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Federal judges cut in front of the California Supreme Court on Tuesday by ruling that the state’s stringent ethics rules for neutral arbitrators are trumped by federally sanctioned standards — an issue the state high court is set to tackle next week. The decision by the 9th U.S. Circuit Court of Appeals stunned San Francisco attorney Cliff Palefsky, who will defend the new rules before the state Supreme Court in oral arguments six days from now. “It’s surprising they wouldn’t let California take the first shot,” said the McGuinn, Hillsman & Palefsky partner who represents the California Employment Lawyers Association as amicus curiae. “The argument for [our] side is obviously going to have to focus on distinguishing this case, rather than starting from a clean slate.” Palefsky remained upbeat, however, saying that the state Supreme Court isn’t bound by the 9th Circuit’s decision. “The state is able to reach its own conclusions on the validity of state law,” he said, “and I hope they do.” The state’s arbitration standards, which went into effect in 2002, require neutral arbitrators to disclose conflicts of interest — financial or personal ties to one of the parties. That didn’t sit well with self-regulating organizations — SROs — such as the New York Stock Exchange and the National Association of Securities Dealers, which operate under their own rules, approved by the Securities and Exchange Commission. They responded by requiring California litigants to waive the state standards if they pursue arbitration. For California residents seeking arbitration with the NASD, it’s either play the game or stay out. Proponents say the rules used by SROs maintain uniformity nationwide and, therefore, overrule state standards. On Tuesday, the 9th Circuit agreed. “The [SEC],” Judge Richard Paez wrote, “has reasonably concluded that allowing California to regulate SRO arbitrations would result in a patchwork of inconsistent state arbitration regulations that would interfere with Congress’ intent in delegating SRO regulatory authority to the commission.” Specifically, he said, state standards are pre-empted by the Securities Exchange Act of 1934. Senior Judge Edward Leavy and Judge Marsha Berzon concurred. The 9th Circuit ruling and the pending Supreme Court decision could have major implications. The Securities Industry Association, another amicus in the state case, estimates that SROs completed more than 100,000 arbitrations between 1980 and 2002. Another 3,900 were opened in the first four months of 2004 alone, the last period for which data is available. The facts of both cases were decidedly different, though they turned on similar issues. In the state case, Southern California investor Jack Jevne and Avalon Investments sued JB Oxford Holdings Inc., a Sherman Oaks investment bank, for allegedly misappropriating funds. In the federal case, Scott Grunwald sued his former employer, Credit Suisse First Boston, after being terminated. Both companies compelled arbitration under NASD rules. The NASD — which had unsuccessfully sued the Judicial Council of California to have the standards declared inapplicable to SRO arbitrations — had to settle for refusing to appoint arbitrators in California unless all parties waived the state rules. Jevne and Grunwald refused and went to court, with each losing at the lower court level. Both cases have attracted attention. The NYSE and NASD intervened in the state case, and amici on their side include Conkle & Olesten, a Santa Monica law firm that emphasizes arbitration. On the other side, the California Employment Lawyers Association, Attorney General Bill Lockyer, the Trial Lawyers for Public Interest and the Judicial Council have signed on as amici. In the federal case, the NASD, NYSE, the SEC and the Judicial Council — which wrote the rules –joined as amici. On Tuesday, Jevne’s lawyers plan to argue that NASD and other self-regulatory organizations aren’t governmental agencies and, therefore, their rules lack the pre-emptive force of federal regulations. “The SEC and the SROs continue to advance a de facto field pre-emption argument,” Eric Woosley, a partner in Santa Barbara, Calif.’s Zilinskas & Woosley, wrote in court papers. Opponents claim, as they did in the 9th Circuit, that the new California rules add an unnecessary layer to arbitration and obstruct normal procedures. “Under the California standards, SROs (and parties to SRO arbitrations) would be inundated with unnecessary disclosures,” attorneys Douglas Henkin and Mark Perry wrote for NYSE and for NASD Dispute Resolution Inc. Henkin, a partner in New York’s Milbank, Tweed, Hadley & McCloy, and Perry, a partner in Gibson, Dunn & Crutcher’s Washington, D.C., office, echoed the 9th Circuit’s statement that separate state rules could result in a “patchwork of regulation.” Woosley, who will share arguments with Palefsky and Sacramento-based Deputy Attorney General Amy Winn, countered that the NASD process undermines clients’ confidence in the securities system. “It’s imperative that the process be fair,” he said. “As it is, it is not. They are leaving arbitrators on their panels that have conflicts of interest.” Michael Early, a partner in San Francisco’s Steefel, Levitt & Weiss who represented Credit Suisse First Boston in the 9th Circuit, declined comment on Tuesday. Jeffrey Kob, a partner in San Diego’s Miller Milove & Kob who represents JB Oxford Holdings Inc. in the state case, didn’t return telephone calls. Marc Dworsky, a partner at L.A.’s Munger, Tolles & Olson, wrote in an amicus brief for the Securities Industry Association that allowing states to impose their own regulations “would effectively strip arbitration of the very benefits it offers.” The state case, which will be argued in San Francisco, is Jevne v. Superior Court (JB Oxford Holdings Inc.), S121532. Chief Justice Ronald George, who, as head of the Judicial Council, had been a leading proponent for the California rules, has recused himself from the state case. So has fellow Judicial Council member Justice Marvin Baxter. They will be replaced by 5th District Justice Steven Vartabedian and 4th District Justice James Ward. The 9th Circuit ruling is Credit Suisse First Boston Corp. v. Grunwald, 05 C.D.O.S. 1751.

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