Commentary: RR Magazine's Editor in Chief Dan Jamieson's Comment Letter to the NASD
June 22, 2001
Barbara Z. Sweeney
Office of the Corporate Secretary
NASD Regulation Inc.
1735 K Street, NW
Washington, DC 20006-1500
Comment on Proposed Interpretive Material IM-2110-7
Dear Ms. Sweeney:
Thank you for taking comment on Proposed Interpretive Material IM-2110-7.
I am a public investor with no financial stake in this issue. Attached is my May 1, 2000, comment letter to the SEC regarding SR-NASD-00-02, the latest proposed injunctive relief rule. This letter details why employment agreements and their enforcement via TROs, injunctions and litigation can easily violate the ’34 Act. The Act is clear in its goals of promoting just and equitable principles of trade, fostering cooperation and coordination among industry players, prohibiting unfair discrimination among participants, avoiding undue burdens on competition, and above all, protecting investors and the public interest. I hereby incorporate this May 1 letter in this commentary.
Contrary to the NASDR’s position outlined in its Dec. 18, 2000, response to the SEC, SR-NASD-00-02 can indeed violate the Act; surely one cannot argue that since the proposed rule is simply “procedural,” it can do no harm. Besides, the proposed rule is far from simply procedural--it boldly seeks to override existing case law, for example.
In complying with the Act, all SROs should err on the side of protecting the public customer. Please keep in mind that particular firms’ desires are secondary to the public’s right to control their assets and choose their financial advisers. With nearly all injunctive cases, there are no true trade-secret or compliance issues involved--certainly none so grave as to justify harming customers as is currently happening.
Therefore, I fully support the approval of Proposed Interpretive Material IM-2110-7. As well, I have offered several suggestions under each of the questions the NASDR has asked about the proposed rule interpretation:
1. Should members be prohibited from taking actions that stop a customer from transferring his or her account to another firm after the customer has decided to move the account?
1) Yes. Member firms should be prohibited from taking any actions that inhibit transfers. In fact, this commenter’s understanding is that Rule 2110 ensures that customer instructions to transfer accounts will be followed on a timely basis. Rule 2110 serves the public well, because public customers typically rely on their brokers to advise, explain and monitor investments, as well as advise on a myriad of personal financial planning issues. They have the right to choose the broker of their choice as well as the firm of their choice. No customer, even one alleged to have committed the sin of being improperly solicited based on a contract they were unaware of, should suffer the penalty of being denied communication with, or access to, the firm or financial professional of their choice. The public interest demands that customers--not member firms--be in control of their own assets. Always.
2. Are there regulatory approaches, either in addition to or in lieu of the proposed Interpretive Material, that would accomplish the purposes of the proposal?
2) Yes. There are a number of regulatory approaches that would accomplish the purpose of the proposal, although the interpretation is needed as well. Such approaches might be:
a) The NASDR could submit SR- NASD-98-49 to the SEC for approval. This prior proposed final injunctive-relief rule, since withdrawn, was the proposal drafted with much to and fro from competing interests. It would have a generally positive effect in decreasing the tie-ups of client accounts by expediting injunctive cases.
b) Disclose injunctive case data. Under the current injunctive pilot rule, not only must firms file for arbitration when they seek a court order, they must also immediately report to the NASDR when they get a court order. Disclosure of some 1996 data made clear that nearly all (96%) of theses cases settle, raising doubts about the “irreparable harm” of losing an employee. The 1996 NASDR data also made clear that industry-savvy arbitrators would not rubber-stamp injunctive requests. Once judges or injunctive panelists can see the broad picture of industry experience, they will be much less likely to freeze customer accounts and be more likely to expedite the cases to SRO arbitration for efficient resolution.
c) Retain the NASDR injunctive process. The NASDR has proposed eliminating its own facility for providing injunctive relief. Meanwhile, the disclosed data on these cases show that industry savvy NASDR arbitrators are less likely to freeze customer accounts and gag brokers. Any challenges in dealing with the demands of users of the NASDR injunctive process (such as Friday evening and weekend hearings) is not a reason to turn the entire process over to the federal courts and the taxpayer. The NASDR itself is responsible for requiring predispute arbitration agreements for employees, and for giving disputants the option of seeking injunctions. It should stay at the plate with its own injunctive option.
d) Remain neutral on arbitrator authority. The NASDR has proposed prohibiting arbitrators from dealing with a court order until after a full hearing (see SR-NASD-00-02, the currently proposed final rule on injunctive relief). This idea should be dropped, as it not only appears to be contrary to law, but would increase dual-track litigation and customer interference. Similarly, the current Arbitration Code’s Section 10335(g) should be examined to ensure neutrality regarding the powers of courts and panels. That section now reads:
“If a court has issued an injunction against one of the parties to an arbitration agreement, unless otherwise specified by the court, any requested arbitration concerning the matter of the injunction shall proceed in an expedited manner according to a time schedule and procedures specified by the arbitration panel appointed under this Code.” (Emphasis added.)
