, Berne, Lokting &

Schlachter, P.C. to Margaret H. McFarland, Deputy Secretary,

Commission, dated December 4, 1997 (``Letter 5''); Martin R. Galbut,

Galbut & Conant, to Margaret H. McFarland, Deputy Secretary,

Commission, dated December 4, 1997 (``Letter 6''); Robert Dyer,

Allen, Dyer, Doppelt, Milbrath & Gilchrist, P.A., to Margaret H.

McFarland, Deputy Secretary, Commission, dated December 4, 1997

(``Letter 7''); Neal J. Blaher, Law Office of Neal J. Blaher, to

Margaret H. McFarland, Deputy Secretary, Commission, dated December

3, 1997 (``Letter 8''); (there is no Letter 9); Patricia A. Shub,

Patricia A. Shub, P.A., to Margaret H. McFarland, Deputy Secretary,

Commission, dated December 10, 1997 (``Letter 10''); Michael R.

Casey, Casey and Molchan, to Margaret H. McFarland, Deputy

Secretary, Commission, dated December 10, 1997 (``Letter 11''); Mark

A. Tepper, Mark A. Tepper, P.A., to Margaret H. McFarland, Deputy

Secretary, Commission, dated December 11, 1997 (``Letter 12''); J.

Pat Sadler, Sadler & Associates, P.C., to Margaret H. McFarland,

Deputy Secretary, Commission, dated December 8, 1997 (``Letter

13''); Philip M. Aidikoff and Robert A. Uhl, Aidikoff & Uhl, to

Margaret H. McFarland, Deputy Secretary, Commission, dated December

12, 1997 (``Letter 14''); Martin L. Feinberg, to Jonathan G. Katz,

Secretary, Commission, dated December 10, 1997 (``Letter 15'');

James E. Beckley, James E. Beckley and Associates to Jonathan G.

Katz, Secretary, Commission, dated December 19, 1997 (``Letter

16''); Public Investors Arbitration Bar Association (``PIABA''),

dated December 11, 1997 (``Letter 17''); Barry D. Estell, to

Margaret H. McFarland, Deputy Secretary, Commission, dated December

4, 1997 (``Letter 18''); James E. Beckley, Securities Industry

Conference on Arbitration (``SICA''), to Jonathan G. Katz,

Secretary, Commission, dated December 10, 1997 (``Letter 19'');

Andrew O. Whiteman, Hartzell & Whiteman, LLP, to Margaret H.

McFarland, Deputy Secretary, Commission, dated December 11, 1997

(``Letter 20''); Seth E. Lipner, Deutsch & Lipner, to Margaret H.

McFarland, Deputy Secretary, Commission, dated December 11, 1997

(``Letter 21''); Harold J. Bender, to Margaret H. McFarland, Deputy

Secretary, Commission, dated December 9, 1997 (``Letter 22''); Emily

Feldman, to Margaret H. McFarland, Deputy Secretary, Commission,

dated December 10, 1997 (``Letter 23''); Lawrence Sullivan, to

Margaret McFarland, Deputy Secretary, Commission, dated December 10,

1997 (``Letter 24''); Joseph C. Long, Professor of Law, to Margaret

H. McFarland, Deputy Secretary, Commission, dated December 11, 1997

(``Letter 25''); Joseph D. Sheppard III, Carnahan, Evans, Cantwell &

Brown, P.C., to Margaret H. McFarland, Deputy Secretary, Commission,

dated December 19, 1997 (``Letter 26''); Robert D. Mitchell,

Mitchell Law Offices, to Margaret H. McFarland, Deputy Secretary,

Commission, dated December 12, 1997 (``Letter 27''); Peter R. Cella,

Duignan & Cella, to Jonathan G. Katz, Secretary, Commission, dated

December 15, 1997 (``Letter 28''); Diane Nygaard, The Nygaard Law

Firm, to Jonathan G. Katz, Secretary, Commission, dated December 30,

1997 (``Letter 29''); Don K. Leufven, Alonso & Cersonsky, P.C., to

Margaret H. McFarland, Deputy Secretary, Commission, dated December

12, 1997 (``Letter 30''); James E. Beckley, James E. Beckley and

Associates, to Jonathan G. Katz, Secretary, Commission, dated

December 30, 1997 (``Letter 31''); Jonathan H. Colman, to Jonathan

G. Katz, Secretary, Commission, dated December 22, 1997 (``Letter

32''); Joel E. Davidson, Senior Vice President and Deputy General

Counsel, PaineWebber, Inc., to Margaret H. McFarland, Deputy

Secretary, Commission, dated January 9, 1998 (``Letter 33''); Scot

D. Bernstein, Law Offices of Scot D. Bernstein, to Jonathan G. Katz,

Secretary, Commission, dated January 22, 1998 (``Letter 34''); Tracy

Pride Stoneman, Susemihl & McDermott, P.C., to Margaret H.

McFarland, Deputy Secretary, Commission, dated December 17, 1997

(``Letter 35''); Richard P. Ryder, Securities Arbitration

Commentator, to Jonathan G. Katz, Secretary, Commission, dated

January 16, 1997[sic] (``Letter 36''); Paul J. Dubow, Senior Vice

President and Senior Deputy General Counsel, Dean Witter, Discover &

Co., to Jonathan G. Katz, Secretary, Commission, dated January 28,

1998 (``Letter 37''); James E. Beckley, James E. Beckley and

Associates, to Jonathan G. Katz, Secretary, Commission, dated

January 21, 1998 (``Letter 38''); Morton Levy, to Jonathan G. Katz,

Secretary, Commission, dated January 27, 1998 (``Letter 39''); Neal

J. Blaher, to Guy P. Fronstin, Staff Attorney, NASD Regulation,

dated December February 6, 1998 (``Letter 40''); Neal J. Blaher to

Guy P. Fronstin, Staff Attorney, NASD Regulation, dated February 6,

1998 (``Letter 41''); Robert Dyer, Allen, Dyer, Doppelt, Milbrath &

Gilchrist, to Linda Fienberg, Executive Vice President of Dispute

Resolution, NASD Regulation, dated March 2, 1998 (with attached

letter from Neal J. Blaher to Guy P. Fronstin, Staff Attorney, NASD

Regulation, dated February 25, 1998) (``Letter 42''); (there is no

Letter 43); Richard P. Ryder, Securities Arbitration Commentator, to

Jonathan G. Katz, Secretary, Commission, dated September 17, 1998

(``Letter 44''); and Seth E. Lipner, Secretary, PIABA, to Arthur

Levitt, Chairman, Commission, dated October 14, 1998 (``Letter

45'').

\5\ See letters from John M. Ramsey, Vice President and Deputy

General Counsel, NASD Regulation, to Katherine A. England, Assistant

Director, Division of Market Regulation, Commission, dated February

12, 1998 (``Response One''), February 24, 1998 (``Response Two''),

and March 31, 1998 (``Response Three'').

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II. Description

Background and Introduction

NASD Regulation is proposing to amend the Code to increase the

filing fees and hearing session fees 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. The fees and deposits for arbitration

proceedings fall generally into three categories: (1) Filing fees; (2)

hearing session fees; and (3) member surcharges. This filing does not

concern member surcharges.

