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Brokerage Arbitration Suspended

Ethics: Two groups that settle investor disputes say California's rules on conflict of interest are too burdensome.


The self-policing stock market groups that settle investor disputes with brokers have quit providing such arbitration panels in California, saying state ethical standards for arbitrators that took effect July 1 are too burdensome.

The New York Stock Exchange and the National Assn. of Securities Dealers say they already require arbitrators to disclose any professional, personal or business conflicts of interest.

They contend the new state ethics rules are so complex that arbitrators won't take the $400-a-day jobs, and that brokerages will exploit the rules by challenging awards to investors on grounds that arbitrators failed to meet the more stringent state requirements.

The suspension of arbitration panels could create a backlog of unresolved cases within months. The NYSE said it has more than 100 cases pending in California, only half of which have been assigned arbitrators. About 300 NASD disputes so far have had the appointment of arbitrators postponed, officials said.

However, cases in which arbitrators were appointed before July 1 are proceeding.

Brokerages have long insisted on avoiding the courts through mandatory arbitration of investors' complaints, a policy upheld by the U.S. Supreme Court. The cases typically are heard by three arbitrators, one from the brokerage industry and two from outside it. Some are decided by a single non-industry arbitrator.

At its best, arbitration can provide a fast and relatively inexpensive resolution of disputes. But critics complain the industry's self-policing stacks the deck against investors.

"It's the illusion of oversight for the most part," said Cliff Palefsky, a San Francisco-based civil rights lawyer active who helped a state court panel develop the new ethics rules. "They run a forum where they set the rules and already impose an industry member on the panel," he said. "So the requirements of disclosure are more important."

The new rules result from a law sponsored by Martha Escutia, a Whittier Democrat who heads the state Senate Judiciary Committee. It was passed and signed into law by Gov. Gray Davis last year.

The ethics rules, written by the Judicial Council of California, apply to a wide range of arbitration processes, not just securities cases.

The rules expand the "duty of reasonable inquiry" arbitrators must make to ensure that any actual or potential financial interest they may have is disclosed. Among other things, arbitrators must determine and disclose if "immediate family members" have in any way worked for parties involved in disputes for two years prior.

That requirement was too broad even for Philip M. Aidikoff, a Beverly Hills attorney who represents investors in brokerage cases. The new rules "may serve to scare good people off from serving who just don't want to be bothered with this kind of search," Aidikoff said.

The NYSE and NASD are lobbying state legislators to amend the law to exempt them from its requirements.

The federal Securities and Exchange Commission, which oversees the stock exchanges' arbitration programs, supports their request to be exempted, a spokeswoman said Tuesday.

Escutia couldn't be reached for comment. Gene Wong, a legal advisor to the judicial council, said the council had extended a comment period on the new rules through September and would be willing to make some changes to accommodate the NYSE and NASD. However, the council doesn't have authority to grant a blanket exemption, Wong said.

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