Deference to courts is admirable. However, a body of controlling law under the Federal Arbitration Act appears to give arbitrators wide authority to control the case, despite what courts may otherwise order. (Please see the legal cites in comment letters to the SEC regarding SR-NASD-00-02 from Dana Pescosolido and Thomas Campbell.) Arbitrators’ authority covers procedural issues as well, such as how quickly the matter goes to hearing. The “unless otherwise specified by the court” language in the current code might open a door to a plaintiff firm seeking to put a departing broker out of business. Handcuffing arbitrators only serves to delay justice and increase the incidence of bifurcated and two-track cases.
e) Require full disclosure to public customers of noncompete and nonsolicitation agreements their brokers may be subject to. Customers of brokers who are subject to restrictive covenants should be informed of the implications prior to opening an account, or upon the signing of the contract. Further, when a party gets an injunction, the NASDR should require that a standard NASDR-written letter be sent to all affected customers explaining the dispute, and advising the customer of his right to do business with any firm or broker of his choice, and giving the contact information for his established broker as well as for any newly assigned broker at the enjoining firm. The letter should be neutral in tone. Such a letter would protect public customers, and allow customers to do business with the firm and broker of their choice, and therefore help keep customers out of the line of fire, while at the same time not interfere with the enforcement of employment agreements.
f) The NASDR should convene a committee, with broker and investor representatives, to consider what might be acceptable industry standards for what is considered nonconfidential customer information. At a minimum, the industry could, for example, establish a “name, rank and serial number” policy that allows a departing broker/adviser/planner to use basic customer information, such as names, addresses and phone numbers for purposes of maintaining continuity of service and advice. Such a policy might well go further. For example, should reps and advisers be allowed access to specific investment and personal finance information that was available to them when they served the client at the prior firm? This information could include copies of account statements (as permitted under Wisconsin law and followed by A.G. Edwards), or a financial plan constructed with the help of the client. Indeed, the NASDR should ensure the full portability of all client data (such as financial plans and account documentation). Why should customers be required to redo all their paperwork and plans simply because certain member firms are seeking some cash? A set of rules covering portability of information would ensure fairness and customer protection, as well as enact a standard of consistent behavior within the industry that would serve to decrease disputes and customer account freezes.
g) Address chronic problems that inhibit client mobility: 1) Account-transfer complaints. This category ranked No. 1 at the SEC in both 1999 and 2000, for example. Could the NASDR do more to ensure firms are obeying rules on timely transfer in general? 2) Lack of product portability continues to plague the industry. Is there really any reason why securities such as mutual funds are not fully portable? 3) Critically analyze account-termination fees. Are they justified by economics? Or, are they primarily there to inhibit client mobility? Brokers report that in many cases, their clients are being charged, in the aggregate, significant five-figure sums simply to close accounts.
The NASDR is fully empowered to review these areas and develop policy under the ’34 Act. Further, where appropriate, referring questionable industry practices to the Justice Department for possible antitrust enforcement would have a generally beneficial impact on customer protection.
3. Are there situations where a member should be allowed to take actions to stop a customer from moving his or her account?
3). No. It is difficult to think of any situations where a member firm should be allowed to take actions to stop a customer from moving his or her account.
4. Are there situations beyond those described in the proposed Interpretive Material (i.e., seeking temporary restraining orders as part of an employment dispute) where a member should be prohibited from taking actions to stop, impede, or delay a customer from moving his or her account?
4. Yes. Member firms should not be allowed to retain “nonportable” products. Members firms should not be allowed to charge unreasonable account termination fees. Other situations may occur, and in general the NASDR must comport with the ’34 Act and ensure firms do not refuse to carry out a customer’s instructions to transfer accounts.
