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Standing up to Wall Street has never been easy, particularly for the individual investor. For decades, the National Association of Securities Dealers (NASD) and the New York Stock Exchange (NYSE), although private trade organizations, have disciplined their own through a process of self-regulation overseen by the Securities and Exchange Commission. Before investors can buy or sell stocks or open money market accounts, they must agree to waive the right to litigate disputes. Customers must submit to mandatory arbitration to open almost all types of accounts. Even employees in most firms must sign arbitration agreements before they are hired. So when arbitration-friendly California intruded on brokers’ turf in 2002 by imposing tough new ethical standards for neutral arbitrators in all areas, the NASD and the NYSE and other exchanges took notice. And they fought back. First they sought exemption from state rules. Failing that, they argued that the California rules conflict with the Securities and Exchange Act of 1934 and are thus pre-empted by federal law. States are watching States around the country, and particularly New York Attorney General Eliot Spitzer’s office, have been watching the fight to see if they too may get into the business of monitoring securities industry arbitrators, according to participants in the California case. This week, the issue comes to a head in arguments before the California Supreme Court, when they take up the issue of federal pre-emption in the case of Jack Jevne, a retired Montecito investor, Jevne v. JB Oxford Holdings, No. S121532. Throwing a curveball into California’s fight, just days before the hearing, the 9th U.S. Circuit Court of Appeals issued its own ruling declaring the California standards pre-empted by the Securities and Exchange Act, Credit Suisse First Boston v. Grunwald, No. 03-15695. That comes in an employment dispute, however, not an investor action. The one thing the 9th Circuit ruling makes clear: However California’s high court rules, someone will ask the U.S. Supreme Court to take it up. In 2002, concerned about public confidence in the arbitration system, the California Judicial Council, the policy-setting body for the state’s courts, wrote tough new ethical standards for neutral arbitrators in all types of conflicts. The 16 new rules of court require, among other things, that arbitrators disclose potential conflicts of interest and any financial or personal ties to parties in a dispute. Arbitrators must disclose not only their personal interests but also financial or personal ties of immediate family members and any prior relationship with the law firms involved in the dispute. By contrast, the industry groups require only that an arbitrator withdraw if there is a potential conflict. The rules don’t require disclosure of the reason for the withdrawal. “Securities arbitration has been the black sheep of arbitration for years,” said Cliff Palefksy of San Francisco’s McGuinn, Hillsman & Palefsky. He filed an amicus brief for the California Employment Lawyers Association. “The NASD is a trade organization and to have them sponsor their own arbitration falls way outside basic ethical standards,” he said. The industry, which saw 8,900 new arbitration claims filed in 2003, argues that the burden on arbitrators would drive them from the field. Imposing California’s arbitration standards would also lead to a patchwork of state ethics rules for arbitrators around the country, the industry maintains. “By displacing the role of the [NASD] Directors of Arbitration, the California standards directly conflict with the federal scheme, and are therefore preempted, because it is not possible for the [self-regulated organizations] to comply both with their own procedures and the California standards,” wrote NASD attorney Mark Perry. Jevne’s lawyer, Eric Woolsey of Santa Barbara, Calif., said, “The Securities and Exchange Act does not require arbitration, only the industry requires investors to arbitrate.” Woolsey points out that the 9th Circuit case dealt with an employment dispute between an NASD-covered brokerage firm and one of its employees. A labor dispute “has much less public policy implication” than arbitration of investor disputes, he said. “I also believe the 9th Circuit mischaracterized the conflict where none exists between NASD rules and California standards,” said Woolsey of Zilinskas & Woolsey. “It seems to me a private employment contract between a broker and an employee is a whole lot different than requiring arbitration of disputes between California investors and their financial advisors.” Palefsky protested that while the 9th Circuit may have found two provisions in conflict, there are 14 other standards “that don’t conflict and they didn’t take a close enough look at the ones that don’t conflict. That’s not right.” 2,000-case backlog Shortly after the Judicial Council approved the ethics standards, the NASD refused to arbitrate California cases. As many as 2,000 cases piled up while the dispute raged. Now investors must sign waivers of the California rules if they want to proceed. The choice: Give up all claims or waive the California ethics standards. Jevne, who complained that his investment banker allowed more than $1 million of his money to be transferred to a third party without permission, refused to waive California’s ethics rules. Under NASD rules, a three-member arbitration panel must include one arbitrator from the investment industry. W. Reece Bader, the industry arbitrator in Jevne’s case, disqualified himself without explanation. NASD refused to reveal the reason and declined to go ahead with Jevne’s arbitration in California. California Attorney General Bill Lockyer’s office has weighed in on the Jevne dispute. “The problem with the position of the organizations is that they were delegated authority to discipline in the industry, but nothing in the law gives them the power to arbitrate with nonmembers,” said Amy Winn, deputy attorney general in Sacramento. NASD’s Perry declined to comment on either case. NASD spokesman Herb Peron said only that the organization was pleased with the 9th Circuit decision.

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