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

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

third party claims. These fees pay some NASD Regulation's average

direct costs of administering the early stages of an arbitration

case.\6\

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\6\ Average direct costs are discussed further infra.

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Hearing session fees may be assessed by the arbitrators for each

hearing session held in a case.\7\ Arbitrators decide who will pay

these fees in their award at the end of the case. Claimants have to

deposit with NASD Regulation the hearing session fee for the first

hearing when they file their claim,\8\ and arbitrators may request that

either party submit additional deposits of hearing session fees as the

case progresses. A hearing session deposit is intended as an advance

payment for the first, or a subsequent, hearing session. If pays some

of NASD Regulation's average direct cost of conducting a hearing

session.

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\7\ A hearing session is any meeting between the parties and the

arbitrator(s) that lasts four hours or less, including a pre-hearing

conference with an arbitrator.

\8\ NASD Regulation staff can waive the initial filing fee and

hearing session deposit if the claimant demonstrates financial

hardship.

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Under the existing fee structure and these proposed fees, NASD

Regulation is subsidizing through fees on members only and through

general revenues the cost of administering arbitration cases for

investors with small and moderate claims.

Proposed Rule Change

NASD Regulation is proposing to amend the schedules of fees for

both intra-industry and public investor disputes. The filing fees and

hearing session deposit changes proposed 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\ hearing session fees and deposits in all cases between

public investors and members, and in intra-industry cases; and (4)

miscellaneous changes. NASD Regulation also proposes changes to the

arbitrator honorarium schedule.

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\9\ The proposed rule change treats associated persons of

members like public customers for purposes of fees.

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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 \10\ and add three new brackets

to graduate further the fee schedule.\11\ The proposed filing fees

[[Page 10043]]

range from $25 to $600, while the current filing fees range from $15 to

$300.

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\10\ Fees are based on the amount in dispute, and ``bracket''

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

$100,00) to which a particular fee applies.

\11\ 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 (compared to

$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. See Securities Exchange Act

Release No. 38635 (May 15, 1997), 62 FR 27819 (May 21, 1997) (SR-

NASD-97-22). The largest filing fee increases are for the largest

cases; for example, the filing fee for claims of more than

$10,000,000 is being raised 100 percent from $300 to $600.

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

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

the filing fees when 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) and ending at $5,000 (for claims over

$10,000,000).

NASD Regulation is also 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) to $5,000 (for claims over $10,000,000).

Fees for Hearing Sessions. NASD Regulation is proposing to amend

Rules 10205 and 10332 to increase the hearing session fees that can be

assessed for each hearing session held in a case. The proposal

increases the initial deposits required for all cases, and adds three

new brackets to graduate further the hearing session deposit

schedule.\12\ In addition to the initial hearing session deposit

required when a case is filed, the hearing session deposit schedule is

used by the arbitrators to assess fees for each of the hearing sessions

held in case, which together with other miscellaneous costs are

referred to as forum fees. The hearing session deposits range from $25

to $1,200. Hearing session fees are the same within brackets for public

investor-member, member-public investor, and intra-industry cases.

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\12\ For example, the old bracket for claims of $10,000.01 to

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

$25,000 with a new hearing session deposit of $450 (compared to $300

for the old bracket) for 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 from $1,500.

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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. In order to encourage parties

to identify, when possible, the dollar amounts involved in a case, NASD

Regulation is also proposing to amend Rules 10205(e) and 10332(e) to

increase the hearing session deposit for claims where the amount in

dispute is not disclosed by the claimant in the Statement of Claim. The

fee will be increased from $600 to either $1,000 or an amount specified

by the Director of Dispute Resolution or the arbitrators, not to exceed

the maximum hearing session deposit specified in the rules.\13\

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\13\ In cases where the claimant is seeking a remedy other than

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

Regulation has stated that its staff will attempt to establish the

market value of the securities that are the subject matter of the

claim before resorting to the higher maximum default fee specified

in paragraph (e) of the two rules.

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Finally, NASD Regulation is proposing to amend Rules 10205(i) and

10332(h) to provide that the filing fees and hearing session fees for

large and complex cases brought under Rule 10334 \14\ will be those

specified for cases exceeding $10,000,000. In support of the fees for

cases administered under the large and complex case rules, the NASD has

stated that there are significant and distinct costs associated with

such cases, including an administrative conference, multiple hearing

sessions, pre-hearing issues to be resolved and customized arbitration

procedures that may be requested by the parties.

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\14\ Rule 10334 (the rule for large and complex cases) was

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 per arbitrator for each hearing

session, with an additional $75 per day for the chairperson of the

panel. The Office of Dispute Resolution's honorarium cost for a panel

of three arbitrators for one hearing session under the proposed

schedule is $675. The honorarium for a pre-hearing conference will be

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

increased from $75 to $125.

Direct Costs of Administering Arbitration Cases

NASD Regulation states that the fees proposed in this rule filing

were developed to recover much of its average direct costs for

administering arbitration cases. In developing the proposed fee

increases, NASD Regulation reports that it identified the average costs

attributable to such activities as receiving, processing, analyzing,

and serving claims, selecting arbitrators, and scheduling and

conducting hearings.\15\ The proposed filing and hearing session fees

do not pay for NASD Regulation's general costs for administering the

arbitration department, including costs for arbitrator recruitment and

training, computer systems, office space, senior management and legal

services. Instead, these fees are designed to cover the actual costs

incurred by NASD Regulation in administering particular cases. NASD

Regulation estimates that the revenue from the proposed filing and

hearing session fees will total about 68% of its average direct costs

for administering cases.\16\

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\15\ NASD Regulation described its cost analysis, noting in part

that the cost of these functions was identified by totaling the

staff hours and other expenses devoted to the function. Also, the

number of occurrences of the function was counted. The total cost

was divided by the number of occurrences to derive the average cost.

\16\ While its latest budget figures suggest that the filing and

hearing session fees may pay for approximately 68% of its direct

costs of arbitrating disputes, NASD Regulation's actual experience

with revenue received as of June 4, 1998 suggests that the fees may

pay approximately 50% of the direct costs. See letter from Elliott

Curzon, Assistant General Counsel, NASD Regulation, to Robert A.

Love, Special Counsel, Division of Market Regulation, Commission,

dated June 4, 1998.

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In particular, NASD Regulation states that the filing fees were

designed to cover much of the actual costs of the arbitration process

from filing up to the pre-hearing conference. These costs include the

processing, analyzing and serving of claims, and selecting arbitrators.

In lower bracket cases, NASD Regulation states that the filing fees are

lower than its cost of providing the service, and in larger bracket

cases, the filing fees approach but do not exceed its average cost of

providing the service. The costs generally increase as the amount in

controversy increases.

Similarly, NASD Regulation states that the hearing session fees are

designed to cover some of the actual costs of administering a hearing.

The cost of conducting a hearing session includes arbitrator

compensation and travel expenses, hearing conference rooms, and the

cost and expenses of NASD Regulation staff directly involved

[[Page 10044]]

in the case. NASD Regulation states that its analysis indicates the

projected average cost to provide a single hearing session is $1,200.