5. Are changes needed to the language of the proposed Interpretive Material (see Attachment A to Notice) to make it easier to understand?
5) No changes are needed for clarity.
6. Are changes needed to the language of the proposed Interpretive Material (see Attachment A to Notice) to broaden its applicability?
6. Yes. The proposal should be amended (additions in bold) to read:
“It shall be inconsistent with just and equitable principles of trade for a member or person associated with a member to take any action that, directly or indirectly, interferes with a customer's ability to transfer his or her account, including seeking a judicial order or decree that would bar or restrict the submission, delivery or acceptance of a written request from a customer to transfer his or her account, even where the customer is alleged to have been improperly solicited, or where confidential information has allegedly been used in contacting the customer. Nothing in this interpretation shall affect the operation of Rule 11870.”
7. Are changes needed to the language of the proposed Interpretive Material (see Attachment A to Notice) to narrow its applicability?
7. No. The proposed interpretation should not be narrowed.
However, the language that discusses and explains the proposed language should be narrowed. Specifically, the NASDR should remain silent on employment agreements. This area is a sticky wicket regulators should take care to avoid. Broker employment agreements in use today have detailed language about the confidentiality of client data as well as firm information/trade secrets; the form of and use of that data and information; detailed noncompete language; compliance guarantees and agreements; and agreements regarding leaseholds and a variety of other business and compliance issues. In addition, firms have separate employment agreements for veteran brokers they recruit, and still other contracts for rookies they hire. Different contracts are in use for "house" accounts and accounts generated by the firm's sales leads. Brokers working in teams or retiring may be under yet another type of employment agreement. Further, various “codes of conduct,” employee handbooks and compliance manuals also contain language that is clearly intended to function as an employment agreement.
Within the interpretive material, the NASDR has now given its quasi-official backing for any of these employment agreements and the contractual provisions therein (including provisions that prohibit accepting transfers from solicited customers!). Notice to Members 01-36 reads:
… the proposed Interpretive Material would not restrict the ability of member firms to use employment agreements to prevent former representatives from soliciting firm customers. Similarly, the proposal would not prevent a firm from enforcing employment agreements with former representatives. For example, a member could seek an injunction against a former registered representative and/or his or her new firm to prohibit solicitation of the member's customers if the registered representative had signed an employment contract agreeing not to solicit those customers…. (Emphasis added)
The NASDR must remain strictly neutral here. Therefore, the above language contained in the Notice to Members should specifically be retracted, and a final filing with the SEC should remain silent on employment agreements. Remaining silent or neutral would ensure that those firms using agreements could continue to do so, while avoiding any risk that the NASDR unwittingly sanctions an illegal agreement, or favors the interests of its member firms over the interests of public customers and associated persons.
If need be, the rule filing could include its explanatory language, but rewritten in a more neutral tone. For example, the NASDR might say:
“… the proposed Interpretive Material would not restrict the ability of member firms to use employment agreements. (instead of: to prevent former representatives from soliciting firm customers.) Similarly, the proposal would not prevent a firm from attempting to enforce (instead of: enforcing) employment agreements with former representatives. (instead of: For example, a member could seek an injunction against a former registered representative and/or his or her new firm to prohibit solicitation of the member's customers if the registered representative had signed an employment contract agreeing not to solicit those customers.) The NASDR takes no position on the use of, or enforcement of, employment agreements between member firms and associated persons. The proposed Interpretive Material is limited to restricting a member from interfering with a customer's right to transfer his or her account. (instead of: once the customer has decided to move the account.)”
Regarding the last sentence above, it is unclear why the NASDR needs to say, “ … once the customer has decided to move the account. " If a customer cannot be called by her broker, and if the firm will not tell her where her old broker went (typical practice), and if the firm perhaps tells the client that her rep has a “legal problem” with the firm, the customer may well have no reason to decide to move her account. Inclusion of this language appears to be to the benefit of certain member firms, who have been quite skilled at keeping their customers in the dark. The “once the customer … ” language should be stricken.
The NASDR should be commended for taking comment on this important issue. As it has wisely done in the past, the NASDR should make all comments public. This serves to improve the rulemaking process by ensuring that all communications are exposed to the light of day, and that all parties have an opportunity to impact the NASDR’s rulemaking process.
