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Stock Exchange Says It Will Skirt California’s ADR Standards

The Recorder

The securities industry thumbed its nose Wednesday at California’s Judicial Council, announcing it would simply circumvent the state’s new ethics standards for arbitrators now that it has lost a battle over them in federal court.

The New York Stock Exchange said it would allow parties with disputes in California to move ahead with arbitrations if they waive their rights under the state’s new ethics standards. The National Association of Securities Dealers — which joined the stock exchange in the court challenge to the new rules — has used similar waivers since Sept. 30. Together, the two groups have about 750 cases waiting for arbitration in the state.

The pair also received a boost Wednesday from the Securities and Exchange Commission, which said it strongly backed the two groups in their fight against the ethics standards. The SEC released a 50-page report that says California’s new rules are unnecessary, potentially expensive and “may reduce investors’ perceptions of the fairness of … arbitrations,” according to an SEC release.

The stock exchange and the NASD’s arbitration arm sued in federal court to try to stop implementation of the new rules, which were promulgated by the California Judicial Council. But they were stopped short Tuesday when a U.S. district court judge dismissed their case, citing states’ constitutional immunity from suits in federal courts.

The rules require, among other things, that arbitrators disclose financial relationships or other conflicts of interest between themselves and parties in disputes. Failure to follow the standards could result in vacating an arbitration award.

Joseph Cotchett, who defended the Judicial Council in the suit, said he was baffled by the stock exchange’s move.

“They’re out of their minds,” said Cotchett, of Burlingame, Calif.’s Cotchett, Pitre, Simon & McCarthy.

The SEC release prompted more amazement from Cotchett, who said he was surprised the agency hadn’t released it sooner to try to help the securities groups’ case. “I’m dumbfounded. It is amazing that they would release this,” Cotchett said. “What this report is supposed to do is bolster their case. [Why was it] not submitted to court?”

Although the groups have not announced whether they will appeal the ruling to the 9th U.S. Circuit Court of Appeals, they’re pushing ahead with the position that their arbitrators simply don’t have to abide by California’s new law.

At this point it’s unclear whether the securities groups will ever abide by the new ethics standards, no matter what courts rule. Asked whether the stock exchange was allowing the waivers only until any appeals were exhausted in court, spokesman Ray Pellecchia said: “It’s in effect now, and we haven’t put a deadline on it. For however long it’s appropriate.”

Because it has no powers to enforce the ethics rules, which it passed in July, the Judicial Council might not have a way to respond to Wednesday’s development.

Instead, it could be up to California Attorney General Bill Lockyer to step in to get the securities groups to abide by the new rules. Lockyer spokesman Tom Dresslar said that wasn’t likely, though, unless a specific dispute based on the new rules comes up.

Dresslar said his boss could get involved in another way. “[If] they file in state court and avoid this sovereign immunity thing,” he said.