The hearing session fees proposed in this filing for three person

panels are graduated, from $600 (for cases involving $25,000.01 to

$30,000) to $1,200 (for cases above $500,000).\17\

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\17\ Hearing session fees for smaller cases, with a single

arbitrator, are between $25 and $450.

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III. Summary of Comments

The Commission received 43 comment letters on the proposed rule

change, of which 40 opposed the proposed rule change and three favored

it.\18\ The NASD responded to comment letters.\19\

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\18\ See supra note 4.

\19\ See supra note 5.

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Increasing Fees Will Deter Investors

Many of the commenters argue that the arbitration fees are already

too high,\20\ and that the proposed increase in fees will deter

investors from filing claims and impair investors' ability to obtain

compensation.\21\ One commenter suggests that the proposed fee

increases could cause claimants to underestimate or not include damages

in their claims in an effort to avoid paying the higher filing

fees.\22\ Two of the commenters, investors with claims in arbitration,

state that it was a burden for them to file a claim under the current

fee structure.\23\ One of them also states that she could have gone to

court at a lower cost but was prevented from doing so because of her

arbitration contract.\24\ One commenter argues that the fee increase

would destroy confidence in the system.\25\ In addition, commenters

state that arbitration proceedings are already more expensive than

filing an equivalent claim in court.\26\ One commenter states that

because NASD Regulation will be charging hearing session fees for the

pre-hearing conferences, firms could delay proceedings by engaging in

elaborate motion practice and requesting pre-hearing conferences on a

variety of motions, which could impose an additional financial burden

on public customers.\27\

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\20\ See Comment Letter Nos. 7 (``The NASD fees are already too

high, considering the lack of fairness in the procedures''); 17; and

26.

\21\ See Comment Letter Nos. 1 (``Raising the cost of

arbitration increases the financial risks that investors must bear.

Investors will be deterred further from filing claims.''); 3 (``We

are extremely concerned that proposed fee increases will hurt

investors' ability to obtain recovery for legitimate damages * *

*.''); 4; 11; 17; 18; 20; 21; 22; 32; 34 (``Fear of filing fees

should not deprive public customers of access to justice, yet that

is exactly what will be brought about by the NASD's proposal.'');

35; and 39.

\22\ See Comment Letter No. 32.

\23\ See Comment Letter Nos. 23 and 24.

\24\ See Comment Letter No. 23.

\25\ See Comment Letter No. 16.

\26\ See Comment Letter Nos. 2; 11; 15; 16; 18; and 34.

\27\ See Comment Letter No. 10.

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In support of the proposed rule filing, one commenter argues that

the cost of arbitration is still less than cost of litigation because a

plaintiff incurs filing fees in court and is subject to significant

out-of-pocket expenses for deposition transcripts, court reporters and

transcripts, and travel associated with depositions.\28\ That commenter

also argues that requiring a claimant to incur some meaningful expense

would weed out frivolous claims but not discourage valid claims.

Finally, the commenter argues that others' claims of undue burden are

overstated because he has never encountered a claimant who stated the

current fee was not affordable or who asked the commenter's firm to pay

the filing fee.

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\28\ See Comment Letter No. 33. In contrast, one commenter

opposes the proposed rule stating that the argument that litigation

is more expensive is weakened by innovations in court procedures

such as limits on the length of depositions and sanctions for

delays. See Comment Letter No. 16.

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In its response to the comment letters, NASD Regulation states that

it does not believe that the increased filing fees will constitute a

deterrent to arbitration because they remain a small portion of the

amounts alleged as damages (below one percent) and because the Director

of Dispute Resolution can waive the fees upon a demonstration of

financial hardship.\29\

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\29\ See NASD Response One. NASD Regulation also adds that if

the arbitrators assess forum fees against a party that its staff

knows is laboring under a financial hardship, that information will

be considered in connection with its decision whether to initiate

collection efforts.

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NASD Regulation responds to the concern about the expense of pre-

hearing conferences by stating that these conferences may save parties

money because they may avoid or reduce time-wasting disputes over

discovery, evidence, presentations and similar matters. NASD

Regulation, which bases its views on feedback from parties and

observations by staff, also states it will continue to monitor the pre-

hearing conference process to evaluate its effectiveness.

Securities Industry Should Pay for Fee Increases

Many securities firms ensure that any future disputes they may have

with customers will be handled in arbitration through the use of

predispute arbitration clauses in their customer agreements. Numerous

commenters argue that the securities industry should pay most, if not

all, of the proposed fee increase \30\ because it costs the industry

less money to handle its cases in arbitration,\31\ rather than in

court.\32\ For example, one commenter argues that the securities

industry should bear any fee increases to cover NASD Regulation budget

deficits because of the cost savings it receives by avoiding both jury

trials and the higher fees charged by the American Arbitration

Association (``AAA'').\33\ Two commenters argue that, because customers

are compelled to use NASD arbitration by their brokerage firms, it is

unfair to require them to deposit as much as half of the projected cost

of arbitration (which they state is possible under the proposed fee

increase) in order to pursue their claims.\34\ Another commenter argues

that the NASD's high expenses are a consequence of the industry's

successful efforts to compel arbitration at the NASD or other self-

regulatory organizations (``SROs''). The commenter maintains that it is

inappropriate to combine the industry's ability to choose arbitration

over litigation in the courts with an NASD requirement that customers

who use the forum must contribute to maintaining it.\35\ Two commenters

assert that NASD Regulation did not follow the recommendation in

Securities Arbitration Reform, Report of the Arbitration Policy Task

Force to the Board of Governors, National Association of Securities

Dealers, Inc. (January 1996) (``Task Force Report''), which stated that

members should pay most of the costs of arbitration, while investors

should only pay a small share of an increase in fees.\36\

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\30\ See Comment Letter Nos. 3; 6; 7; 11; 15; 20; 21; 25; 26;

28; 30; 32; 34.

\31\ See Comment Letter Nos. 7; 26; and 34 (``The securities

industry gets the benefits of forced arbitration of disputes. There

is nothing wrong with the securities industries paying for that

benefit through its trade organization.'').

\32\ See Comment Letter Nos. 6; 11; 15; 17; 20; 25 (``if the

brokerage industry wants * * * to mandate a specific private system,

the industry should be willing and required to bear virtually the

entire expense of that system''); 28; and 32.

\33\ See Comment Letter No. 30.

\34\ See Comment Letter Nos. 10 and 11.

\35\ See Comment Letter No. 8.

\36\ See Comment Letter Nos. 3 (``the expense of this increase

should be borne by the securities industry as recommended by the

NASD's Arbitration Policy Task Force''); 16; and 17.

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In support of the proposed rule change, two commenters argue that

members already bear most arbitration costs, and that the current ratio

of member and customer fees is maintained in the proposed fee

increases.\37\ In addition, one commenter argues that the industry

should not pay 100% of the fee increase because

[[Page 10045]]

claimants, as well as the industry, benefit from arbitration. The

commenter noted in particular that claims in arbitration are resolved

more quickly than claims in litigation.\38\

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\37\ See Comment Letter Nos. 33 and 37.

