From: Tim Canning [tc@tclaws.com] Sent: Friday, April 18, 2003 2:52 PM To: marketreg@sec.gov; rule-comments@sec.gov; chairmanoffice@sec.gov Subject: Comments on SR-PCX-2002-17 & SR-PCX-2003-13 Thank you for the opportunity to comment on the Exchange’s request for expedited approval of two proposed rule changes effecting its arbitration department (SR-PCX-2002-17 amendment no. 1 and SR-PCX-2003-13). I have strong objections and reservations about the Exchange’s plan for disposing of its current arbitration cases. Due to the potentially short time frame for considering the rule changes on an expedited basis, I will summarize the objections I have to those rules. I (as well as other interested parties) would appreciate the opportunity to comment in more detail after the proposed rule changes are published in the Federal Register. In the interim, the Commission should direct the Exchange to resume administering the arbitrations pending at its forum. I am an attorney in Northern California. I have been practicing law for over 12 years. Approximately ninety-five percent of my current practice involves representing investors or public customers in claims against financial advisors and stockbrokers, primarily in SRO-sponsored arbitration but also in state and federal court. I am also a former arbitrator for the Exchange. I represent approximately 40 public customers in 22 arbitration matters now pending before the Exchange. Many of those arbitration cases are and have been ready for the appointment of arbitrators; some are set for arbitration hearing over the next two months; and others are in the early stages of processing. The two things they all have in common is, first, every client paid the Exchange to administer their arbitration, and second, the Exchange has refused to move the cases along since July, 2002 – nearly 9 months now. My understanding is that the Exchange proposes to resume administering only those arbitration cases in which arbitrators have already been appointed, but only if all parties waive the California Ethics Standards and the “private arbitration company” statute (Cal. Code of Civil Procedure section 1281.92). All other arbitration cases pending at the Exchange will be transferred to the NASD but only if all parties waive the California ethics standards. In the event any one party does not execute a waiver satisfactory to the Exchange, the Exchange will simply dismiss the arbitration. The public customers I represent will bear the brunt of the hardships stemming from the proposed rule. These are hardships that do not need to occur, and which the Commission staff can avoid. Many of the issues that I touch upon in this comment were recently reviewed by the California Superior Court in and for the County of San Francisco, in connection with a petition for appointment of arbitrators that one of my clients brought against the Pacific Exchange. (Brindley v. Salomon Smith Barney, et al., S.F. Superior Court case no. CPF-03-502595). The Court rejected the Exchange’s arguments, and has ordered the Exchange to resume administering the Brindleys’ arbitration. Harm to Public Investors The Exchange’s proposal will inflict significant harm on public investors who have claims pending at the Exchange (as well as members and former associated persons). First, even if claimants waive their rights under California law, there is no assurance that respondents will waive their rights, particularly those who are no longer associated with member firms. (Though at least one respondent must have been a member of the Exchange when the arbitration claim was filed, the individual respondents may not have been or may no longer be associated with member firms; the Exchange would not be able to force those non-members to waive their California rights). In this situation, a claimant may find his or her claim involuntarily dismissed by the Exchange, even though claimant did everything that was demanded of him or her. A dismissal – even if without prejudice – may work significant harm. Not only has the claimant lost his or her filing fee and hearing session deposits, but more significantly, the claimant may find that a statute of limitations has run as a result of the dismissal. Though filing an arbitration claim tolls the statute of limitations in most instances, that tolling evaporates if the claim is dismissed – it is treated as though no claim was ever filed, for purposes of accrual and tolling. Further, a dismissal will cause significant delays in resolving the disputes. If a case is dismissed by the Exchange, the claimant would have two choices: refile the arbitration at another securities forum, or pursue the matter in court. Refiling the arbitration claim at another SRO is not a practical solution. The most recent statistics from the NASD reveal that it takes nearly 17 months on average for cases to go to hearing from the time it is filed. With the surge in arbitration filings, one would expect that time to increase over the next year. Refiling the claim in court is not a speedy or inexpensive alternative. California’s budget crises is having a significant impact on the courts’ ability to handle civil cases. Further, doing so may violate