Interpretive Letter to Cliff Palefsky, Esq., National Employment Lawyers Association

September 21, 1999

Cliff Palefsky, Esq.
National Employment Lawyers Association
c/o McGuinn, Hillsman, and Palefsky
535 Pacific Avenue,
San Francisco, CA 94133

Dear Mr. Palefsky:

This is in response to your letter of June 22, 1999, which was referred to this office from the Office of Dispute Resolution, and our subsequent conversation of July 15, 1999.

In a prior letter sent jointly to George Friedman, Senior Vice President and Director, Office of Dispute Resolution, NASD Regulation, and to Robert Clemente, Director of Arbitration, New York Stock Exchange (NYSE), dated April 16, 1999, you asked that the NASD and NYSE "formally consider and clarify the applicability of the ‘class action’ exception to class actions brought under the FLSA" (Fair Labor Standards Act). You expressed the view that, even though FLSA actions are "opt in" rather than "opt out" class actions, the policy considerations underlying the class action exception are applicable to these claims as well. You stated that exchanges do not have rules or procedures to handle these complicated representative actions. In addition, you indicated that the statute of limitations on FLSA class claims is not tolled upon the filing of the complaint, but rather, is tolled only after individuals actually opt in. You contended that this enhances the need for expedited notice procedures whereby the employer is compelled to identify the potential class members and to supervise the distribution of appropriate notice.

In his response to you, dated June 15, 1999, Mr. Friedman noted that your question involves NASD Rule 10301(d), which is attached for your reference. Rule 10301(d), adopted in 1992, is based on the Uniform Code of Arbitration. The Uniform Code has been developed and updated over many years by the Securities Industry Conference on Arbitration (SICA), which includes the NASD and the exchanges that offer arbitration forums, as well as representatives of the public and the securities industry (staff of the Securities and Exchange Commission (SEC) attend as non-voting invitees). Rule 3110(f)(6), adopted at the same time, added a corresponding notice to the requirements for predispute arbitration agreements for customers. (Rule 3110(f) does not apply to associated persons.) Mr. Friedman’s letter also referred you to the Approval Order issued by the SEC for the above rules, which contained a discussion of the purpose of the class action rules. Exchange Act Release No. 31371 (File No. SR-NASD-92-28) (Oct. 28, 1992).

I have reviewed the above SEC Approval Order and related materials. The NASD’s 1992 rule filing indicates that the proposed rule change developed from a suggestion made to all self-regulatory organizations (SROs) in a letter dated July 13, 1988, from the then-Chairman of the SEC, David S. Ruder. Chairman Ruder asked the SROs to consider adopting procedures that would give investors access to the courts in appropriate cases, including class actions. The National Arbitration Committee of the NASD (now known as the National Arbitration and Mediation Committee) initially believed that special rules for class actions were unnecessary in light of the broad discretion that the Code of Arbitration Procedure (Code) gives arbitrators and the Director of Arbitration to defer certain arbitration proceedings to the remedies provided by applicable law. Later, this matter was discussed at meetings of SICA. SICA determined that it would be preferable for each SRO to clarify the treatment of class actions in its forum, and adopted model language in its Uniform Code of Arbitration. The NASD subsequently adopted that language, currently found in Rules 3110(f)(6) and 10301(d).

Rule 10301(d)(1) provides that a claim submitted as a class action is ineligible for arbitration under the Code. This language is broad enough to encompass any type of class action filed in arbitration. Paragraph (d)(2) provides that a claim filed by a member of a class is ineligible for arbitration if it is encompassed in the class action, unless the claimant has elected not to participate in the class action or has withdrawn from the class. Paragraph (d)(2) also provides that disputes over whether a claim is encompassed by the class action may be referred either to a panel of arbitrators or to the court with jurisdiction over the class action. Paragraph (d)(3) provides that no member or associated person may seek to enforce an arbitration agreement against a party who is part of a class action in court unless the class certification is denied, the class is decertified, the party is excluded from the class, or the party elects not to participate in the class or withdraws from the class.

In its 1992 Approval Order (referenced above), the SEC noted that the judicial system has already developed the procedures to manage class action claims, and that entertaining such claims through arbitration at the NASD would be "difficult, duplicative and wasteful." The Approval Order stated, "The Commission agrees with the NASD’s position that, in all cases, class actions are better handled by the courts and that investors should have access to the courts to resolve class actions efficiently."

Although Rule 10301(d) was designed to address investor class actions filed under Rule 23 of the Federal Rules of Civil Procedure, the underlying rationale would also cover other types of class actions. Therefore, FLSA class actions, like class actions under Rule 23, should likewise be considered to be ineligible for arbitration in the NASD Regulation forum.

Please note that the opinions expressed herein are staff opinions only and have not been reviewed or endorsed by the Board of Directors of NASD Regulation, Inc. This letter responds only to the issues you have raised based on the facts as you have described them in your letter, and does not necessarily address any other rule or interpretation of the NASD or all the possible regulatory and legal issues involved.

Very truly yours,

Jean I. Feeney 
Assistant General Counsel

Attachment: Excerpt from Code of Arbitration Procedure Regarding Class Actions in Arbitration
 

Excerpt from NASD Code of Arbitration Procedure
Regarding Class Actions in Arbitration

10301. Required Submission

* * *

(d) Class Action Claims

(1) A claim submitted as a class action shall not be eligible for arbitration under this Code at the Association.

(2) Any claim filed by a member or members of a putative or certified class action is also ineligible for arbitration at the Association if the claim is encompassed by a putative or certified class action filed in federal or state court, or is ordered by a court to an arbitral forum not sponsored by a self-regulatory organization for classwide arbitration. However, such claims shall be eligible for arbitration in accordance with paragraph (a) or pursuant to the parties' contractual agreement, if any, if a claimant demonstrates that it has elected not to participate in the putative or certified class action or, if applicable, has complied with any conditions for withdrawing from the class prescribed by the court.

Disputes concerning whether a particular claim is encompassed by a putative or certified class action shall be referred by the Director of Arbitration to a panel of arbitrators in accordance with Rule 10302 or Rule 10308, as applicable. Either party may elect instead to petition the court with jurisdiction over the putative or certified class action to resolve such disputes. Any such petition to the court must be filed within ten business days of receipt of notice that the Director of Arbitration is referring the dispute to a panel of arbitrators.

(3) No member or associated person shall seek to enforce any agreement to arbitrate against a customer, other member or person associated with a member who has initiated in court a putative class action or is a member of a putative or certified class with respect to any claims encompassed by the class action unless and until: (A) the class certification is denied; (B) the class is decertified; (C) the customer, other member or person associated with a member is excluded from the class by the court; or (D) the customer, other member or person associated with a member elects not to participate in the putative or certified class action or, if applicable, has complied with any conditions for withdrawing from the class prescribed by the court.