From: Jeff Sonn, Esq.
Affiliation: Sonn & Erez
July 14, 2005
Jonathon G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street
Washington DC 20549-0609
Re: File No. SR-NASD 2003-158
Comment on Reorganization and Revisions to NASD Rules Relating to Customer Disputes
SEC Release No. 34-51856
Dear Mr. Katz:
Our firm appreciates the opportunity to comment on the re-write of the NASD Code of Arbitration Procedure as it affects customer-industry disputes. My practice has been focused on representing customers with sales abuse claims in NASD arbitration and Court since 1988. I have represented both customers and brokers in the past, although the majority of my practice over the last 10 years is comprised of representing public investors.
As explained below, I believe the current rules, as well as the re-write, unfairly expose defrauded investors to the dismissal of their claims on the merits without a hearing. The following is an example: I was representing claimants in a customer dispute before the NASD, involving allegations of the fraudulent of proprietary mutual funds Respondent moved to dismiss the customers' claim, as well as moved for summary judgment, based on the "bespeaks doctrine," that is that a customer cannot bring claims for oral misrepresentations where the prospectus sets forth the risk of the investment.The "bespeaks caution" doctrine refers to the use of cautionary language aimed at warning investors of potential risks that may occur in the contingent or unforeseen future. See Stolz Family P'ship L.P., 355 F.3d 92, 97 (2d Cir.2004).To defeat the defense of the bespeaks caution doctrine, an investor must show that the cautionary language failed to expressly warn of, or does not directly relate to, the risk that brought about Plaintiffs' loss. Id.; see also Saslaw v. Askari, No. 95Civ7641, 1997 WL 221208, at * 7 (S.D.N.Y. Apr.25, 1997). However, the bespeaks caution doctrine is not applicable if it is abused or gamed. Cautionary words about future risk cannot insulate from liability the failure to disclose that the risk has transpired. See In re Prudential Secs. Inc. P'ships Litig., 930 F.Supp. 68, 72 (S.D.N.Y.1996) ("The doctrine of bespeaks caution provides no protection to someone who warns his hiking companion to walk slowly because there might be a ditch ahead when he knows with near certainty that the Grand Canyon lies one foot away."). The SEC has held that, in the enforcement context, a registered representative may be found in violation of the NASD's rules and the federal securities laws for failure to fully disclose risks to customers even though such risks may have been discussed in a prospectus delivered to the customers. See, e.g., Larry Ira Klein, 52 S.E.C. 1030, 1036 (1996) ("Klein's delivery of a prospectus to Towster does not excuse his failure to inform her fully of the risks of the investment package he proposed."); Robert A. Foster, 51 S.E.C. 1211, 1213 n.2 (1994) ( "Notwithstanding Foster's distribution of the prospectuses, he is liable for making untrue statements of material facts and omitting to state material facts . . . As the Commission has long held, information contained in prospectuses 'furnishes the background against which the salesman's representations may be tested."') (Order Instituting Proceedings, Making Findings and Imposing
Sanctions) (quoting Ross Secs., Inc., 41 S.E.C. 509, 510 (1963)).
Despite clear law that Registered Representatives may be held liable for making untrue statements contrary to the prospectus (usually delivered to the client after the sale is made), the Respondent filed motions predicated on the current NASD Rule 10214, which states in relevant part that "[t]he arbitrator(s) shall be empowered to award any relief that would be available in court under the law" and cites to Sheldon v. Vermonty, 269 F.3d 1202, 1206 (10th Cir. 2001) that the court has accepted Respondent's interpretation. See also Vento v. Quick & Reilly, 2005 WL 906585,*3 (10th Cir.)("Mr. Vento's primary objection, regarding the lack of authorization for a dismissal on the pleadings under Rule 10305, was explicitly rejected by this Court in Sheldon v. Vermonty . . .").
However, the Tenth Circuit never explained how it reached this conclusion when NASD Rule 10214 applies only to statutory employment discrimination claims, not customer claims. NASD Rule 10210. Contrary to the NASD's description of a hearing on its website, which includes testimony and cross-examination, the Tenth Circuit believes that oral argument on a motion to dismiss on the pleadings constitutes a full hearing under NASD Rule 10303. Sheldon, 269 F.3d at 1207.
When I objected to the panel's consideration of such motions to dismiss and for summary judgment, and pointed out that the panel had no explicit jurisdiction to consider such dispositive motions, the Chairperson advised me that the panel would "take it under advisement" Later, the panel ruled it had jurisdiction to consider the dispositive motions and would consider same at the beginning of the final hearing. What is the purpose of the NASD Code of Arbitration Procedure and the parties' submission agreements, if a panel can simply ignore the provisions of the NASD Code and apply federal and/or state civil practice rules to an NASD customer claim? What is the purpose of spending thousands of dollars on exhibits, expert witnesses, attorney and paralegal time, and arbitrator forum fees if you show up to a final hearing and the panel summarily decides the case without taking evidence? This type of abuse can only be prevented by a clarification in the re-write.
In our view, the clarification should specify that NASD Rules do not permit dismissal on the pleadings pursuant to federal or state civil practice rules and/or current NASD Rule 10214. NASD Rule 10314 contains the requirements for a statement of claim, not federal or state civil practice rules. NASD Rule
10303 requires an evidentiary hearing.