\38\ See Comment Letter No. 37.

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NASD Regulation responds that the proposed rule change, in

combination with previous rule changes increasing member surcharges and

adding a process fee for members only,\39\ ensures that the securities

industry will continue to pay most of the costs of arbitration.\40\

NASD Regulation states that the notice of the proposed rule change \41\

demonstrates that the industry will bear the majority of the costs of

operating the arbitration program and that the customer's portion of

the costs will continue to be relatively modest. Moreover, NASD

Regulation responds that the assertion that some members may enjoy

indirect savings from arbitration as a result of lower litigation

costs, settlements, or judgments does not provide a basis under the Act

for disapproving the proposed rule change. NASD Regulation asserts that

the appropriate basis for Commission approval of the proposed rule

change is whether the proposed fees provide for the equitable

allocation among the users of the arbitration program of reasonable

fees.

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\39\ See Securities Exchange Act Release No. 38807 (July 1,

1997), 62 FR 36858 (July 9, 1997) (increasing a member surcharge

each time a member firm or associated person becomes a party to an

arbitration case) and Securities Exchange Act Release No. 39504

(December 31, 1997), 63 FR 1134 (January 8, 1998) (SR-NASD-97-96)

(imposing a process fee on members who are parties in arbitration

proceedings).

\40\ See NASD Responses One and Three.

\41\See Securities Exchange Act Release 39346 (November 21,

1997), 62 FR 63580 (December 1, 1997).

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NASD Regulation argues that claimants also enjoy substantial

savings in arbitration because, for example, arbitration takes less

time than litigation.\42\ It also points out that appeals of decisions

are rare, involve narrower grounds and are less likely to succeed, and

that claimants avoid the expense of depositions and similar costs

associated with discovery in litigation. Finally, NASD Regulation

states that arguments concerning whether mandatory arbitration is

appropriate should not be addressed by the Commission in this rule

filing, and that the Supreme Court has expressly upheld the

enforceability of predispute contracts to arbitrate disputes between

investors and broker-dealers.\43\

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\42\ See NASD Responses One and Two.

\43\ See NASD Response One, citing Shearson/American Express,

Inc. v. McMahon, 482 U.S. 220 (1987) (``McMahon'').

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Commenters also argue that the increase in the allocation of fees

is significant in percentage terms, and in the dollar amount an

investor will have to pay in filing and forum fees.\44\ Another

commenter states that the NASD should consider the historical

allocation of expenses, not the historical revenue split, between

member users and investors/individual employee users.\45\ The NASD

responds that its filing demonstrates that the proposed fees are

reasonable because the filing and hearing session fees pay only for a

portion of the average direct costs of providing arbitration services

to the parties.\46\

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\44\ See Comment Letter Nos. 17 (``the increase is significant

in percentage terms and dollar terms'') and 28.

\45\ Comment Letter No. 36.

\46\ See NASD Response One. In addition, NASD Regulation

discussed the general costs and revenues of its program in response

to this comment.

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Arbitration Contracts

Several of the commenters suggest that the fee increases in the

proposed rule change would undermine the rationale underlying the

Supreme Court's decision in McMahon, which holds that predispute

agreements to arbitrate claims between customers and broker dealers

under the Act are enforceable.\47\ Commenters also argue that

arbitration is supposed to be an inexpensive and speedy alternative to

litigation, and question how that could continue to be true after the

proposed fee increases.\48\ NASD Regulation responds that arbitration

will continue to be more economical than litigation in light of the

complexity of court litigation, especially discovery costs.\49\

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\47\ See Comment Letter Nos. 4; 17; and 48.

\48\ See Comment Letter Nos. 8 (``[A]rbitration was--and is--

intended as a speedy and inexpensive alternative to litigation.'')

and 34 (``[T]he arbitration concept was originally sold as an

inexpensive alternative to traditional litigation. The proposed

filing fee increases may not appear large to the professionals who

will review them; but they are huge to elderly public customers who

are living on fixed incomes and have lost the bulk of their life

savings.'') (emphasis in original).

\49\ See NASD Response One.

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Administration of the Arbitration Process

Several commenters assert that the proposed rule change does not

address problems with the administration of the arbitration process,

and that the Commission should not approve the proposed rule change

until NASD Regulation has addressed these problems.\50\ Specifically,

commenters cite concerns about submitting materials to arbitrators,\51\

scheduling,\52\ the arbitrator selection process,\53\ the discovery

process,\54\ and the telephone system.\55\

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\50\ See Comment Letter Nos. 5; 20; and 21.

\51\ See Comment Letter No. 5.

\52\ See Comment Letter Nos. 5; 20; and 21.

\53\ See Comment Letter Nos. 5; 21; and 35. The Commission notes

that it has recently approved a proposed rule change filed by the

NASD relating to the selection of arbitrators under a new list

selection process. See Securities Exchange Act Release No. 40555

(October 14, 1998), 63 FR 56670 (October 22, 1998).

\54\ See Comment Letter Nos. 20; 21 (``Problems with the

discovery process and the abuse thereof * * * have gone unaddressed

in these amendments.''); and 26.

\55\ See Comment Letter Nos. 20 and 21.

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In response, NASD Regulation states that the commenters who argue

that the forum is less efficient than courts by comparing arbitration

fees to court fees and expenses fail to make a proper comparison. NASD

Regulation points to the significant tax subsidy that supports public

courts, the large administrative overhead of the court system, and the

cost to parties added by the complexity of court litigation. NASD

Regulation also states that arbitration is a private forum whose costs

must be paid for either by its sponsor or users. It states that it is

more equitable to fund arbitration with revenue from member firm users

rather than from general assessments against all members. NASD

Regulation also states that the overwhelming majority of the costs of

the forum will be paid by member users of the forum and not by

investors.

In support of the proposed rule change, one commenter states that a

fee increase is necessary for NASD Regulation to perform adequately its

administrative function because it will help maintain the efficiency of

the arbitration process and upgrade arbitrator training.\56\

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

\56\ See Comment Letter No. 37.

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Fees May Make Arbitration Unaffordable for Some People

Commenters also argue that the proposed fee increases, if

implemented, could deny investors equal protection under the law or due

process because arbitration would be mandatory, but too expensive for

investors.\57\ Two

[[Page 10046]]

commenters argue that to increase the fee to investors would create a

system of justice available only to the rich.\58\

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\57\ See, e.g., Comment Letter Nos. 1 (``[M]any of our clients

are denied equal protection under the law because they do not have

the financial means to pay for NASD arbitration.''); 12 (``[A]dding

additional costs to the Claimant * * * will result in more Claimants

being denied fair and reasonable access to the arbitration process *

* *. This appears to raise very serious equal protection

arguments.''); 13 (``As long as brokerage firms are allowed to force

public customers into SRO sponsored arbitration any increase in fees

raises equal protection and antitrust issues.''); 16; 18; and 25

(``[T]he customer is required to surrender his right to litigate * *

* in court * * * in favor of a private system which he does not want

and which, if the fee increases are granted, he will be required to

bear a substantial financial burden to support * * *. Such a

condition * * * presents a situation where the customer is actually

being denied equal protection of the law.'').

