NEW YORK (AP) _ Merrill Lynch & Co. plans to rewrite its corporate policy to allow employees to take disputes with the company to court, a ground-breaking move that could hasten the demise of Wall Street's mandatory arbitration system.

The leading Wall Street firm refused to comment Thursday, but a source familiar with the plan said it would give employees the option to sue the firm after an unsuccessful attempt at mediation. Many Wall Street employees are now prohibited by an industry rule from taking internal disputes to court.

The change is part of an effort by Merrill Lynch to settle a 1996 sex-discrimination lawsuit, but would be made even if it isn't included in settlement, the source said. It comes at a time Wall Street is facing mounting scrutiny from many corners over its treatment of minorities and women.

New York Attorney General Dennis Vacco held hearings Thursday on sex discrimination in the industry. A week ago the Rev. Jesse Jackson held a forum on diversity on Wall Street that was attended by President Clinton. Last fall, Smith Barney settled an embarrassing sexual-harassment lawsuit that generated many headlines because of its lurid details, including a basement ``boom boom room'' at a Garden City branch.

If Merrill adopts a policy allowing lawsuits, it would be a major victory for women and minorities who have long criticized mandatory arbitration as unfair and have pushed for a system that is optional and gives them an opportunity to take their cases to court.

``Getting rid of mandatory arbitration has always been one of our primary goals,'' said Mary Stowell, the attorney for the women who have sued Merrill Lynch. ``What is wrong with the arbitration system in the securities industry is the mandatory nature of it _ it ends up being unfair.''

Stowell, a partner in the Chicago law firm Stowell, Friedman & Vernon, declined to comment on specifics of the Merrill Lynch case because of a confidentiality agreement. She said the leak of Merrill Lynch's intentions breaches that agreement and could scuttle settlement talks in the lawsuit.

Stowell also handled the sexual harassment lawsuit against Smith Barney that resulted in a settlement in which the firm agreed to spend $15 million on diversity programs and allow employees to resolve disputes through independent arbitration.

The Smith Barney deal was hailed as a milestone in the industry because it allowed employees to sidestep mandatory arbitration. But it does not provide an opportunity for disputes to be taken to court, where juries might be more sympathetic to employees and award them bigger damages than arbitrators.

It was the fear of facing potentially hostile juries, critics say, that for years had kept the securities industry firmly opposing any changes to the 17-year requirement that many employees give up their rights to sue as a pre-condition of employment.

But with pressure mounting on the industry, that wall cracked. First there was the Smith Barney settlement that allows employees to take cases to referees outside the industry. Then the National Association of Securities Dealers, a self-regulatory body, agreed to abolish mandatory arbitration.

Its proposal, which is still awaiting approval from the Securities and Exchange Commission, would allow brokerage firms to set their own rules for resolving disputes, similar to systems set up by Smith Barney and the one Merrill is considering. But critics fear that many firms would still require arbitration and prohibit lawsuits.

There is hope that the Merrill Lynch action could be the catalyst that pushes other Wall Street firms to allow employees to take their complaints to court _ ending arbitration as the only choice. Merrill is the biggest securities firm on Wall Street.

The plan Merrill Lynch is considering would only allow employees to go to court as a last resort. The employees would be given the option, after mediation has failed, of taking their complaints either to an arbitration panel arbitration or court.

``Merrill should be complimented on taking the lead in this area,'' said Bill Singer of Singer Zamansky, a law firm that has represented many Wall Street employees in disputes with their firms. ``The best we could hope for is the old adage, `when Merrill sneezes the industry gets a cold.'''

Although Merrill Lynch should be commended if it makes the step in allowing employees to take claims to courts, Singer said, he would be ``circumspect about the applause.'' He said public and legal pressure made the move inevitable.

``They may not have done it voluntarily,'' he said. ``They were losing the war anyway. ``Merrill was reading the tea leaves and seeing the future might be better off arguing the merit of a discrimination case rather that arguing whether anybody has a right to bring it.''