May 1, 2003
Mayo v. Dean Witter Reynolds, Inc.:
Tough New California Ethical Standards for Arbitrators
Do Not Apply to Securities Arbitrations
In a recent ruling, in Mayo v. Dean Witter Reynolds, Inc., 2003 U.S. Dist. LEXIS 6710, District Judge
Jeremy Fogel held that California’s tough new disclosure requirements for arbitrators, which went into
effect July 1, 2002,1 are preempted by the Securities Exchange Act and by the Federal Arbitration Act and
do not apply to securities-industry arbitrations. Because California is the first state to adopt such stringent
rules for arbitrators, this decision may inhibit other states from following suit.
The California standards differ from the standard NASD, NYSE and NASDDR rules in several
significant ways. Under the standard rules governing self-regulatory organizations (SROs) registered
with the SEC pursuant to the Securities Exchange Act of 1934 (such as the NYSE), arbitrators are
required to disclose personal or financial interests, be they direct or indirect, that might affect the outcome
of the arbitration and to disclose any personal or professional relationship that might reasonably create an
appearance of bias. See NYSE Arbitration Rule 610(a); NASD Rule 10312(a). However, there is no
requirement that additional information about an arbitrator’s background be provided, even if requested.
See NYSE Arbitration Rule 608. In contrast, the California standards require disclosure of “all matters
that could cause a person aware of the facts to reasonably entertain a doubt that the proposed arbitrator
would be able to be impartial.” Ethics Std. 7(d).
Further, the California standards require the disqualification of an arbitrator in circumstances when the
SRO’s rules do not. While the SRO’s rules regarding arbitrators provide for one preemptory challenge
per party, the individual body’s Director of Arbitration has the sole discretion to make all other
disqualification decisions, including all disqualifications for cause. See NYSE Arbitration Rules 608–
6011; NASD Rules 10309–10313. In contrast, the California standards permit disqualification of
arbitrators upon notice by any party if the arbitrator either failed to make the required disclosures or made
a disclosure that would be grounds for disqualification. See Ethics Std. 10; Cal. Code Civ. Proc. §
1281.91.
1
See California Senate Bill 475; Cal. Code Civ. Proc. § 1281.85(a).
Securities Law Alert is intended as an information source for the clients and friends of Nixon Peabody LLP.
Its content should not be construed as legal advice, and readers should not act upon information in this publication without professional counsel.
Due to the differing requirements, the NYSE and NASDDR temporarily suspended arbitrations in
California. The NYSE began to offer California investors the option of having their disputes heard
outside of California so that the new standards would not apply.2 In September 2002, arbitrations in
California were reinstated, but only for those investors who were willing to waive application of the
California standards. See NYSE Arbitration Rule 600(g). The plaintiff in Mayo then brought this action,
requesting that the court vacate an earlier arbitration order, claiming the NYSE’s refusal to appoint an
arbitration panel compliant with the California standards constituted an intervening change in
circumstances requiring denial of the earlier motion to compel arbitration.
The Mayo court concluded that the Exchange Act and the federal regulatory scheme established pursuant
to the Exchange Act preempted application of the California standards to the NYSE and other SROs. The
court cited the principle that states are not permitted to enforce a state law if it conflicts with federal law
or if compliance with the state law prevents compliance with the federal law, and in Mayo, the obligations
of the SROs under the California standards were deemed to conflict with obligations under their own
SEC-approved rules. For example, it would be impossible to allow the Director of Arbitration to have
control over the removal process and at the same time allow either party to the dispute to have an
arbitrator removed. Also, NYSE Arbitration Rule 600(g), which requires that California investors either
waive application of the new California standards and proceed with arbitration in California or proceed
with the arbitration out-of-state, effectively precluded application of the California standards, making it
impossible for the NYSE to comply with both sets of rules.
The Mayo court also found persuasive the argument that the regulatory scheme imposed by the securities
laws was designed to provide uniform, national rules for participants in the securities markets. The court
agreed that arbitration rules for SROs should apply uniformly across all states. Allowing the California
standards to be enforced would serve to frustrate that goal, particularly if an arbitration award that would
have been confirmed in any other state became subject to vacatur in California under its unique rules.
See Cal. Code Civ. Proc. § 1286.2(a)(6).
In addition, the court ruled that the California standards are preempted by the Federal Arbitration Act
(FAA). The plaintiff had signed a Uniform Submission Agreement (USA) to begin his arbitration
proceedings before the NYSE. Relying on Scheck v. Alberto-Culver Co., 417 U.S. 506, 519 (1974), the
District Court found that an “agreement to arbitrate before a special tribunal is, in effect, a specialized
kind of forum-selection clause that posits not only the situs of the suit, but also the procedure to be used
in resolving the dispute.” Here, the Client Account Agreement entered into by the parties, and most
notably the arbitration provision, established that New York substantive law and the procedural rules of
the NYSE, NASD, or the Municipal Securities Rulemaking Board would apply to any dispute resolution.
Further, the California standards had not even been promulgated when plaintiff had executed the USA
and agreed to submit to arbitration. The purpose of the FAA was to uphold the validity of arbitration
agreements, and to disapprove this one (and others like it) would run contrary to the FAA.
Given the significance of this decision and its impact on California law, Mayo is likely to be appealed.
For now, however, SROs overseeing securities disputes in California are not bound by California’s
stricter ethical standards for arbitrators.
2
The plaintiff’s own arbitration proceedings were suspended because of this moratorium. While his arbitration
was pending, the NYSE and NASDDR brought suit for declaratory relief against the California Judicial
Council. NASD Dispute Resolution Inc. v. Judicial Council of California, 232 F. Supp. 2d 1055 (N.D. Cal.
2002), was dismissed when U.S. District Court Judge Samuel Conti of San Francisco ruled that the judiciary
and its agencies were protected from such suits by the Eleventh Amendment to the United States Constitution.
This decision is being appealed to the Ninth Circuit.
-2-
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shareholder derivative suits, closely held corporate disputes, and shareholder buy-outs and dissenters’
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please refer to the final page of this Securities Law Alert.
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