\58\ See Comment Letter Nos. 3 and 4.

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NASD Regulation responds that the fees remain a low percentage of

the damages claimed, and that NASD Regulation may waive fees and

deposits if a customer demonstrates financial hardship.\59\ NASD

Regulation also responds that mandatory arbitration, which the Supreme

Court has upheld, is not at issue in this proposed rule change.

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

\59\ See NASD Responses One and Three.

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Non-SRO Alternative

Several commenters suggest that NASD Regulation adopt a rule that

would allow investors the choice of resolving their disputes at a non-

SRO forum, and point that PIABA has submitted a petition to the

Commission on this point. They argue that such a rule would eliminate

the need for an increased budget or fees for two reasons: first,

because many claimants would choose the AAA,\60\ which they argue is a

better forum than NASD Regulation; \61\ and second, because the

appropriate fees for NASD Regulation's arbitration services can only be

determined when its arbitration forum is required to compete with other

arbitration forums.\62\ In addition, one commenter suggests that the

NASD's arbitration expense projections are high compared with the AAA

expenses.\63\ In support of the proposed rule change, one commenter

argues that the AAA fees are substantially higher than the proposed

fees, and that ``claimants' bar is willing to pay higher fees if it

deems it to be in its best interest.'' \64\

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\60\ See Comment Letter Nos. 7; 26; 27; and 30 (``The American

Arbitration Association alternative would be a means of reducing the

caseload and the budget deficit of the NASD.'').

\61\ See Comment Letter Nos. 14; 20 (``AAA's case administration

is much, much better * * *. The letter notes also that ``the cost of

the AAA is much higher * * *''); 27; and 35.

\62\ See Comment Letter No. 13.

\63\ See Comment Letter No. 36.

\64\ See Comment Letter No. 37.

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In response, NASD Regulation states that enabling investors to take

their claims to AAA would not address commenters' concerns about the

cost of arbitration because AAA is no less expensive and is not

subsidized by member firms.\65\ It also states its understanding that

AAA does not waive its fees in cases of financial hardship. NASD

Regulation also submitted a comparison of NASD Regulation and AAA fees

and charges for customer arbitrations, stating that ``NASD arbitration

charges under the proposed new fee schedule will generally be

substantially less than the AAA's charges for comparable cases.'' \66\

In addition, NASD Regulation states that the issue of the widespread

use of arbitration contracts raised by the commenters is not before the

Commission in connection with this rule filing.

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

\65\ See NASD Response One.

\66\ See letter from John M. Ramsey, Vice President and Deputy

General Counsel, NASD Regulation, to Katherine A. England, Assistant

Director, Division of Market Regulation, Commission, dated August

18, 1998.

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Arbitrator Honoraria

One commenter argues that the arbitrator honoraria should not be

increased.\67\ The commenter argues that SRO arbitrators are volunteers

rendering a public service, not professional arbitrators, and that

because the proposed increase would not actually compensate arbitrators

for the amount of time they typically devote to cases, the increase

would not attract more qualified arbitrators. He also stated that if

this honorarium increase did attract arbitrators, it would raise a

concern that those arbitrators might not award appropriate damages

against respondent firms for fear of being struck from future panels.

Another commenter argues that an increase in arbitrator honoraria is

reasonable but that it should not apply to pre-hearing conferences.\68\

One commenter states that the expense of the arbitrator honoraria

increase should be paid by the industry, and characterizes the Task

Force Report as supporting this argument.\69\

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\67\ See Comment Letter No. 28.

\68\ See Comment Letter No. 36. The commenter does not believe

that pre-hearing conferences warrant the same fee for arbitrators as

a hearing session because they are often conducted over the

telephone and are of short duration.

\69\ See Comment Letter No. 3.

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Miscellaneous

One commenter argues that the proposed fee increase would reduce

the uniformity of the arbitration rules used by the SROs and lead to

forum shopping, as was typical before SICA was established to create a

uniform code.\70\ One commenter who supports the proposed rule change

states that it takes no position on the issue of uniformity but noted

that other SROs are smaller and may have lower expenses, and

accordingly no need to increase fees.\71\ One commenter argues that the

fee increase will cause investors to use other SRO arbitration forums

not prepared to handle the increase in case load.\72\ Another commenter

suggests that NASD Regulation increase the amount it contributes to

funding the arbitration budget rather than trying to make arbitration

self-sustaining.\73\

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

\70\ See Comment Letter No. 28.

\71\ See Comment Letter No. 37.

\72\ See Comment Letter No. 16.

\73\ See Comment Letter No. 4.

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

One commenter states that public customers' interests are not

represented in the administration of the NASD's Arbitration

Department.\74\ NASD Regulation responds that the public is represented

in the administration of the arbitration program because NASD

Regulation's National Arbitration and Mediation Committee (``NAMC'')

includes several public members.\75\ NASD Regulation also responds that

three of the six members of its Subcommittee on Arbitration Fees, which

was formed by the NASD Regulation Board of Directors to develop the

proposed fee increases, are representatives of the public.\76\

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\74\ See Comment Letter No. 11.

\75\ See NASD Response One.

\76\ NASD Regulation identified James E. Burton, CalPERS, Bonnie

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

Libra, Abramson & Thomson and PIABA board member, as representative

of the public.

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

Finally, several commenters argue that there have been changes in

the NASD's fee administration that have not been noticed for comment,

or approved by the Commission, that result in arbitrators increasingly

assessing fees against customer claimants, even when these claimants

recover an award.\77\ One commenter, an individual investor who

recently completed an arbitration at the NASD, states that even though

he prevailed in arbitration, the arbitrators assessed half the

arbitration fees against him.\78\ He also states that if he had been

allowed to file his claim in court, the fees would automatically have

been assessed against the loser. One commenter states that a practice

of assessing fees against investors can have the effect of a sanction

for bringing losing cases. That commenter argues that the fact that an

investor does not prevail does not mean that a ``sanction'' is

appropriate.\79\ Another commenter notes that there is a developing

trend

[[Page 10047]]

among arbitration panels to request additional session deposits. In

that commenter's view, this results from information and training

materials given to the arbitrators at training sessions, or advice

given by employees of NASD Regulation. The commenter views this as

inappropriate because fee assessments are a matter of arbitrator

discretion.\80\

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

\77\ See Comment Letter Nos. 1 (``We are experiencing more and

more cases where customers are directed by the arbitrators to pay

all or 50% of the hearing session fees even when the member firms

are found liable.''); 17 (``Over the last two years, it has become

common that the arbitrator split arbitral fees between the investor

and the firm, even in cases where the investor received a

substantial recovery. * * * PIABA is even more disturbed about the

NASD's recent implementation of a policy requiring investors to pay,

in advance, half the anticipated costs of an arbitration.''); and

39.

\78\ See Comment Letter No. 24.

\79\ See Comment Letter No. 17.

\80\ See Comment Letter No. 8.

