MSRB NOTICE 2005-18 (MARCH 21, 2005)

NOTICE OF FILING OF AMENDMENT TO RULE G-8, ON RECORDKEEPING, TO ADD REQUIREMENTS FOR PREDISPUTE ARBITRATION AGREEMENTS WITH CUSTOMERS, EFFECTIVE MAY 1, 2005

On March 21, 2005, the Municipal Securities Rulemaking Board (“MSRB”) filed with the Securities and Exchange Commission (“SEC”) a proposed rule change to amend Rule G-8, on recordkeeping, to add requirements governing the use of predispute arbitration agreements with customers.  The amendment will become effective May 1, 2005.  The proposed rule change also includes an amendment to Rule A-11, on indemnification, to delete its obsolete references to arbitrators.[1]

SUMMARY OF PROPOSED AMENDMENTS

In 1997, the MSRB determined that it was no longer cost-effective to continue operating an arbitration program since so few cases were being filed with its program. Accordingly, the MSRB amended Rule G-35, on arbitration, to provide that it would not accept any new arbitration claims filed on or after January 1, 1998 (the “1997 Amendments”).[2]  The MSRB noted that any customer or securities dealer with a claim, dispute or controversy against a dealer involving its municipal securities activities may submit that claim to the arbitration forum of any self-regulatory organization (“SRO”) of which the dealer is a member, including NASD.  Bank dealers, however, are unique in that they are subject to MSRB rules but are not members of any other SRO.  Thus, it was necessary to provide an alternative arbitration forum for claims involving the municipal securities activities of bank dealers.  The 1997 Amendments accomplished this by providing that as of January 1, 1998 every bank dealer, as defined in Rule D-8,[3] shall be subject to NASD’s Code of Arbitration Procedure for every claim, dispute or controversy arising out of or in connection with the municipal securities activities of the bank dealer acting in its capacity as such, and that bank dealers shall abide by NASD’s Code as if they were “members” of NASD for purposes of arbitration.  The enforcement mechanism for bank dealers was not altered by the amendments; the bank regulatory agencies continue to be responsible for the inspection and enforcement of bank dealers’ municipal securities activities, including arbitration.

At the time of the 1997 Amendments, the MSRB agreed to continue operating its arbitration program in order to administer its current, open cases and any new claims received prior to January 1, 1998, but stated that it would discontinue administering its program when all such cases were closed.  On May 14, 2002, the MSRB transferred its final, open case to NASD.  Accordingly, in August 2002, the MSRB submitted a filing to the SEC to delete Sections 1 through 37 of Rule G-35, on arbitration, thereby effectively discontinuing the operation of its arbitration program.[4]  The filing also incorporated by reference into Rule G-35 the NASD Code of Arbitration Procedure and all future amendments thereto.[5]

When the MSRB deleted Sections 1 through 37 of its arbitration code in 2002, the requirements governing predispute arbitration agreements (previously in Section 36 of Rule G-35) were also deleted.  While Rule G-35 currently provides that bank dealers shall abide by the NASD Code of Arbitration Procedure, NASD’s requirement for predispute arbitration agreements is not contained in that Code.  Instead, the NASD requirement is set forth in its Rule 3110, on books and records, and IM-3110(f), on customer account information.  NASD Rule 0116, on application of NASD rules to exempted securities, provides that NASD Rule 3110 and the related interpretive materials (among other rules and interpretive materials) do not apply to municipal securities.  Thus, there currently is no requirement specifically governing the way bank dealers or municipal-only dealers use predispute arbitration agreements with customers.  To remedy this situation, the MSRB is filing a technical amendment to Rule G-8, on recordkeeping, to add such a requirement.  The language of the proposed amendment tracks the language of NASD Rule 3110(f), on predispute arbitration agreements with customers, as recently amended, and the MSRB has set an effective date of May 1, 2005, to coincide with the recent NASD amendments.[6]  In addition, the MSRB is filing a technical amendment to Rule A-11, on indemnification, to delete its obsolete references to arbitrator indemnification.

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Questions concerning this notice should be directed to Jill C. Finder, Assistant General Counsel.