14341 Spa Dr.
Huntington Beach, CA 92647
Editor's note: To view the NASD proposal, click on http://www.nasdr.com/pdf-text/0136ntm.txt
Even though the comment period expired July 6, 2001, the NASD will still accept your feedback. To comment, go to http://www.nasdr.com.
Commentary: RR Magazine's Editor in Chief Dan Jamieson's Comment Letter to the SEC on the NASDR's Proposed TRO Rule
May 1, 2000
Securities and Exchange Commission
Jonathan Katz, Secretary
450 Fifth St., N.W.
Washington, D.C. 20549-0609
Comment to File No. SR-NASD-00-02, the Injunctive Relief Rule.
Dear Mr. Katz:
Thank you for taking comments on the proposed injunctive relief rule.
As a journalist who covers retail employment practices on Wall Street, I have been following the injunctive relief (or TRO) rule for a number of years. I have no financial stake in the outcome of this controversy.
I must respectfully say that it is disheartening to see this proposal come before the Commission. Never has so much time and effort been spent by the Commission and the NASD to accommodate the wishes of just a few powerful member firms to the disadvantage of other firms, registered representatives ("brokers"), other industry employees and investors.
Section 15A(b)(6) of the ’34 Act directs the SEC to ensure that SRO rules are:
"designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in securities, to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest; and are not designed to permit unfair discrimination between customers, issuers, brokers, or dealers. …"
Section 15A(b)(9) of the Act directs the SEC to ensure that SRO rules:
"do not impose any burden on competition not necessary or appropriate in furtherance of the purposes of this title."
After several rounds of comment letters and years of debate, in July 1998 the NASD filed a rule proposing to amend Rule 10335 (SR- NASD-98-49, the "prior" proposed rule). This prior proposed permanent rule has been withdrawn in favor of the current filing. The prior proposal would have limited court TROs to 10 days and required a full arbitration hearing in 28 days. It was a step in the right direction because it limited what firms could do in court. Limits on court TROs and injunctions are necessary since these orders can prohibit brokers from making a living and from advising their customers, and often freeze customer accounts as well (see below). All of these results can easily violate the intentions of Sections 15A(b)(6) and 15A(b) (9) of the ’34 Act.
Because the proposed rule eliminates any real limits on how TROs and injunctions are used—to the benefit of a few major brokerages that bring the majority of these suits--the proposed rule is unfairly discriminatory, fosters acrimony instead of cooperation and coordination, impedes an open market, erodes investor protection, and is an undue burden on competition.
Injunctive requests are done for purely economic reasons. These cookie-cutter suits are cheap to bring and are quite effective in leveraging a settlement from the recruiting firm. Settlements are typically 20% or so of a broker’s trailing 12 months production--$100,000 for a $500,000 producer, for example. Suing brokers is therefore highly profitable.
By more closely regulating injunctions, the prior proposed rule would have devalued the worth of TROs/injunctions. Firms that use the broker-suing strategy did not want to see the value of the TRO strategy eroded. As the Commission well knows, Merrill Lynch and American Express Financial Advisors (AEFA) made past-due, 11th hour comments to the Commission regarding the prior proposed rule. The NASDR claimed it felt compelled to consider these comments, since the SEC had accepted them. The NASDR could have dismissed these firms’ concerns or amended the prior proposed final rule in response. Instead, it set up a subcommittee of its arbitration committee to hatch up a new plan behind closed doors. Hence, the prior rule proposal, tediously crafted over several years, has been blown up by political maneuvering. Adding further insult to the interests of both brokers and public customers, the Commission has seen fit to publish this new rule with a stingy 21 days set aside for comments.
The new proposal essentially wipes away any regulation of TROs/injunctions. While this is no doubt the desired goal of a few powerful brokerage firms, such an industry practice should be strictly regulated because unchecked, it can very easily violate industry and federal standards for just and equitable dealings.
Why the Proposal Should Be Rejected
Specifically, here is why the proposal should be rejected:
The Proposal Would Violate Sections 15A(b)(6) and 15A(b)(9) of the ’34 Act.
As noted, the Act requires rules that are fair and non-discriminatory, not a burden on competition, that foster cooperation and coordination, facilitate transactions, remove impediments, and protect customers and the public interest. The proposed rule violates each of these principles.
Additionally, the process by which the rule was drafted was unfair and violated the SEC’s 1996 remedial sanctions order against the NASD.
