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DATEK SECS. CORP v. NASD

February 3, 1995

DATEK SECURITIES CORP, ET AL., Plaintiffs, against NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC., Defendant.


The opinion of the court was delivered by: CONSTANCE BAKER MOTLEY

 MEMORANDUM OPINION

 BACKGROUND

 This case arises out of an administrative complaint filed by the National Association of Securities Dealers ("NASD") against the Plaintiffs on June 14, 1994 alleging several hundred violations of the NASD's Rules of Practice and Procedures for the Small Order Execution System ("SOES") over three separate periods between 1991 and 1993. (PP 11, 18). *fn1" Plaintiff Datek Securities Corporation, a New York corporation, is a registered broker-dealer and has been a member of the NASD since 1970. (P 10). The individual Plaintiffs are present or former Datek employees and are associated members of the NASD. (P 11). Defendant NASD is a self-regulatory organization ("SRO") registered with the Securities and Exchange Commission ("SEC") as a national securities association pursuant to § 15A of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78o-3. The Exchange Act assigned the NASD and the other SROs the responsibility for conducting investigations and commencing disciplinary proceedings against member firms and their associated member representatives relating to compliance with the federal securities laws and regulations. See 15 U.S.C. § 78o-3(b)(7). The Exchange Act expressly provides that the SEC and the United States Courts of Appeals have the discretion to stay any sanctions imposed by the NASD pending review. 15 U.S.C. §§ 78s(d), 78y(c).

 SOES is a computerized trading system that provides for the instantaneous execution of small orders of securities--up to 1,000 shares at the times relevant to this action--strictly on behalf of public customers against market makers for particular securities. (P 17). In simple terms, the 1994 NASD disciplinary action charges that separate trades executed by different Plaintiffs on behalf of different Datek clients within five minute periods did not result from independent investment decisions. (P 19). Therefore, the NASD charges that when these trades are aggregated, as they must be under the NASD Rules of Practice and Procedure, they violate the 1,000-share maximum. (P 19).

 Plaintiffs are subject to longstanding institutional bias by the NASD because they have used the SOES to earns profits at the expense of large market makers who often neglect to adjust the spread between their bid and ask prices to reflect changes in the market. (PP 22-23). This prejudice has been manifest in three separate disciplinary proceedings brought in 1989, 1992, and 1993 against Datek and one of the individual Plaintiffs, Sheldon Maschler, regarding SOES transactions. (PP 24-30). The 1992 proceeding ultimately resulted in Datek and Maschler serving six-month suspensions. (PP 27, 29). All three proceedings were marred by bias and conflicts of interest. (PP 24-30). Bias in the 1994 disciplinary proceeding that is the subject of the instant case is reflected in the NASD disciplinary panel's engaging in ex parte evidence gathering and review of material not placed in the record. (P 32).

 The NASD and its members have additional reasons for being personally biased against Plaintiffs Datek and Maschler. The first of these reasons is these plaintiffs' publicly-disclosed cooperation with an investigation by the United States Department of Justice into potential antitrust violations by the NASD and its member firms. (P 33). Second, Plaintiff Maschler has been approached by the SEC to assist it in an investigation of possible instances of "backing away" from trades by numerous powerful NASD member firms. (P 34). Finally, the NASD and its members may be seeking to retaliate against the Plaintiffs for the Plaintiffs' damage action against the NASD and various of its members which is pending in another court. (P 35).

 Plaintiffs are seeking preliminary and permanent injunctive relief restraining the NASD's proceedings based on two related grounds: (1) Defendant's alleged historical and continuing bias against the Plaintiffs; and (2) resulting violations by the NASD of its own Code of Procedure. Defendant NASD has filed a motion to dismiss the Complaint pursuant to Rules 12(b)(1), 12(h)(3) and 12(b)(6) of the Federal Rules of Civil Procedure. The essence of the NASD's argument is that the Plaintiffs have failed to exhaust their administrative remedies. As explained below, Plaintiffs' allegations are not sufficient to bring their Complaint within any of the established exceptions to the exhaustion requirement.

 The dispute between the parties comes down to the applicability of the exhaustion requirement. *fn2" In Touche Ross & Co. v. SEC, 609 F.2d 570 (2d Cir. 1979), the Second Circuit described this doctrine and its policy basis:

 
The doctrine of exhaustion of administrative remedies is concerned mainly with the timing of judicial review. In general, a litigant is required to pursue all of his administrative remedies before he will be permitted to seek judicial relief. The rationale behind the exhaustion doctrine is that a court's refusal to intervene prematurely in the administrative process gives the agency an opportunity to develop factual findings, to apply its expertise to new issues and to exercise its discretionary powers. 609 F.2d at 574.
 
With regard to the instant case, "it is well-established that the doctrine of exhaustion of administrative remedies applies with equal force to the disciplinary proceedings of NASD." Bruan, Gordon & Co. v. Hellmers, 502 F. Supp. 897, 902 (S.D.N.Y. 1980) (Motley, J.) (citing First Jersey Securities, Inc. v. Bergen, 605 F.2d 690, 696 (3d Cir. 1979), cert. denied, 444 U.S. 1074, 62 L. Ed. 2d 756, 100 S. Ct. 1020 (1980). See also McLaughlin, Piven, Vogel, Inc. v. NASD, 733 F. Supp. 694, 696-97 (S.D.N.Y. 1980); Westheimer v. Commodity Exchange, Inc., 651 F. Supp. 364, 367 (S.D.N.Y. 1987).

 II. Exceptions to the Exhaustion Doctrine.

 Plaintiffs rely on Guitard v. U.S. Secretary of the Navy, 967 F.2d 737 (2d Cir. 1992) in which the Second Circuit listed ...


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