WealthManagement Magazine

NASD Issues U-5 Immunity Rule

The NASDR recently released its proposed U-5 immunity rule, which would give brokerage firms partial immunity for what they disclose on termination reports, as well as U-4s and other disclosure documents.According to proposed text of the rule, a firm "shall not be liable in [an arbitration] proceeding to a covered person [broker] for any defamation claim related to an alleged untrue statement that

The NASDR recently released its proposed U-5 immunity rule, which would give brokerage firms partial immunity for what they disclose on termination reports, as well as U-4s and other disclosure documents.

According to proposed text of the rule, a firm "shall not be liable in [an arbitration] proceeding to a covered person [broker] for any defamation claim related to an alleged untrue statement that is contained in a covered form [U-4, U-5, etc.] if the statement was true at the time that the statement was made."

To win a defamation claim in arbitration, brokers would have to show with "clear and convincing evidence" that "(A) the defending party knew at the time that the statement was made that it was false in any material respect; or (B) the defending party acted in reckless disregard as to the statement's truth or falsity."

The proposed rule would amend the NASD's bylaws regarding the filing of disclosure forms.

The immunity standard would also cover other statements, including verbal disclosures made to other potential employers prior to the filing of a U-4 or U-5 that are "subsequently included in a filed form in the same language," the proposal says.

The NASDR admits that "the number of defamation cases relative to the NASD's overall arbitration caseload is small," but that a uniform immunity standard is needed because "members' potential exposure to liability as a result of such claims may be substantial" and because firms "have also questioned the fairness of exposure to potentially significant liability for disclosures they are required by the NASD to make." What about brokers' views?

The NASDR says it and other regulators "have worked with representatives of NASD member firms and employees in an effort to formulate a fair and workable solution to this problem."

But T. Sheridan O'Keefe, president of the Minneapolis-based National Association of Investment Professionals (NAIP), says the NASDR "didn't take into account any of our views." The year-old NAIP is an association for brokers. (O'Keefe writes a monthly column for RR magazine. The editor of RR also serves on the NAIP's board.)

In a September letter to the NASDR, O'Keefe said the NAIP "does not believe a specific standard of immunity needs to be developed, since under state laws, partial immunity already applies to U-5 statements."

O'Keefe called for a halt to the immunity discussions and complained that "the nation's 550,000 registered representatives have had no input at all in the U-5 immunity debate. Neither has the public. Meanwhile, the NASDR has worked closely-and in private-with the Securities Industry Association from day one of these discussions. ... "

O'Keefe now tells RR that firms are fearful of losing brokers to competitors, especially independent firms, and therefore want U-5 immunity as another tool to lock brokers in.

A task force made up of representatives from the SIA, all the SROs, the SEC, state regulators and several plaintiffs' attorneys, has been discussing the immunity issue for about six months. Informal discussions between regulators and the industry have been going on for several years. The NAIP's O'Keefe says he initiated contact with the NASDR, but that his comments were received well after the proposal had been drafted.

Meanwhile, the SIA announced its opposition to the proposal the day the rule was released, Nov. 3. Stuart Kaswell, SIA general counsel, says the rule needs to be expanded to include other claims an ex-employee might make. Otherwise, plaintiffs' attorneys will draft complaints around defamation, he says. "If you don't have a fairly broad sweep, you haven't accomplished anything."

Another proposal the SIA doesn't like is a requirement that registered reps be given a copy of their U-5 10 days before filing, and be given a chance to respond. The trade group says the window could give a fired employee more time and leverage to get the U-5 watered down.

Jeff Liddle, a New York plaintiff's attorney and part of the task force, also disagrees with the 10-day look-"it's exactly the sort of thing that can be used against [a broker] in defending [a U-5 claim] two years later," he says. "The firm will argue, `You didn't disagree with it at that time, what's the problem now?'"

Broker/dealers would also be required to provide "immediate notification to employees of material revisions to be filed on Form U-5," the NASDR release says.

Regarding the evidentiary standard, the NASDR concedes that some states have a lower "preponderance" of evidence standard for defamation, but says a uniform clear and convincing standard will provide "significant protection to member firms for required disclosures without depriving employees of recourse for false statements made knowingly or recklessly. ... "

The NAIP, in its comment letter to the NASDR, argued that such a standard would "set a higher legal standard for defamation than now exists in New York, California, Illinois, Ohio, Michigan, Virginia, Pennsylvania and Washington D.C., among other states." The broker group warned that "Incorporating into the rules any kind of strict legal definition would be unprecedented, and unwise, as it will likely lead to further litigation over arbitrator's interpretations of legal and evidentiary standards."

Liddle claims NASDR research on state law was faulty, and that only two states use a clear-and-convincing standard for defamation.

According to the proposed rule, both a firm and any employee at the firm responsible for making statements on disclosure forms would be protected by the immunity rule. However, the NASDR is seeking comment as to whether anyone who handles U-4s or U-5s should be registered or be a lawyer in order for qualified immunity to apply.

The rule is being proposed as a four-year pilot program, after which the NASDR would "assess the impact of the Rule on the nature and quality of disclosure by member firms."

The NASDR is taking comments on the proposal until Dec. 31 at www.nasdr.com. The rule would then need to be approved by the NASDR board and the SEC.

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