The NASD Code should be amended to specify that arbitrators may not apply federal or state civil practice rules to deny customers their right to a hearing and that a motion for dismissal of a customer claim based on the application of NASD Rule 10214 and federal or state civil practice rules is a "bad faith"
motion. Since the record shows that some arbitrators and the Tenth Circuit believe that federal or state pleading requirements may be applied to dismiss customer claims with prejudice, clarification is prudent.
Furthermore, the NASD Code should specifically ban motions for summary jud gment by making the filing of a summary judgment motion evidence of bad faith.
Without depositions, interrogatories and requests for admissions, claimants cannot reasonably defend a motion for summary judgment.
Summary judgment, under the federal rules of civil procedure ("Fed. R. Civ.
P."), provides for affidavits which may be opposed by depositions, interrogatories or further affidavits. Fed. R. Civ. P. 56. Rule 56 is inconsistent with NASD's 20 day exchange rule, 10321(c), as well as the purpose of arbitration – to provide a fast, fair and efficient resolution. As further explained below, summary judgment without adequate discovery and post-judgment review is a denial of due process.
CR 12504 is new. There is no dispositive motion rule in the current Code. We strongly believe, as does the Virginia Supreme Court, that motions to dismiss have no place in arbitration. Bates v. McQueen, No. 04228 (Va. S.Ct. June 9, 2005)("the failure to conduct ‘the hearing' . . . was tantamount to no arbitration. . . . a hearing is a fundamental part of the arbitration process. . . . "). If there is to be a dispositive motion rule, it needs to be modified to address the troubling issues that are raised by a dispositive motion practice in NASD arbitration.
The CR 12504 limitation that motions to decide claims before a hearing on the merits may only be granted in "extraordinary circumstances" is fatally flawed since it does not specifically define what is an "extraordinary circumstance." The absence of a definition in the proposed rule will promote abusive litigation tactics, rather than limit dismissal without hearing.
CR 12504 is in effect a summary judgment rule, and summary judgment and arbitration form an imperfect union. Important procedural protections underlying summary judgment motions simply are not available in arbitration. The non-moving party cannot take a deposition, and has limited powers to obtain other information more readily available in court. Under the CR as written, a respondent can submit supporting affidavits from a broker, branch office manager, and compliance director, and the moving party has little if any opportunity to challenge the ‘uncontradicted' statements before the hearing. A dispositive motion rule has to recognize the limitations that non-moving parties face in responding to the motions, and that the only way to test a respondent's position (absent the discovery safeguards available in court litigation) is through testimony at a hearing.
Even though motions to dismiss are allowed (though rarely granted) in court, there are many reasons why such motions need to be severely curtailed in arbitration. First, arbitrators are not judges, and are often not in a position to make the kind of exacting legal determinations required to decide a motion to dismiss. Second, arbitrators have more flexibility than courts in adhering to the strictest rules of law, making technical dismissals inappropriate. Third, arbitration pleadings are less formal than court proceedings, making dismissal based on pleadings subject to interpretation and guesswork. Fourth, arbitrators do not write reasons for their awards. Fifth, unlike court, there is little judicial review of arbitrator decisions. Such review (of court decisions) is important because it insures against legal mistakes. Sixth, the testimonial hearing requirement is the essence of arbitration, which is not an overly legalistic procedure for resolving disputes. Finally, courts are independent, government-policed fora with experienced decision makers; SRO arbitration is controlled by an organization in which respondents, and not claimants, are members.
The differences between arbitration and court thus explain the differences in procedure. The expedited nature of arbitration assures respondents that they will not be involved in lengthy proceedings (including depositions and motions) if a case is not dismissed early. Having agreed to arbitration, respondents must abide by the rules, which include not being able to obtain early dismissal. DeSapio v. Kohlmeyer, 35 N.Y.2d 402, 406 (1974)("If [respondents] wish the procedures available for their protection in a court of law, they ought not to provide for the arbitration of the dispute"[in their customer agreements]).
In light of these observations, if a dispositive motion rule is to be introduced into the Code, it must specify that all factual allegations made by the non-moving party are to be taken as true for the purposes of the motion. Unlike court summary judgment, the decision makers cannot be allowed to weigh the evidence against the allegations and find that affidavits or other evidence remove issues of fact raised in the pleadings.
The rule must make clear that the motion must be denied whenever credibility is at issue, there are any factual issues in dispute, or whenever the panel must make factual findings against the non-moving party. The rule must also provide that the motion should be denied whenever a hearing is necessary to shed light on all the issues in the case or in the interest of justice. In addition, if the non-moving party asserts that it can cure any defect by filing an amended statement of claim, that party should be given the opportunity to do so.
A dispositive motion rule with those requirements would satisfy the desire to have some procedural mechanism for a party to avoid a hearing when there are no facts in dispute, and the interest of the non-moving party to put on the evidence supporting its claims or defenses.
If additional information would be helpful, we are available to cooperate.
Very truly yours,
Jeff Sonn, Esq.
Sonn & Erez
One Financial Plaza
Ft. Lauderdale, FL 33394