FINRA - Rules and Regulations - FINRA Manual Online

Location: FINRA Manual > Notices > 1995 > 95-85 Clarification Of NASD Notice to Members 95-16 And NYSE Information Memorandum 95-16: Content And Enforcement Of Provisions In Customer Agreements And Predispute Arbitration Clauses

NASD Rules
(1 link)

3110. Books and Records

95-85 Clarification Of NASD Notice to Members 95-16 And NYSE Information Memorandum 95-16: Content And Enforcement Of Provisions In Customer Agreements And Predispute Arbitration Clauses

SUGGESTED ROUTING

Senior Management
Legal & Compliance
Operations

Executive Summary

NASD Notice to Members 95-16 (March 1995) and NYSE Information Memorandum 95-16 (April 1995) (collectively referred to as "95-16") were published to address issues concerning provisions in customer agreements and predispute arbitration clauses that appear to violate NASD and NYSE rules. The NASD and NYSE are issuing this Notice to address important questions raised by members and others concerning the statements in 95-16, NASD Notice to Members 95-16 see attached.

Questions about this notice should be directed to William R. Schief, Vice President, Regional Attorneys/Enforcement, NASD; at (301) 208–2858, Elliott R. Curzon, Assistant General Counsel, NASD, (202) 728–8451; your coordinator at the NYSE; or Salvatore Pallante, Senior Vice President, NYSE, at (212) 656–8480.

NASD® National Association of Securities Dealers, Inc.

NYSE New York Stock Exchange

TO: Members And Member Organizations

DATE: October 16, 1995

SUBJECT: Clarification Of NASD Notice To Members 95-16 And NYSE Information Memorandum 95-16:

Content And Enforcement Of Provisions In Customer Agreements And Predispute Arbitration Clauses

NASD Notice to Members 95-16 (March 1995) and NYSE Information Memorandum 95-16 (April 1995) (collectively referred to as "95-16") were published to address issues concerning provisions in customer agreements and predispute arbitration clauses that appear to violate NASD and NYSE rules. The NASD and NYSE are issuing this notice to address important questions raised by members and others concerning the statements in 95-16.

Background

Earlier this year NASD Notice to Members 95-16 and NYSE Information Memo 95-16 were issued to notify members that customer agreements of some members contained predispute arbitration clauses and other provisions that were inconsistent with NASD and NYSE arbitration rules.¹ Specifically mentioned were NYSE Rules 636(d), 613, 607(b), 603, and 627(a); Article III, Section 21(f) of the NASD Rules of Fair Practice; and the NASD Code of Arbitration Procedure.

Members were cautioned not to include nor seek to enforce provisions in customer agreements that restrict or limit, contrary to such rules, the ability of customers to arbitrate disputes or the authority of the arbitrators to make an award, including an award of punitive damages.

Important questions have been raised by members and others regarding the meaning and application of certain statements in 95-16. Those questions and our answers are presented in this notice to provide further clarification.

Article III, Section 21 (f)(4) of the NASD Rules of Fair Practice and NYSE Rule 636 address the form and content of predispute arbitration clause in customer agreements. These rules recognize that customer agreements "cannot be used to curtail any rights that a party may otherwise have had in a judicial forum."²

The NASD and NYSE expect their members to comport with high standards of professional conduct when dealing with their customers with respect to the arbitration of disputes and predispute arbitration clauses.

Questions And Answers

Question No. 1: May customer agreements contain a "governing law clause?"³

Answer: Yes, provided: (a) there is an appropriate contact or relationship between the transaction at issue or the parties and the law selected; and (b) that the clause is otherwise consistent with the aforementioned NYSE or NASD rules. For example, neither the governing law clause, nor any other clause in the customer agreement, may "limit[] the ability of a party to file any claim in arbitration or limit[] the ability of the arbitrators to make any award," or limit or contradict any of the aforementioned NYSE or NASD rules, such as rules relating to the location of the arbitration hearing. Article m, Section 21(f)(4) of the NASD Rules of Fair Practice, NYSE Rule 636.

Question No. 2: Is it permissible to include a disclosure in the customer agreement that the law governing the agreement prohibits or may prohibit an award of punitive damages in arbitration?

Answer: No. Such a disclosure would be inconsistent with NYSE Rule 636(d) and Article III, Section 21(f)(4) of the NASD Rules of Fair Practice.

Question No. 3: Is a "governing law clause" (as described in Question No. 1) which names the state of residence of the customer permissible?

Answer: Yes, provided that the clause is otherwise consistent with aforementioned NYSE or NASD rules.

Question No. 4: If, under the governing law set forth in the customer agreement, punitive damages are not available in court, may a party assert this as a defense in an arbitration proceeding to a claim for punitive damages?

Answer: Yes, although the arbitrators will determine whether, or to what extent, this defense will be accepted.

Question No. 5: Is there anything in NASD Notice to Members 95-16 (or NYSE Information Memorandum 95-16) intended to endorse the awarding of punitive damages in arbitration?

Answer: No, they are not intended to encourage or discourage the award of punitive damages.

Question No. 6: May a party in arbitration raise the governing law provision (in the customer agreement at issue) in arguing issues before the arbitrators such as state law interest rates and state law economic loss theories?

Answer: Yes, although the arbitrators will determine which arguments they will permit.

Question No. 7: May a firm designate a hearing location for self-regulatory organization (SRO) arbitrations in its arbitration clause?

Answer: No.

Question No. 8: May a firm dictate the composition of a panel for an SRO arbitration in its arbitration clause?

Answer: No.

Conclusion

Enforcing provisions of a customer agreement that are inconsistent with NYSE or NASD rules will be deemed to constitute violative activity and could subject the member to disciplinary action.

As stated in 95-16, members should promptly review their customer agreements and make such changes as are necessary and appropriate to ensure that they comply with the NASD's and NYSE's rules. Members should also advise their customers of the changes to the agreements. Members will have thirty (30) days from the date of this notice to make any necessary changes to their agreements. Members using agreements determined not to be in compliance may be subject to disciplinary action.

Questions about this notice should be directed to William R. Schief, Vice President, Regional Attorneys/Enforcement, NASD, at (301) 208–2858; Elliott R. Curzon, Assistant General Counsel, NASD, (202) 728–8451; your coordinator at the NYSE; or Salvatore Pallante, Senior Vice President, NYSE, at (212) 656–8480.

John E. Pinto

Executive Vice President

National Association of Securities Dealers, Inc.

Edward A. Kwalwasser

Executive Vice President

New York Stock Exchange, Inc.

¹ Copies of Notice to Members 95-16 are available from the NASD Support Services Department at (202) 728–8061; and copies of NYSE Information Memorandum 95-16 are available from your NYSE Coordinator.

² Order Approving Proposed Rule Changes by the New York Stock Exchange, Inc., National Association of Securities Dealers, Inc., and the American Stock Exchange, Inc., SEC Release No. 34–26805 (May 10, 1989); 54 F.R. 21144:

"This provision makes clear that the use of arbitration for the resolution of investor/broker-dealer disputes represents solely a choice of arbitration as a means of dispute resolution. Agreements cannot be used to curtail any rights that a party may otherwise have had in a judicial forum. If punitive damages or attorneys fees would be available under applicable law, then the agreement cannot limit parties' rights to request them, nor arbitrators rights to award them. The agreements may not be used to shorten applicable statutes of limitation, restrict the situs of an arbitration hearing contrary to SRO rules, nor limit SRO forums otherwise available to parties."

³ Sometimes referred to as a "choice of law clause."