TROs serve only to inhibit broker and client mobility and extract settlements from competing firms. The proposal would continue, and probably increase, the roughshod treatment of clients and their accounts. In what seems to be a growing number of instances, clients are being handcuffed along with their brokers. They have been prohibited by courts from transferring their accounts, from making transactions with their established broker, and from getting financial advice from a trusted source—the broker they know and trust, the very same broker who knows the customer. Holding up transfers is a violation of NASD Uniform Practice Rule 11870 and NYSE Rule 412. Preventing transfers and forbidding communication harms the facilitation of transactions. Interfering with clients’ communication with the firm and broker of their choice is against the public interest. Indeed, many courts have stated that investors’ rights should be of foremost concern in these disputes.
Because TROs and injunctions prohibit a broker from making a living for a period of time, because stalling tactics are often used, and because of the heavy burden of defending oneself simultaneously in both arbitration and court, this legal practice can be an undue burden on competition. Therefore, a very limited time frame for court-ordered injunctions/TROs is called for.
But this proposal will do nothing to expedite an arbitration. While it provides for a hearing in 15 days, arbitrators are also specifically banned from expediting resolution of the court conflict. They can only request that parties seek to take action, and even then, only "after a full and fair presentation of evidence from all relevant parties. …" Thus the proposal appears designed to give plaintiffs no limits on the games they play in court. It is this gamesmanship that inspired rulemaking in the first place. By having no limits, and even handcuffing panels, this proposal would be discriminatory and an undue burden on competition. It would lead to less cooperation and coordination, harm facilitation of transactions, and be against the public interest.
Furthermore, the ability of a broker to change employers and maintain contact with customers is crucial for investor protection. Contrary to the apparent bias of some regulators who understandably become jaded by dealing with the dregs of brokerage society, most brokers are actually the "good guys." Typically, they will speak out against practices they deem contrary to their clients’ (and therefore their own) interests. When there is a case of wrongdoing at a firm, an RR must be absolutely free to leave. The rep must be free to maintain contact with clients. And they must be free to blow a whistle or give evidence without the threat of undue legal action. As A.G. Edwards CEO Ben Edwards has said, broker mobility keeps managements honest. Mobility is a key element of investor protection. But the proposed rule would weaken broker and client mobility and erode the main goal of the ’34 Act-- investor protection.
The proposal is also discriminatory against member firms. By the end of Oct. ’97, the NASDR’s comment period for NTM 97-59 had produced 17 letters--14 of those letters recommended eliminating the court option for TROs. Many of those negative commentators were member firms. This proposal is a complete turnaround from the prior proposed final rule that generally balanced all comments received by the NASDR. But this proposal eliminates the NASDR injunctive option and requires that TROs come from courts. Acting on the behest of a small minority of influential members is against the Act.
NASDR staff should be commended for disclosing something about how the NASDR political process works:
"In response to additional formal and informal comments received after the amendments and responses to comments were filed, the Injunctive Relief Rule Subcommittee of NASD Regulation's Inc's National Arbitration and Mediation Committee (``NAMC'') undertook to reconsider every aspect of the proposed rule change. In addition to its NAMC members, the Subcommittee included representatives from member firms that has [sic] expressed an interest in the rule, including all of the retail firms that commented negatively on the prior rule filing." (Emphasis added.)
Merrill Lynch and AEFA were firms that commented negatively. They had access to backdoor, "informal" channels to force reconsideration of every aspect of the prior proposal that they did not like. To accommodate these firms, the NASDR created the new subcommittee, the members of which remain secret. The subcommittee then drafted this current proposal. As the NASDR admits, all member firms opposing the prior draft rule had representatives and input into the rulemaking process; brokers and investors had none. The process was inarguably discriminatory under the Act, and a violation of the remedial sanctions order (see below).