March 21, 2005

TEXT OF AMENDMENTS [7]

Rule G-8 – Books and Records to be Made by Brokers, Dealers and Municipal Securities Dealers

(a) Description of Books and Records Required to be Made.  Except as otherwise specifically indicated in this rule, every broker, dealer and municipal securities dealer shall make and keep current the following books and records, to the extent applicable to the business of such broker, dealer or municipal securities dealer:

(i) - (x)  No change.

(xi) Customer Account Information.  A record for each customer, other than an institutional account, setting forth the following information to the extent applicable to such customer:

(A) - (L)  No change

(M) Predispute Arbitration Agreements with Customers.

(1) Any predispute arbitration clause shall be highlighted and shall be immediately preceded by the following disclosure language (printed in outline form as set forth herein) which shall also be highlighted:

(a)    Arbitration is final and binding on the parties.

(b)   The parties are waiving their right to seek remedies in court, including the right to a jury trial.

(c)    Pre-arbitration discovery is generally more limited than and different from court proceedings.

(d)   The arbitrators’ award is not required to include factual findings or legal reasoning and any party’s right to appeal or to seek modification of rulings by the arbitrators is strictly limited.

(e)    The panel of arbitrators will typically include a minority of arbitrators who were or are affiliated with the securities industry.

(2) Immediately preceding the signature line, there shall be a statement which shall be highlighted, that the agreement contains a predispute arbitration clause.  The statement also shall indicate at what page and paragraph the arbitration clause is located.

(3) A copy of the agreement containing any such clause shall be given to the customer who shall acknowledge receipt thereof on the agreement or on a separate document.

(4) No agreement shall include any condition which limits or contradicts the rules of any self-regulatory organization or limits the ability of a party to file any claim in arbitration or limits the ability of the arbitrators to make any award.

(5) All agreements shall include a statement that “No person shall bring a putative or certified class action to arbitration, nor seek to enforce any predispute arbitration agreement against any person who has initiated in court a putative class action; who is a member of a putative class who has not opted out of the class with respect to any claims encompassed by the putative class action until: (i) the class certification is denied; or (ii) the class is decertified; or (iii) the customer is excluded from the class by the court.  Such forbearance to enforce an agreement to arbitrate shall not constitute a waiver of any rights under this agreement except to the extent stated herein.”

Rule A-11:  Indemnification of Members[,] and Employees [and Arbitrators]

Each member and employee of the Board [and each arbitrator selected by the Board under Rule G-35] shall be indemnified and held harmless against all liabilities and related expenses incurred in connection with the performance of his or her official duties, provided that such member[,] or employee [or arbitrator] has acted, or omitted to act, in good faith and within the scope of his or her authority.


[1] File No. SR-MSRB-2005-05. Comments on the proposed rule change should be submitted to the SEC and should reference this file number.

[2] File No. SR-MSRB-97-04, approved in Release No. 34-39378 (December 1, 1997).

[3] Rule D-8 defines “bank dealer” to mean a municipal securities dealer which is a bank or a separately identifiable department or division of a bank as defined in Rule G-1.

[4] File No. SR-MSRB-2002-09 (August 19, 2002), approved in Release No. 34-46666 (October 16, 2002).

[5] At the request of the SEC’s Division of Market Regulation, the MSRB requested that, pursuant to Section 36 of the Act and Rule 0-12 thereunder, the SEC grant an exemption from the requirements of Section 19(b) of the Act and Rule 19b-4 thereunder to allow the MSRB to incorporate by reference into Rule G-35 any changes to the NASD’s Code without requiring that the MSRB submit a separate filing for each such change.  See letter from Diane G. Klinke, General Counsel, MSRB, to Jonathan G. Katz, Secretary, SEC, dated April 4, 2002.  The SEC granted this exemption in Release No. 34-49260 (February 17, 2004).

[6] In November 2004, the SEC approved amendments to NASD Rule 3110(f) that require NASD member firms to modify their predispute arbitration agreements with customers to provide enhanced disclosure about the arbitration process.  The amendments also require NASD members to provide copies of predispute arbitration agreements and relevant arbitration forum rules to customers upon request; clarify the use of certain limiting provisions; and require firms seeking to compel arbitration of claims initiated in court to arbitrate all of the claims contained in the complaint if the customer so requests.  See Release No. 34-50713 (November 22, 2004), effective May 1, 2005.

[7] Underlining indicates new language; brackets indicate deletions.