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Proposed Rule

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Explanation of Proposed Amendments

A) Explanation of Proposed Amendments to NFA Compliance Rule 3-15:

Under NFA Compliance Rule 3-15, NFA has the authority to take a Member Responsibility Action ("MRA") against a Member in situations where NFA's President, with the concurrence of NFA's Board or Executive Committee, has reason to believe that summary action is necessary to protect the commodity futures markets, customers or other Members or Associates. Under this Rule, NFA has the authority to summarily suspend a Member, restrict its operations or direct other remedial action.

Although Rule 3-15 gives NFA broad powers, it does not explicitly authorize NFA to order a Member to infuse additional capital or to maintain its adjusted net capital at a particular level. Other self-regulatory organizations ("SROs"), such as the Chicago Board of Trade and the Chicago Mercantile Exchange, have rules which give them that authority. Over the years, there have been a number of instances in which a Member firm was in technical compliance with capital rules but nevertheless, based on its history of problems or business practices, posed a real threat to the public. In these situations the explicit authority granted to other SROs would have been a helpful tool for NFA. Therefore, the Board amended Rule 3-15 to specifically state that NFA has the power to order an immediate infusion of capital as part of an MRA. As with other SROs who have this same authority, this change would only apply to those firms for which NFA acts as designated self-regulatory organization.

B) Explanation of Proposed Amendments to NFA Code of Arbitration and Member Arbitration Rules (collectively "arbitration rules"):

Simplified Arbitration Process for Summary Proceedings

Currently, NFA processes all arbitration cases in essentially the same way, regardless of the claim amount or proceeding type. For example, NFA allows a respondent 45 days to serve its Answer in a case, which is longer than in most other forums. NFA also provides the parties with 30 days to request documents and written information and an additional 30 days to satisfy or object to those requests. The Board felt that some of these procedures could be modified for the smaller claims that are filed at NFA, which would result in a more efficient process for those cases.

Specifically, the Board felt that the cases that qualify as summary proceedings at NFA are suitable for shorter Answer and discovery deadlines since these cases are usually simpler and less complicated than those that require an oral hearing. For these reasons, the Board amended the arbitration rules to shorten the Answer deadline in summary proceedings to 20 days. The arbitration rules were also amended to reduce the discovery timetable so that the parties have 20 days to request documents and written information and an additional 20 days to satisfy or object to those requests.

Additionally, the Board felt that certain other procedures may not be necessary in summary proceedings. For example, it may be more efficient for the arbitrator to decide pre-hearing motions to dismiss or for summary judgment at the same time he or she is reviewing all the other written submissions from the parties. On the other hand, the arbitrator needs to decide discovery motions or continuance requests prior to considering the full case. Therefore, the arbitration rules were amended to limit the pre-hearing motion practice for claims that qualify as summary proceedings to discovery and continuance requests.

Under the arbitration rules, the parties have the option of asking for an oral hearing for claims that qualify as summary proceedings (i.e., claims over $5,000 through $25,000 in customer cases and claims over $10,000 through $50,000 in Member cases). NFA's experience indicates that the claim amount provides a good indication of a case's complexity. Therefore, the changes to the arbitration rules apply the simplified procedures to smaller cases, even if a party asks for an oral hearing.

NFA's Arbitration Department is always looking for ways to use technology to further increase its efficiencies. To that end, the Department is currently developing an electronic or "paperless" arbitration process. Since an arbitrator decides a summary proceeding based on the parties' written submissions, NFA staff hopes to replace those paper submissions with electronic ones, which will further expedite the process and reduce costs for the parties and NFA. Consequently, these rule changes are an important step in laying the groundwork for the Department to develop its electronic arbitration process. Therefore, the arbitration rules also reflect several minor changes that staff believes are more appropriate for electronic filings (e.g., using "Arbitration Claim" instead of "Demand for Arbitration").

Pre-hearing conference and arbitration service fee

For cases with oral hearings, arbitrators will be able to hold a pre-hearing conference shortly after the discovery deadlines pass. At the conference, the parties and arbitrators will, for example, resolve discovery issues, identify other pre-hearing motions and schedule hearing dates. This procedure gives the arbitrators more responsibility to manage a case early on in the arbitration process and to keep the process moving forward.

It is expected that the arbitrators will conduct the pre-hearing conferences by telephone, though the proposed rules would allow them to hold an in-person conference, if necessary. The arbitration rules were amended to provide that, unless otherwise ordered by the arbitrators, the parties are required to exchange exhibits 10 days before the first scheduled oral hearing date instead of 35 days before the hearing as currently is required. Certain minor adjustments to the arbitration rules were made to reflect the impact the pre-hearing conference has on other aspects of the arbitration process, including scheduling the hearing, preparing the hearing plan, and handling pre-hearing decisions by the arbitrators.