A comparison of the prior proposed final rule and this one shows the result of the unfair process. Certain favored member firms got what they wanted, while the rest of the industry, employees and investors will be further disadvantaged. Instead of a 10-day limit on TROs, we now get no effective limit. In fact, the rule would add an explicit NASDR policy that allows court orders to stay in effect during the entire run of an NASDR arbitration hearing—a dangerous attempt by the NASD to supersede existing case law. The filing says: "NASD Regulation does not believe that arbitration panels have the authority to dissolve, modify or supersede a court order." Only "after a full and fair presentation of evidence from all relevant parties" are panelists allowed to seek action from parties related to court orders (emphasis added). Although not entirely clear, the language appears to say that arbitrators cannot do anything about a court order until a full hearing concludes. Even then, they can only ask the parties to take action. Full hearings often take many months. Seeking and appealing TRO and injunctive rulings itself can take many months. Therefore, the rule will be valuable ammunition for plaintiffs who seek to create lengthy bifurcated proceedings. While a respondent would get an arbitration hearing within 15 days under the proposal, instead of in 28 days under the prior proposal, this is hardly a worthwhile concession. Plaintiffs would be given a green light to stay in court for the duration of a hearing. The result will be more two-track litigation, discriminatory treatment of brokers and clients, more burdens on competition, less cooperation and coordination, restrictions and impediments on transactions, and a general disregard for the public interest.
Instead of using existing practice to pick a panel, this proposal creates a new and complicated procedure for picking arbitrators who specialize in injunctive relief. These so-called specialists, if there is such a thing, will tend to be either public members or industry members aligned to member firms, further disadvantaging brokers and customers. Public panelists are more likely to rule based on narrow legal readings of contracts. Industry panelists who specialize in injunctive relief would most commonly be lawyers at member firms or at law firms that work for member firms. The injunctive defense bar, in contrast, is more limited in numbers and probably less likely to serve as arbitrators. The result will be a pool of arbitrators primarily made up of public and firm-aligned panelists. These panels will tend to focus on legal technicalities or the rights of firms. This will be discriminatory against brokers and customers. Ideally, these cases should be heard by neutral industry panelists whose industry savvy and common sense are more likely to result in decisions comporting to accepted industry practice, SRO rules and federal securities law. TROing firms understand that non-lawyer industry panelists are generally more likely to allow brokers the freedom to work, and clients the right to choose their advisers, with a minimum of restrictions. Tilting the panelist pool toward public and firm-aligned attorneys is discriminatory.
As the Commission has noted, the proposed rule would restrict arbitrators’ abilities to allocate costs. The proposal would force brokers suffering falling incomes due to gag orders and account freezes--as well as mounting legal bills--to split the costs of an expensively produced injunctive panel as well as certain costs for the full hearing. Restrictions on arbitrators’ powers should never be approved by the Commission. Any such action will give potent ammunition to legal challenges to industry arbitration and decrease confidence in the fairness of NASDR-run forums. If the fee-splitting language is left in, it will also provoke further litigation as brokers will be forced to seek recovery in court for wrongful injunctions since panelists will be limited in their ability to fix any inequity. The fee-splitting language is discriminatory and an undue burden on competition.
In addition, the process by which this proposal was drafted violated the 1996 remedial sanctions order. Under the SEC’s order, the NASD was directed to make rules "with any consultations with interested NASD constituencies made in a fair and evenhanded manner." The NASD later made representations to the SEC that all constituencies would have input at the early stages of any rulemaking process. The process by which this proposal was drafted obviously involved consultations with some interested constituencies. But it excluded consultations with TRO defense attorneys, registered representatives, other industry employees who may sign restrictive covenants, and investors--all of whom are affected by injunctions more profoundly than any member firm. The exclusion of key constituencies, together with the secrecy under which the rule was drafted, is a clear violation of the remedial sanctions order and is discriminatory under the Act.
Further discrimination occurred when this proposal was put out for comment with a meager 21-day comment period. The Commission must give employee and investor interests at least a fighting chance to impact rulemaking. Surely the Commission understands that industry employees and investors do not have high-powered lobbying efforts. If anything, the Commission should error on the side of ensuring that these interests are over-represented. It is not too much to ask that non-member firm constituencies be given an opportunity to digest and critique this proposal--a backroom deal hatched with unusual speed that may have ignored prior debate and input. Ninety days for comments is a bare minimum. Anything shorter would be discriminatory treatment. Had employees and expert TRO defense attorneys been involved, a more balanced rule would have been likely, or the prior proposed rule would have been preserved, and a 21-day comment period may then have been appropriate. Unfortunately, that was not the case.
The investing public and brokers were further disadvantaged because the proposal was not publicized on either the SEC’s or NASDR’s websites. The NASDR and Commission know well that the TRO process has generated much debate, controversy, press coverage and legal seminars on raiding. That both the NASDR and SEC omitted to publicize this entirely new proposal born from a confidential drafting process almost defies innocent explanation. Upon reflection, a fair-minded Commission must publicize the proposal and lengthen the comment period. To do otherwise would discriminate against industry employees as well as investors. Three months for comment does not seem unreasonable for a proposal many years in the making that can have grave effects on both brokers and customers.