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

NASD Regulation responds that, contrary to commenters' assertions,

its figures demonstrate that members are paying approximately 80

percent of the fees assessed, and that public investors are paying 20

percent.\81\ NASD Regulation stated that it is also revising its

arbitrator training to clarify the issues that arbitrators should

consider in assessing forum fees in order to encourage the fair

allocation of forum fees for investors and industry parties. NASD

Regulation states that such factors include whether a party

substantially prevailed, or engaged in dilatory or unreasonable

conduct. Moreover, NASD Regulation stated in conjunction with this rule

proposal that it now advises arbitrators of the dollar amount of the

fees that may be assessed under the fee schedules so that they more

clearly understand the consequences to all parties of fee allocations

based upon a percentage. Previously, some arbitrators may have ordered

percentage-based allocation of fees without checking the total dollar

amounts that had accumulated over multiple hearing sessions. Finally,

NASD Regulation states it is no longer suggesting, in training

materials or otherwise, that arbitrators assess interim hearing session

deposits until after a substantial number of hearing sessions have been

held.\82\

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\81\ See NASD Responses One and Three. NASD Regulation states

that these percentages cover the time period September 1, 1996 to

August 31, 1997. This figure does not include the initial filing fee

paid by claimants. When filing fees and hearing session fees are

added together, and adjustments are made for deposits and refunds,

the customer share of net revenue during that period was 23%.

According to NASD Regulation, its data for 1995, 1996 and 1997 also

show approximately the same customer to member ratio.

\82\ NASD Regulation states it has experienced increasing

difficulty collecting forum fees from unsuccessful claimants after

an award has been made, and notes its understanding that other, non-

industry forums, such as AAA, will not accept a case for disposition

unless fees are paid in advance.

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IV. Discussion

Under Section 19(b) of the Act, the Commission must approve a self-

regulatory organization's proposed rule change if it finds it is

consistent with the Act.\83\ The key statutory provision with respect

to an association's fees is section 15A(b)(5) of the Act,\84\ which

requires that the rules of an association provide for the ``equitable

allocation of reasonable'' fees.

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\83\ In approving this rule, the Commission notes that it has

considered the proposed rule's impact on efficiency, competition,

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

\84\ 15 U.S.C. 78o-3(b)(5).

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

In support of this proposal, NASD Regulation conducted an analysis

of its costs in order to determine how to allocate fees and fee

increases reasonably and fairly among members and investor users of the

program. In particular, NASD Regulation analyzed its operating cost

figures in order to compute appropriate fee increases.\85\ NASD

Regulation's analysis permitted the Office of Dispute Resolution to

extrapolate its likely costs for 1998 and compare them to the expected

revenue under the new fee structure. NASD Regulation's analysis of its

average cost of performing these activities \86\ and a hypothetical

cumulative cost for each case,\87\ charted against the fee revenue

received for each case, indicates that the revenue from filing fees has

been expended before a pre-hearing conference is held. NASD

Regulation's analysis also indicates that once an award is rendered

following a hearing, all of the revenue from the additional forum fees

(principally the fees based upon the number of hearing sessions) that

could be collected in a case also has been expended.\88\ In short, the

filing fees and hearing session deposits, even with the increase in

fees proposed in this rule filing, do not cover the cost of

administering the program.\89\

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\85\ NASD Regulation looked at costs associated with such

activities as: (1) Receiving and processing claims; (2) analyzing

and serving claims; (3) selecting arbitrators; (4) scheduling

hearings; and (5) conducting hearing sessions.

\86\ NASD Regulation stated that it computed the average

activity cost by taking the total cost for each activity and

dividing it by the number of times each activity occurred.

\87\ NASD Regulation stated that it charted the activities and

their costs sequentially as they likely would occur in a case to

produce a hypothetical cumulative cost at each major stage of a

case.

\88\ NASD Regulation stated that its 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, NASD regulation states that in its

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. It believes that the cost

variance may result from the increased contentiousness of the

litigants when there are larger damages in dispute as well as from

the fact that there are sometimes more parties involved in cases

where large amounts are in dispute.

\89\ While its budget figures project that the proposed filing

and hearing session fees may pay for approximately 68% of its direct

costs of administering cases, NASD Regulation's actual experience

with revenue received during the year suggests that the fees may pay

approximately 50% of the direct costs. The proposed filing and

hearing session fees would not pay for NASD Regulation's general

costs for administering the arbitration department, including costs

for arbitrator recruitment and training, computer systems, office

space, senior management, and legal services. See letter from

Elliott Curzon, Assistant General Counsel, NASD Regulation, to

Robert A. Love, Special Counsel, Division of Market Regulation,

Commission, dated June 4, 1998.

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

Based upon the analysis of its costs of administering the

arbitration program, NASD Regulation designed the proposed fee

increases to attempt to cover the projected actual costs incurred by

NASD Regulation in administering particular cases. In particular, NASD

Regulation states that the filing fees were designed to cover much of

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

the prehearing conference. According to NASD Regulation, in the lower

bracket cases the filing fees are lower than its cost of providing the

service, and in larger bracket cases, the filing fees approach but do

not exceed its average cost of providing the service. The hearing

session deposit fee increase was also based upon the analysis of the

projected average cost to provide a single hearing session.\90\

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\90\ According to the NASD, in 1996 the cost of the dispute

resolution program exceeded fee revenue by $11.3 million. For 1997,

even with the implementation of increases in the member surcharge

and an increase in revenue due to increases in the arbitration

caseload, the cost exceeded revenue by $14.9 million. For 1998, the

cost of the program was expected to exceed revenue by $6.1 million

(this was assuming the proposed changes were approved and

implemented by the beginning of the year; it also excludes, however,

the member process fee, which was implemented to cover this gap).

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 pre-hearing 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).

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

The Commission believes that the proposed fee increases for members

and associated persons are reasonable under the Act because they are

designed to cover the direct costs of administering the arbitration

program. Moreover, the

[[Page 10048]]

fee increase (to cover direct costs) as applied to those claims that

solely involve industry parties is consistent with the SRO rules to

resolve industry disputes outside the court system, through the

arbitration process.\91\

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

\91\ See, e.g., NASD Rule 10201.

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

The proposed new filing fees range from $25 to $600 for public

investors. The average increase is 50% in most categories. The largest

filing fee increases are in cases where the claims are for $1 million

or more.\92\ There is no increase in the $1,000 to $10,000 categories.

The Commission believes that these increases are reasonable because

they are designed to require that public investors pay no more than the

average direct costs incurred by NASD Regulation to provide arbitration

services to the parties. Moreover, the arbitrators in their award may

determine that a respondent must reimburse an investor for any filing

fee it has paid.\93\

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\92\ In the $3 million to $5 million category, the increase is

140%; in the $1 million to $3 million, $5 million to $10 million,

and over $10 million categories, the increase is 100%.

\93\ NASD Rule 10332(c).