The Board determined to pay the arbitrators for conducting the conferences and pass those costs on to the parties. While NFA could increase the hearing fees to cover those costs, the Board was reluctant to impose the expense of the pre-hearing conference solely on the claimants. Claimants, who are usually customers, already pay filing and hearing fees when they submit their disputes to NFA. Therefore, instead of increasing customers' costs to use NFA's arbitration forum, the Board felt that respondents, who are usually Members, should bear some of the arbitration expense by assuming the costs of the pre-hearing conference. Consequently, the Board decided to charge respondents an arbitration service fee.

The arbitration service fee would be payable to NFA when respondents file their Answer in a case. Since a pre-hearing conference will only apply to cases requiring an oral hearing, NFA would only collect the service fee for Answers filed in those cases (i.e., in customer cases over $25,000 and in Member cases over $50,000). Furthermore, the Board has set a payment structure for the pre-hearing conference that is similar to our payment structure for regular hearings. As a result, amendments to the arbitration rules reflect an arbitration service fee for an Answer filed in a three-arbitrator case at $675 (or $200 x three arbitrators, plus a $75 honorarium for the chairperson) and at $275 in a one-arbitrator case.

Under the current rules, if a claimant does not pay the required filing and hearing fees, NFA will reject the case and the claimant cannot proceed with NFA arbitration. The Board felt that respondents should experience similar consequences. For that reason, NFA will reject an Answer if the appropriate fee is not paid and prohibit the non-complying respondent from taking part in the arbitration. However, the proposed amendments would give the arbitrators the authority to accept an Answer and allow the respondent to participate in the hearing if the respondent can convince the arbitrators that there is a good reason for not paying the fee.

Other forums, like NASD and the National Feed and Grain Association (NFGA), use pre-hearing conferences in their arbitration matters, and NFA uses them in its disciplinary cases. All of them have found the pre-hearing conference effective in reducing delays. Furthermore, the American Arbitration Association and NFGA charge service fees, which are usually based on the claim amount, in addition to their filing and hearing fees. The NASD imposes surcharges and process fees on member firms named as parties in NASD arbitration proceedings to recoup costs of the arbitration process. While NFA does not recommend going as far as the NASD, we believe imposing an arbitration service fee is reasonable and that the proposed amounts are affordable.

Refunding arbitration fees

In order to encourage earlier settlements, the Board decided to change the way hearing fees are refunded. Currently, the arbitration rules provide for a full refund of the hearing fees if the parties settle or withdraw their claims no fewer than eight days before the first scheduled hearing date. The Board, however, determined that the deadline for a refund should be increased to 15 days before the hearing to encourage the parties to resolve their disputes earlier in the process and, at a minimum, reduce any unrecoverable travel or facility expenses that NFA incurs when cases settle less than two weeks before the hearing.

In addition, the existence of the pre-hearing conference and arbitration service fee may provide a greater incentive for claimants and respondents to resolve a case early in the arbitration process. Therefore, the arbitration rules were amended to provide for a graduated refund schedule to further encourage settlements. Under this proposal, NFA would issue a full refund of the hearing and arbitration service fees if a case settles or is withdrawn within five days before the pre-hearing conference, if one is scheduled, or within 30 days before the regular hearing if no pre-hearing conference is scheduled. If a case settles or is withdrawn within 15 days before the oral hearing date, NFA would give the parties a partial refund of the hearing and arbitration service fees.

Miscellaneous

The arbitration rules were amended to clarify who will pay the additional hearing fees associated with requests for oral hearings in cases that qualify as summary proceedings and requests for two additional arbitrators in cases that qualify for one-arbitrator oral hearings. The rules were amended so that the parties who ask for oral hearings in the cases that qualify as summaries pay the additional hearing fee. With regard to extra hearing fees for appointing two additional arbitrators in cases qualifying as one-arbitrator oral hearings, the party who asks for three arbitrators will pay the additional fees. However, if the single arbitrator asks NFA to appoint two more arbitrators, then the parties will equally share the increased fees.

Finally, to ensure that the fees charged under the Member Arbitration Rules are reasonable, particularly in light of the proposed arbitration service fee, the hearing fees for claims between $20,000 and $100,000 and the filing fees for claims between $50,000 and $100,000 are reduced under the proposed amendments.

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