Injunctive relief has been described in this proposal and past proposals as an effort to deal with "raiding" cases. This is a misuse of the word "raiding." As used in the industry at least, a "raid" involves the capture of many employees or key managers from a competitor. Somehow, for purposes of proposed NASDR injunctive relief rules, defections of lone brokers have been tarred with the negative "raid" moniker, prejudicing brokers in this rulemaking process. This is discriminatory.
For the above reasons, the proposal would violate the Act’s requirement that rules be fair and non-discriminatory, not a burden on competition, that they foster cooperation and coordination, facilitate transactions, remove impediments and in general protect customers and the public interest.
Additionally, the process by which the rule was drafted was unfair and in violation of specific NASDR procedures.
The NASDR Offers No Substantiation for the Proposal.
The proposal is incomplete and cannot be approved as a result.
The Commission has granted a number of delays of a permanent rule in order to allow the NASDR to gather more data about the current pilot program. Four delays have been granted by the agency based on this reasoning.
But where is this data? The NASDR’s proposal is completely lacking in any factual information about injunctive cases. Such data does exist. Under the current pilot, not only must firms file for arbitration when they seek a court order, they must also immediately report to the NASDR when they get a court order.
Why has the NASDR neglected to include updated data in this proposal? It is likely that certain member firms put pressure on the NASDR to refrain from disclosing such data. Disclosure of some 1996 data made clear that nearly all (96%) of theses cases settle. It became transparent that TROs and injunctions are used to extort a settlement from the recruiting firm, rather than preserve legitimate business interests from the "irreparable harm" of losing an employee. The 1996 NASDR data also made clear that industry-savvy arbitrators would not rubber-stamp injunctive requests.
Aside from lack of basic data needed by the Commission to make an informed and fair policy decision, the NASDR offers up no detailed analysis of any problems with the current pilot or with the prior proposed permanent rule. The current proposal says only that:
"users of the rule have complained that the bifurcated procedures and multiple layers of review provided by the current pilot rule are unnecessarily complex and confusing. The principal objectives of the proposed amendments are to simplify and expedite the procedures for seeking immediate injunctive relief in intra-industry disputes and to fairly and effectively integrate court-ordered initial injunctive relief with the arbitration of the underlying claims in the same disputes."
The current pilot rule that has been in effect since 1996 does little more than to require the simultaneous filing of an arbitration claim when an injunction is sought. What is complex and confusing about it? How many cases have become bifurcated? How many cases went to hearings with a court order still in effect during a hearing? What exactly is the "multiple layers of review" problem? How much time was spent resolving these disputes? What have been the delays that justify an entirely new proposal? The NASDR provides no clue. These are all questions the Commission must get answers to before acting on this proposal.
Recall, too, that the prior proposed final rule was drafted to end the bifurcation problems (with a 10-day TRO limit) and speed up resolution (with a full hearing in 28 days). But that rule was never implemented. Was it too complex? Why would the prior proposal not have solved the bifurcation problem and expedited the injunctive process? Why will this new proposal, whereby all injunctive cases go to court, help alleviate the bifurcation problem? Why will this new proposal, which explicitly forbids arbitrators from impacting a court order, help solve problems of bifurcation and delay?
Being remiss in demanding any kind of substantiation for this new proposal would be a gross failure on the part of the Commission to follow through on its basic oversight duties. The SEC must either reject the current proposal outright, or send it back to the NASDR for proper substantiation. Upon accepting any new proposal, the Commission must then make more than a cursory attempt at critiquing the proposal and directing comment.
The Proposal Would Constitute Illegal Rulemaking by the NASDR and the SEC.
As noted above, the proposal would eliminate any authority over court orders that arbitrators now enjoy under controlling law. The proposal says that panelists can only order the parties to take action regarding an order after a hearing is complete.
But according to Thomas Campbell, who apparently defends more of these cases than anyone, "Under controlling federal law, which would be superseded by the proposed rule, the courts may not enter preliminary injunctions or TROs that last beyond the commencement of hearings on the interim injunctive relief claim." Campbell further says, "there is no confusion as to the power of the arbitrators and the courts. The courts may not encroach on the arbitrators’ jurisdiction or authority."