contractual obligations between a public customer and a brokerage firm. Second, even assuming that all parties to the arbitration waive the California Standards and the case is transferred to the NASD, the Exchange has not provided any information as to how that transfer will be accomplished. Presumably, the cases transferred will be placed at the back of the NASD’s line, along with all of the other arbitrations pending at the NASD that do not have arbitrators appointed. Again, for these cases, the arbitration participants would be facing an added seventeen month delay – perhaps more -- as they are being processed by the NASD. By way of example, one client of mine filed his case with the Exchange in March, 2002—over twelve months ago. No arbitrators have been appointed. If the Exchange dismisses this case immediately, or forces my client to transfer it to the NASD, my client likely will not get a hearing until October 2004, at the earliest – over two and one-half years from the date his claim was originally filed! In addition to the delay, there will be increased costs. In its proposed rule change, the Exchange states that the arbitration participants will have to pay the NASD for its filing fees and hearing session fees. Not only are the NASD fees higher than the fees charged by the Exchange, but the arbitration participants have already paid the Exchange a filing fee and hearing session fees – resulting in the arbitration participants having to pay twice. Demanding waivers of California law from arbitration participants will only hurt all arbitration participants in the long run. Because the waivers are likely unenforceable under California state law, the awards rendered will be open to easy challenge by the losing party. In the case of public customers, the waivers are being obtained under duress and economic coercion; in the case of Exchange’s members, they must execute the waivers or face disciplinary action. Should a public customer lose an arbitration, the customer may well argue that the waiver is void, and since the arbitrators did not comply with California law, the award should be vacated. Similarly, should a member lose an arbitration, the member may well argue that their waiver is void, and the award should be set aside. I do not agree with the Commission’s position that waiving the California Ethics Standards is necessary or even desirable. Under current conditions, however, it is apparent that no public customer can have an SRO arbitration without first executing a waiver – not at the Exchange, not at the NYSE, and not at the NASD. If the NASD and NYSE can continue administering arbitration claims after a waiver is executed, why can’t the Exchange? It should not matter to the Commission which SRO administers the arbitrations. It matters very much to my clients and other arbitration claimants with matters pending at the Exchange. Speed, economy and finality are three crucial goals of securities arbitration. The Exchange’s proposed rules are contrary to each of those goals. No Harm to the Exchange Standing in stark contrast to the harm that will be inflicted should the Exchange’s proposal be adopted, is the lack of harm to which the Exchange will be exposed should the Exchange be directed to resume administering arbitrations in accordance with its Rule 12. Under the proposed rule, the Exchange will continue to administer at least some arbitrations. The Exchange will maintain staff and facilities to administer arbitrations for many months to come. No hardship or undue expense will befall the Exchange or the markets should the Exchange simply resume administering all pending arbitrations, and not just a select few. The Exchange generally states that its proposed rule changes are a result of “potential financial and litigation risks” associated with the new California law and “the uncertain legal environment” in California. However, the California Ethics Standards and the new provisions of the California Arbitration Act do not pose any financial or litigation risk to the Exchange, and impose only modest burdens on the Exchange, if any at all. In fact, the Exchange exposes itself to substantial financial and litigation risks by refusing to administer pending arbitrations. First, there is nothing contained in the current California Ethics Standards that imposes any significant burden on the Exchange. Instead, those standards are directed to the arbitrators themselves. The standards simply do not require the Exchange to collect or maintain comprehensive information about the arbitrators. It is likely that most arbitrators in the Exchange’s pool will want to collect the information required by the Ethics Standards. In my experience, many of the arbitrators in the Exchange’s pool are also private arbitrators, or arbitrators for AAA and JAMS. If those arbitrators wish to continue working as arbitrators in California, the individual arbitrators will have to maintain the information called for by the Ethics Standards. As a result, complying with the Ethics Standards will not impose any additional burden for most Exchange arbitrators. Second, the information required to be disclosed does not conflict with the Exchange’s current