SEC Permits NASD To Discipline Members And Associated Persons Who Fail To Honor Arbitration Or Mediation Settlement Agreements

Executive Summary

On August 10, 1995, the Securities and Exchange Commission (SEC) approved amendments to the NASD's rules to make a failure to honor a written and executed settlement agreement of a dispute arbitrated by any self-regulatory organization or mediated by the NASD^® a violation of the Rules of Fair Practice. The amendments also permit the NASD to suspend or cancel the membership or registration of a member or associated person for failing to honor a written and executed settlement agreement of a dispute arbitrated or mediated by the NASD. The amendments will become effective on October 2, 1995. The text of the amendments follows this Notice.

Background

On August 10, 1995, the SEC approved amendments to the Resolution of the Board of Governors— Failure to Act Under Provisions of Code of Arbitration Procedure (Resolution) to make a failure to honor a written and executed settlement agreement obtained in connection with a dispute arbitrated by any self-regulatory organization (SRO) or mediated by the NASD a violation of Article III, Section 1 of the Rules of Fair Practice. The SEC also approved amendments to Article VI, Section 3 of the By-Laws to permit the NASD to suspend or cancel the membership or registration of a member or associated person for failing to honor a written and executed settlement agreement of a dispute arbitrated or mediated by the NASD. The amendments will become effective on October 2, 1995.

Enforcing Settlement Agreements

In administering its Arbitration Program, the NASD has noted that many disputes or claims for damages submitted to arbitration before the NASD, another SRO forum, or the American Arbitration Association (AAA), are settled before a hearing on the merits. The NASD also recently implemented a Mediation Program, to be administered with the Arbitration Program, designed to increase the number of claims that are settled before a hearing.

The NASD has also noted that occasionally members and associated persons fail to honor settlement agreements reached in connection with arbitration proceedings. The NASD is concerned that a failure by a member or associated person to honor a settlement agreement imposes substantial added costs on the prevailing party or parties in the form of delayed recoveries, actions to enforce the agreements, and additional fees connected with canceling or rescheduling hearings on short notice. The NASD Arbitration Department also incurs additional costs in rescheduling hearings, and, on occasion, has had to appoint new arbitrators to hear a matter. In addition, the NASD believes that the credibility of the arbitration process suffers if members and their associated persons are able to delay the resolution of a dispute by failing to honor a settlement agreement. Finally, the NASD believes that reducing or eliminating such failures on the part of members and associated persons is an appropriate preventative measure that should not await the development of serious problems.

The Resolution states that "it may be deemed ... a violation of Article III, Section 1 of the Rules of Fair Practice for a member or person associated with a member to ... fail to honor an [arbitration] award The Resolution was adopted in 1973 and has been used to discipline members and associated persons who fail to pay an arbitration award unless they have moved to vacate the award.¹ The Resolution applies to awards rendered in NASD arbitrations, as well as arbitrations sponsored by other SROs and the AAA.

The NASD believes that the failure by a member or associated person to honor a settlement agreement entered into in connection with an arbitration proceeding or a mediation should have the same consequences as the failure to pay an arbitration award. Therefore, the NASD is amending the Resolution to make the failure by a member or associated person to honor a written and executed settlement agreement actionable as a violation of Article III, Section 1 of the Rules of Fair Practice.² The amendment is limited to settlement agreements that have been reduced to writing and have been executed. The amendment, therefore, will not encompass unexecuted settlements.

Revocation And Disciplinary Proceedings

In 1993, the NASD amended Article VI, Section 3 of the By-Laws to provide that a membership or registration could be suspended or canceled on 15-days' notice for failing to honor an arbitration award rendered in an NASD arbitration. The use of such revocation proceedings was limited to awards in NASD-sponsored proceedings because NASD oversight of the arbitration process provides greater assurance about the awards that would be enforced in such proceedings.³

The NASD believes that the failure by a member or an associated person of a member to honor settlement agreements entered into in connection with an arbitration proceeding or mediation sponsored by the NASD should be subject to the same revocation proceedings as are arbitration awards. Accordingly, the NASD is also amending Article VI, Section 3 of the By-Laws to provide that membership or registration can be suspended or canceled on 15-days' notice for failing to honor a settlement agreement obtained in connection with an NASD arbitration or mediation. The action of the NASD under Article VI, Section 3 of the By-Laws with respect to failure to honor settlement agreements will be conducted as a revocation proceeding pursuant to the provisions of Article VI of the Code of Procedure. Article VI permits the member or associated person to request a hearing, and the final decision is reviewable by the SEC.

While the NASD recognizes that the amendments would apply only to member firms and associated persons, not another non-member or unregistered party who fails to honor a settlement agreement, members should note that the NASD has no jurisdiction over non-members and persons not associated with members and cannot, therefore, sanction such persons for failing to honor agreements. Members and associated persons with members have a fundamental obligation to "observe high standards of commercial honor" under Article III, Section 1 of the Rules of Fair Practice and to promote investor protection by ensuring that the arbitration process is fair and efficient. Honoring settlement agreements is a component of meeting those obligations.