Neither the NASDR nor the SEC have the authority to override controlling law. Nor should they be weighing in on developing law in this area, other than to support arbitration in general. Any final injunctive relief rule must remain absolutely neutral as to arbitrators’ powers over court orders. To do otherwise puts the Commission in the role of a final judge on this issue.
Recommendations for a New Rule
The following steps should be part of the process and the content of any revised injunctive relief rule:
--The NASDR should be encouraged to submit the prior proposed final rule for approval. Alternatively, NASDR staff and executives should be sent back to the drawing board to redraft a new proposal. This time, a truly balanced sample of representatives should be included on any committee charged with formulating a rule. TRO defense attorneys should be included, as well as brokers and customers. The process should be public, and open debate encouraged.
--Consideration should be given to retaining the NASDR injunctive process and to other alternatives for panel formation. While parties may have legitimate needs for court injunctions in unique situations, the NASDR injunctive process may be best for purely contractual disputes, and for disputes where the main claim is contractual but where various torts may be asserted as a pretext for getting into court. The NASDR should consider other ideas on panel formation, such as a three-person industry panel that would have a current or former broker, branch manager and securities attorney, or a specialized pool of single arbitrators who hear injunctive relief cases. These single panelists need not be public members or "injunctive specialists." Panelists could easily become familiar with these cases’ almost identical facts and circumstances, which would help ensure fairness and consistency. Another option is that the party being enjoined should have the option of an all-industry panel to hear the case. Such an option would make NASDR arbitration code consistent with NYSE procedure, and ensure equitable treatment of these contractual disputes. If the NASDR retains an injunctive option, all NASDR injunctive decisions should be made public regardless of ultimate disposition.
--The right to go to court can be maintained, but with strict limits. The prior proposal’s 10-day limit on TROs should be retained. Some type of arbitration should occur within the 10 days. Courts could well ignore this rule, but at least an NASDR/SEC policy on getting these disputes to arbitration in 10 days ensures that brokers and customers get a bit of bargaining power, while ensuring firms can protect legitimate business interests.
--NASDR must remain neutral on arbitrator authority. Eliminating powers arbitrators might otherwise have is unfair. Any final rule must be neutral on panels’ powers over court orders or allocations of costs. The current Code’s Section 10335(g) should be amended to maintain neutrality regarding the powers of courts and panels.
--Under no circumstances should a member firm be able to enjoin or seek to enjoin or inhibit customers, the transfer of their accounts, or customers’ contact and communication with a broker of their choice. A rule must be developed to ensure protection of investors’ rights in this area.
--Require full disclosure. Customers of brokers who are subject to a restrictive covenant should be informed of the implications. Further, when a firm gets an injunction, the NASDR should require that a standard NASDR-written letter be sent to all affected customers explaining the dispute, and advising the customer of his right to do business with any firm or broker of his choice, and giving the contact information for his established broker as well as for any newly assigned broker at the enjoining firm. The letter should make clear which party is responsible for the gag order and/or account freeze.
--The NASDR should convene a committee, with broker and investor representatives, to study whether restrictive covenants for retail brokers are a violation of the securities acts and SRO rules. The committee should consider what might be acceptable industry standards for "confidentiality" of customer information such as names, phone numbers and addresses, and to what extent if any the duties of a broker to a client can be interfered with. The practices of firms that sue defecting employees may conflict with law and procedure in several states. For example, under California law stockbrokers are considered fiduciaries, bringing into question any restrictive covenant that would prohibit communication with clients. In Wisconsin, departing registered representatives are allowed to copy records of the customers they personally served.
The proposed Rule is defective and must be rejected by the Commission or sent back to the NASDR. It fails to regulate TROs and injunctions and as such would violate Sections 15A(b)(6) and 15A(b)(9) of the ’34 Act.
Any final rule should strictly regulate injunctions and TROs, and maintain neutrality in allowing arbitrators to handle court orders and cost allocations as they deem appropriate and legal. A reasonable compromise may have been achieved with the prior proposed rule, subject of course to public comment and Commission consideration of those comments. Several simple, but key elements should be a part of any final injunctive rule.
Editor's note: For any comments regarding this article, or to suggest a story idea for RRDaily or Registered Representative Magazine, contact Editor in Chief Dan Jamieson at [email protected].