rules on what arbitrators must disclose. The Exchange’s arbitration rules already require arbitrators to disclose “any direct or indirect financial or personal interest in the outcome of the arbitration” and “any existing or past financial, business, professional, family or social relationships that are likely to affect impartiality or that might reasonably create an appearance of partiality or bias.” Exchange Rule 12.11(a). The Ethics Standards impose similar obligations on arbitrators. The Ethic Standards merely provide definition to the general disclosures required by Exchange rules. There is no conflict between the Ethic Standards and the Exchange’s rules. Finally, complying with the Ethics Standards would not eliminate the “industry arbitrator” from arbitration panels. Though the Ethics Standards would bar an employee of an Exchange member from sitting on a public customer arbitration panel, those standards would not necessarily prohibit employees of other brokerage firms who are not Exchange members nor would those standards prohibit other “industry” arbitrators, such as RIAs or financial planners. Yet, even if the Exchange cannot comply with the Ethics Standards, the solution of extracting waivers from the arbitration participants was acceptable to the NASD and the NYSE; the Exchange offers no reason why that solution is not acceptable to the Exchange. The Exchange also expresses concern about California Code of Civil Procedure section 1281.92. By its own terms, that section only applies to “private arbitration companies.” The Exchange cannot be viewed as a “private arbitration company” under any realistic definition of that phrase. An organization which exists pursuant to the Securities Exchange Act, whose operating rules must be approved by a governmental body, and which is performing a public regulatory function – such as the Exchange -- simply cannot be viewed as a “private arbitration company”. Neither the NASD nor the NYSE has publicly expressed any concern over this issue. In sum, the Exchange can administer public customer arbitrations in California in compliance with California’s arbitration act and the Ethics Standards without any undue burden, and without facing liability to the participants should required disclosures not be made. At the very least, if there truly is some burden, the Exchange should be required to make a specific factual showing of burden, and not rely on mere unsupported assertions of burden and risk. The Exchange has also expressed concern about being sued should an arbitrator not make a required disclosure and an award is set aside as a result. However, under that scenario, the doctrine of arbitration immunity would protect the Exchange from liability. Indeed, under California law, an organization that administers an arbitration is immune from damage claims except where the organization fails to administer an arbitration that it agreed to administer. Where an arbitrator fails to perform, that arbitrator is not protected from a suit in equity – such as an injunction action – or an action for damages. Indeed, in its drive to shut down its arbitration department, the Exchange is exposing itself to substantial liability arising out of its refusal to administer arbitrations, liability from which the Exchange could have been immunized had it simply continued administering the arbitrations. The Commission should also consider that, in the past, when public customers needed to be informed about changes in securities industry arbitration rules, the Commission required that public customers be informed of those changes, in writing, and frequently in bold type. When the customers who I represent agreed to do business with the firms that are members of the Exchange, they were told that an inexpensive, efficient arbitration system was in place. At a minimum, the Exchange should change those disclosures before changing the system. In sum, the Exchange should be directed to finish administering the cases which it had already agreed to administer. In all 22 cases pending at the Exchange in which I represent the claimant, my client paid the Exchange for its services, services which the Exchange agreed to provide. Though the Exchange does not disclose how many arbitration cases are pending in its forum, it is likely that most of the cases in which I am involved can be heard and resolved by the end of 2003. The harm that would be inflicted on the public should the Exchange’s proposed rules take effect – i.e., increased costs, increased delay, decreased finality – far outweigh any harm the Exchange would incur by continuing to administer pending arbitrations. At the very least, the Commission should publish the Exchange’s proposed rules for comment, without immediate effectiveness. In the interim, the Exchange should be directed to resume administering all arbitrations pending at that forum, which the Exchange promised that it would administer. Thank you again for considering these comments. If you would like to discuss any of the points I raise above further, please do not hesitate to contact me. Sincerely, Tim Canning 350 E Street, Suite 201 Eureka, CA 95501 (707) 442-3064 fax:(707) 760-3523 email: tc@tclaws.com