In addition, there are procedural protections for members and associated persons designed to prevent unwarranted suspensions or revocations. A member or associated person receiving a notice of revocation proceedings or a disciplinary complaint may request a hearing to demonstrate that a valid reason exists for not honoring a settlement agreement. Thus, for example, if a settlement agreement contained a condition precedent to the member's performance under the agreement, that would likely constitute a complete defense to the revocation proceeding until the condition precedent occurred and the obligation of the member to perform under the agreement arose. The NASD would have the discretion not to initiate a proceeding if clear evidence of a valid reason for not honoring a settlement agreement existed.

If a settlement agreement resulted from arbitrations conducted at other SROs or the AAA, the amended Rules do not provide for the use of the NASD's suspension or revocation proceedings. Where a party to an arbitration conducted in another forum complains to the NASD that a member or associated person failed to honor a settlement agreement, the complaint would be investigated in the same manner as any other customer complaint. Such an investigation would include obtaining copies of the records of the arbitration proceeding from the other forum and determining if there are any facts that would demonstrate that disciplinary action is warranted. If it is determined that the member or associated person may have failed to honor a settlement agreement, a formal complaint would be issued and the member or associated person would be entitled to a hearing before a panel of a District Business Conduct Committee and would be afforded a right to appeal any adverse decision to the National Business Conduct Committee, the SEC, and the courts.

Questions regarding this Notice may be directed to Deborah Masucci, Vice President and Director, Arbitration Department, at (212) 858–8330, or Elliott R. Curzon, Assistant General Counsel, Office of General Counsel, at (202) 728–8451.

¹ Under the Federal Arbitration Act and many state statutes, such a motion to vacate must be filed within 90 days after the award is rendered.

² Because the NASD is the only forum currently offering mediation, the amended Resolution specifies that only settlement agreements entered into in connection with an NASD mediation are subject to the requirements. In the event other SROs adopt mediation programs, the NASD may consider expanding the scope of the Resolution.

³ The use of Article VI of the Code of Procedure for such proceedings was initiated in connection with the NASD's adoption of an amendment to Article VI, Section 3 of the By-Laws relating to failure to pay arbitration awards. See, SR-NASD-91–73, approved by the SEC in Securities Exchange Act Rel. No. 31763 (January 28, 1993).

Text Of Amendment To The Code Of Arbitration Procedure And By-Laws

(Note: New text is underlined; deletions are bracketed.)

CODE OF ARBITRATION PROCEDURE

Resolution of the Board of Governors—

Failure to Act Under Provisions of Code of Arbitration Procedure

It may be deemed conduct inconsistent with just and equitable principles of trade and a violation of Article III, Section 1 of the Rules of Fair Practice for a member or a person associated with a member to; (1) fail to submit a dispute for arbitration under the NASD Code of Arbitration Procedure as required by that Code[, to]; (2) fail to appear or to produce any document in his possession or control as directed pursuant to provisions of the NASD Code of Arbitration Procedure[, or]; (3) fail to honor an award [of arbitrators properly rendered pursuant to the Uniform Code of Arbitration], or comply with a written and executed settlement agreement, obtained in connection with an arbitration submitted for disposition pursuant to the procedures specified by the National Association of Securities Dealers, Inc., the New York, American, Boston, Cincinnati, [Midwest] Chicago, Pacific, or Philadelphia Stock Exchanges, the Chicago Board Options Exchange, the Municipal Securities Rulemaking Board, or pursuant to the rules applicable to the arbitration of securities disputes before the American Arbitration Association where timely motion has not been made to vacate or modify such award pursuant to applicable law[.]; or (4) fail to comply with a written and executed settlement agreement, obtained in connection with a mediation submitted for disposition pursuant to the procedures specified by the National Association of Securities Dealers. Inc.

BY-LAWS ARTICLE VI

Dues, Assessments and Other Charges

Sec. 1 and 2 No change.

Suspension or Cancellation of Membership or Registration

Sec. 3. The Corporation after fifteen (15) days notice in writing, may suspend or cancel the membership of any member or the registration of any person in arrears in the payment of any fees, dues, assessments or other charges, or for failure to furnish any information or reports requested pursuant to Section 2 of this Article, or for failure to comply with an award of arbitrators properly rendered pursuant to Section 41 of the Code of Arbitration Procedure, where a timely motion to vacate or modify such award has not been made pursuant to applicable law or where such a motion has been denied[.], or for failure to comply with a written and executed settlement agreement obtained in connection with an arbitration or mediation submitted for disposition pursuant to the procedures specified by the Corporation.