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

The amount of the hearing session deposit increases are also

reasonable. The resulting hearing session deposits are graduated from a

relatively low level for cases in lower brackets so as to not

discourage public investors from seeking relief, up to the projected

average cost of conducting hearings in the higher brackets.\94\ Under

the proposal, the hearing session deposit will be the same for claims

filed by public investors and members. The hearing session deposit, and

by extension the hearing session fees, are designed not to exceed the

NASD Regulation's actual costs. According to the proposal, these costs

are, on average, approximately the same regardless of who the parties

are, even if they may vary by the amount in dispute or the number of

parties involved. It is these average direct costs for providing a

hearing (including arbitrator compensation and a hearing room, for

example) that are paid for with these fees. In addition, the fees are

not automatically imposed on either party.

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\94\ NASD Regulation's projected average cost to provide

hearings in 1998 is approximately $1,200 per hearing session. This

is based upon NASD Regulation's activity-based costing study,

described more fully in the notice of the proposed rule change. See

Securities Exchange Act Release No. 39346 (November 21, 1997), 62 FR

63580 (December 1, 1997). The activities used in computing this cost

include arbitrator expenses and compensation, hearing room expenses,

expenses of keeping a record, and staff work and expenses. NASD

Regulation states that the Office's experience also shows that the

costs of conducting hearings vary as the amount in dispute and the

number of parties involved increase. In many cases, 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.

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The proposed rule change also provides for the equitable allocation

of these filing and hearing session fees. Under NASD Rule 10332(c)

governing the assessment of fees, which remains unchanged by this rule

filing, ``[t]he arbitrators, in their awards, shall determine the

amount chargeable to the parties as forum fees and shall determine who

shall pay such forum fees.'' Under the rule, arbitrators may apportion

forum fees among the parties, or may assess all of them against one

party or the other. Under the rule, the arbitrators also may determine

not to assess some or all of the fees, in which case NASD Regulation

would have to absorb the costs of the proceeding. Under its rule

structure, the only fee NASD Regulation is assured that it does not

have to return to the parties is the initial filing fee.

Significantly, NASD Regulation has stated it will waive the initial

filing fee and hearing session deposit at the time of filing if a party

can demonstrate financial hardship.\95\ It is the Commission's

understanding and expectation that NASD Regulation will make known to

potential claimants, especially investors, that there can be a

financial hardship waiver of the filing fee and initial hearing session

deposit. The Commission also understands that the procedure for filing

a request for a waiver will be clear to claimants. After the initial

filing fee and hearing session deposit are paid or waived, the

arbitrators in a given case have the discretion to require additional

hearing session fee deposits. In a case where the NASD Regulation has

waived the initial filing fee due to financial hardship, it would seem

improvable that an arbitrator would require the claimant to pay hearing

session fee deposits. (Conversely, an arbitrator could well conclude

not to require additional hearing session fee deposits on financial

hardship grounds even where NASD Regulation staff had refused to waive

the filing fee and initial hearing session deposit.) Because the

financial hardship waiver is important to the Commission's finding that

the proposed fee increases are equitable, the Commission plans to

monitor closely NASD Regulation's administration of the waiver process.

Further, NASD Regulation states that it takes financial hardship into

account when deciding whether to pursue collection action against a

party who has been ordered to pay fees, but has failed to do so.

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\95\ Arbitrators also may order a respondent to reimburse a

claimant for the amount of the filing fee paid at the beginning of

the case.

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Arbitrators are charged with making fee assessment decisions after

consideration of whether a party substantially prevailed, or engaged in

dilatory or unreasonable conduct. Arbitrators, who are entrusted with

resolving many other difficult issues involving the parties, also are

capable of resolving the equitable allocation of these increased

fees.\96\ NASD Regulation stated in conjunction with this proposal that

it now advises arbitrators of the dollar amount of fees that may be

assessed under the fee schedules against the parties so that they

clearly understand the consequence to all parties of fee allocations

based upon a percentage. NASD Regulation also has stated that it is

revising its arbitrator training to clarify issues and factors

arbitrators should consider in assessing forum fees, in order to

promote fair fee assessments. Moreover, the overall fee structure

continues to provide that the arbitration program is subsidized by the

NASD and its members.\97\

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\96\ NASD Regulation has stated that, historically, arbitrators

have assessed approximately 77 percent of the fees against member

parties to arbitrations. NASD Regulation does not expect this

pattern to change, but also has undertaken to monitor fee

assessments.

\97\ NASD Regulation states that a small number of large firms

are involved in more than 50 percent of all arbitration cases, and

it determined to shift member costs to these member users. The

NASD's arbitration program will continue to be subsidized by member

firms, but the subsidy has largely shifted from all members to

member users. This subsidy comes from two separate fees imposed only

on member parties to arbitration cases. In 1994, NASD Regulation

began charging members a non-refundable ``member surcharge'' fee

(and increased the fee in 1997) if the member or an associated

person of the member was named in an arbitration proceeding. In

1998, NASD Regulation began charging a ``member process'' fee

against firms involved in an arbitration as the case progresses to

different phases (accordingly, a firm that is able to settle a case

before a hearing would be able to avoid some of the member process

fee). The fee was intended to address a projected $6.1 million

deficit that would remain even with the approval of this rule

proposal. See supra notes 39 and 90.

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Some commenters argue that the fee increases in the proposed rule

change are inconsistent with the Act because some investors may be

deterred by the fees from bringing claims to arbitration. The

Commission understands that investors will weigh any increase in the

fees as part of their consideration whether to file an arbitration

claim. As the Commission has stated previously, arbitration fees

``should not be permitted to operate in a manner that weighs too

heavily on individual parties or serves as a disincentive to pursuing

the redress of investors' grievances against broker-dealers or their

[[Page 10049]]

associated persons.'' \98\ Clear procedures for waiving initial fees in

cases of financial hardship and arbitrator discretion should help

prevent fees from becoming too onerous for individual investors.

Set out below are three charts that compare hearing session fees

under the current and proposed new fee structures. The first chart

includes sample hearing session fees for larger cases, which typically

are resolved by three arbitrators. The second chart includes sample

hearing session fees for smaller cases, which typically are resolved by

a single arbitrator. The third chart includes sample fees for smaller

cases decided on the paper record.

Chart I is based largely on the sample cases set out in Exhibit 2

to the proposed rule change. It takes into account both the amount of

the hearing session fees that could be assessed and the number of

hearing sessions typically conducted within the bracket.

Chart I

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

Hearing session

Hearing session fees under current

fees under current rule in 1998 Hearing session

Case dollar amount and number of hearing sessions rule in 1990 dollars (adjusting fees under new

dollars current fees for rule

inflation) \99\

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

$30,000.01-$50,000 (four hearing sessions)\100\..... $1,600 $2,008 $2,400

$50,000.01-$100,000 (four hearing sessions)......... 2,400 3,012 3,000

$100,000.01-$500,000 (six hearing sessions)......... 4,500 5,647 6,750

$500,000.01-$1,000,000 (nine hearing sessions)...... 6,750 8,470 10,800

$1,000,000.01-$3,000,000 (ten hearing sessions)..... 10,000 12,548 12,000

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

Chart II is based upon the fees that can be assessed for cases up

to $30,000 that are decided with an in-person hearing.

