Qualified Immunity Rule Stalls

Concern over pre-empting state defamation law may have killed the NASD's controversial qualified immunity rule.RR has learned that the SEC last year asked the NASD to address concerns that the rule would be an illegal pre-emption of state defamation law. In an October 1998 letter submitted to the SEC, the NASD argued that the SEC could legally approve the rule (see box).But the rule is still stalled

Concern over pre-empting state defamation law may have killed the NASD's controversial qualified immunity rule.

RR has learned that the SEC last year asked the NASD to address concerns that the rule would be an illegal pre-emption of state defamation law. In an October 1998 letter submitted to the SEC, the NASD argued that the SEC could legally approve the rule (see box).

But the rule is still stalled at the SEC--more than a year after a public comment period ended. SEC watchers say the unusually long time period indicates the agency is having trouble with the proposal.

A spokesperson for the Securities Industry Association, which has been actively supporting the rule, says the brokerage trade group is uncertain where the rule stands.

Belinda Blaine, associate director at the SEC Division of Market Regulation, confirms that the agency hasn't made a final decision. "Sometimes we do a lot of thinking" about a rule, she says. Normally, if a rule won't fly, it's withdrawn, Blaine says.

But several plaintiffs' attorneys say the agency has effectively put the proposal on ice, even though under the '34 Act the SEC is supposed to either approve or reject rules.

The qualified immunity rule would generally raise the legal standard for brokers to win a defamation claim against an employer in NASD arbitrations. Its claimed purpose is to improve U-4 and U-5 disclosure information. The industry strongly supports the controversial proposal, while plaintiffs' attorneys and brokers have opposed it.

In comment letters, critics of the qualified immunity idea contend that the SEC lacks legal authority to override state defamation law. Apparently responding to the criticisms, the SEC asked the NASD for a legal analysis, which the NASD submitted in October.

The submission came to light only after RR in July filed a Freedom of Information Act suit against the agency. The SEC had previously refused to release the NASD legal analysis.

In a legal submission to the SEC last fall, the NASD argued that in passing the qualified immunity rule, the SEC would not be illegally pre-empting state law.

The NASD cited a Supreme Court case, Merrill Lynch v. Ware, which it claimed "indicated" that a rule approved by the SEC could pre-empt state law if the rule promoted the '34 Act. The NASD and the securities industry say qualified immunity would do exactly that. It would protect firms from frivolous broker defamation claims and thereby improve disclosures of bad reps.

But the NASD appears to be on thin legal ice in citing the 1973 Ware decision. In that case, the high court threw out Merrill's demand to arbitrate a wage claim and specifically warned against a federal pre-emption of state law unless "persuasive" reasons required it.

The court concluded that, "We also find in the structure of the ['34] Act an intent on the part of Congress that state policies in this [employment law] area should operate vigorously."

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