Chart II

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

Hearing session

Hearing session fees with one

fees with one arbitrator under Hearing session

Case dollar amount \101\ arbitrator under current rule in fees with one

current rule in 1998 dollars arbitrator under

1990 dollars (adjusting fees new rule

for inflation)

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

$.01-$1,000......................................... $30 $38 $50

$1,000-$2,500....................................... 50 62 100

$2,500.01-$5,000.................................... 200 250 250

$5,000.01-$10,000................................... 400 502 500

$10,000.01-$25,000 \102\............................ 600 752 900

$25,000.01-$30,000 \103\............................ 900 1,128 1,350

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

Chart III is based upon sample cases decided on the paper record

without an oral hearing. This option, which is available for cases up

to $25,000, is the least expensive option for resolving disputes.

Chart III

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

Fees for cases

Fees for cases decided on the

decided on the paper record under Fees for cases

Case dollar amount paper record under current rules in decided on the

current rule in 1998 dollars paper record under

1990 dollars (adjusting fees new rules

for inflation)

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

$.01-$1,000......................................... $15 $19 $25

$1,000.01-$2,500.................................... 25 31 50

$2,500.01-$5,000.................................... 75 94 125

$5,000.01-$10,000................................... 75 94 250

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

$25,000.01-$30,000.................................. NA NA NA

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\98\ Securities Exchange Act Release No. 26805 (May 10, 1989), 54 FR 21144 (May 16, 1989).

\99\ Current fees, adjusted for inflation, are added here as a point of reference. They were not included in the

NASD's proposed rule change.

\100\ Under the new fee structure, parties with disputes in this bracket will be able to agree to have one

arbitrator decide their case. If one arbitrator is used, the hearing session fee would be $1,800.

\101\ Two hearing sessions are assumed for all cases up to $25,000, and three hearing sessions are assumed for

cases between $25,000.01 and $30,000. See letters from John M. Ramsey, Vice President and Deputy General

Counsel, NASD Regulation, to Katherine A. England, Assistant Director, Division of Market Regulation,

Commission, dated August 18, 1998 and September 10, 1998.

\102\ If three arbitrators were used, the current fee for two hearing sessions would be $800, the current fee

adjusted for inflation would be $1,004. Three person panels are not typically available under the new fee

structure for cases below $25,000.01.

\103\ If three arbitrators were used, the current fee for three hearing sessions would be $1,200, the current

fee adjusted for inflation would be $1,506, and the fee under the new rule would be $1,800.

[[Page 10050]]

The existing fee schedule was established in 1990.\104\ Inflation

has risen 25% since that time.\105\ Moreover, the NASD's arbitration

facilities have grown in the past eight years since the fees were last

revised.\106\ In dollar amounts, the additional cost to investors with

smaller claims as a result of the fee increased would not be

substantial. For large claims, a significant amount of money already is

at stake in the litigation and the amounts that the arbitrators may

assess against one or both of the parties is not so large that it

should affect the decision to pursue claims, especially when the

arbitrators assess fees only after fully considering each party's

position. Again, the NASD's financial hardship fee waiver process

should help assure that investors do not forego their claims solely on

account of the fee increase.

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\104\ Securities Exchange Act Release No. 28086 (June 1, 1990),

55 FR 23493 (June 8, 1990).

\105\ Consumer Price Index, All Urban Consumers, All Items, U.S.

Department of Labor, Bureau of Labor Statistics.

\106\ For example, 3,617 cases were filed in 1990, and 5,997

cases were filed in 1997. To administer these cases, NASD Regulation

has developed a new computer system to process the selection of

arbitrators under a list selection system for selecting arbitrators

that the Commission recently approved. See supra note 53.

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Comments challenging the efficiency and quality of arbitration

administered by the NASD reinforce the importance of the work

undertaken by the NASD's Arbitration Policy task Force and its NAMC, as

well as the Commission's own oversight of the arbitration process.\107\

These criticisms, however, do not refute NASD Regulation's

demonstration that it expends significant amounts of money

administering its arbitration program that have not in the past been

matched by fee revenue, and that these fee increases are directed at

recovering the direct costs of administering the forum. More

importantly, they also are outweighed by the fact that arbitrators make

fee allocations after a hearing on the record.

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\107\ The NASD has reported that it has implemented steps to

improve efficiency, including the early selection of arbitrators.

The increase in arbitrator honoraria proposed in this filing is part

of NASD Regulation's effort to attract and retain qualified

arbitrators. Moreover, the Commission has recently approved NASD

Regulation's list selection method for choosing arbitrators, which

may be preferred by investors. See Securities Exchange Act Release

No. 40555 (October 14, 1998), 63 FR 56670 (October 22, 1998). NASD

Regulation also has reported to the Commission initiatives to

improve case processing and administration by, among other things,

upgrading its computerized case tracking system and hiring

additional staff.

The comments that arbitration fees are higher than court fees do

not on their own indicate that the proposed fees are not reasonable.

Litigation is likely to involve other significant costs associated

with depositions and attorney fees that would likely be lower in an

arbitration setting.

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Some commenter's other broad attacks against the proposed fee are

equally unpersuasive. As noted above, several commenters, citing

McMahon, questioned whether the fee increases would prevent claimants

from being able to vindicate their rights in arbitration. Because the

fee increases will not affect the substantive rights of claimants, and

because NASD Regulation has a fee waiver process for claimants who have

a financial inability to pay the fees, the Commission sees no conflict

with McMahon.\108\ As to the comments regarding whether arbitrators

require periodic payments of hearing session deposits and how

arbitrators allocate fees in their awards, NASD Regulation states it is

revising its arbitrator training to clarify the issues and factors

arbitrators should consider in assessing forum fees, in order to ensure

that those fees are assessed fairly.\109\ It is clear that

determinations about whether to request additional hearing session

deposits from the parties during a case are at the sole discretion of

the arbitrators.

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\108\ We also do not agree with the commenters' statements that

the fee increases would raise equal protection or due process

concerns. A threshold requirement of any constitutional claim is the

presence of state action. See, e.g., Lugar v. Edmondson, 457 U.S.

922, 936 (1982). A government agency's oversight or approval of a

regulated entity's business and operations does not constitute state

action. See, e.g., Jackson v. Metropolitan Edison Co., 419 U.S. 345,

357 (1974). Courts that have considered the issue have concluded

that the NASD's operation of an arbitration forum does not

constitute state action simply because the Commission reviews and

approves arbitration rules. See, e.g., Cremin v. Merrill Lynch

Pierce Fenner & Smith, Inc., 957 F. Supp. 1460, 1465-1470 (N.D. Ill.

1997).

\109\ See NASD Response One.

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In conclusion, the proposed fee increases are reasonable because

they do not exceed the direct average cost of resolving a dispute.

Moreover, the NASD's financial hardship fee waiver process should help

assure that investors do not forego filing their claims solely on

account of the fee increase. Finally, the proposed fee increases are

equitably allocated because it is the arbitrators who decide who will

pay them in any individual case.

V. Conclusion

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

Act,\110\ that the proposed rule change (SR-NASD-97-79) is approved.

\110\ 15 U.S.C. 78s(b)(2).

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By the Commission.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 99-4955 Filed 2-26-99; 8:45 am]

BILLING CODE 8010-01-M