WHEN YOU DECAMP one brokerage for another, your firm can say anything it wants about you on your Form U5 even if it's a lie, even if it's defamatory, just to punish you.

WHEN YOU DECAMP one brokerage for another, your firm can say anything it wants about you on your Form U5 — even if it's a lie, even if it's defamatory, just to punish you. You may be able to clear your permanent record (which is essentially what a U5 is) after spending months and tens of thousands of dollars running the legal gauntlet. But you won't be eligible to receive monetary damages — no matter how blatant and damaging the defamation.

That's because, on March 29, the New York Court of Appeals in Albany issued a decision giving broker/dealers “absolute privilege” over statements issued on U5s posted on the Central Registration Depository at the NASD. In short, b/ds have been granted immunity against monetary damages in U5 language. By granting immunity, the logic goes, the brokerages will be better able to protect the investing public; management won't have to hold back for fear of being sued for defamation. Obviously, the ruling is potentially devastating to registered reps, whose reputations and livelihoods are dependent upon the information contained on the U5 forms. Remember: The CRD system is available online to the investing public — your clients and potential clients — so they can “check” you out, examine your employment history to make sure you are “clean.” Recruiters use it, too, since most big brokerages take a pass on reps with more than one complaint on a U5.

It's true that the Rosenberg ruling, as it is known, applies only in New York State, but then New York City happens to be the financial capital of the world, making it the “most important jurisdiction,” says David Wechsler, who represents individual reps as a lawyer with New York's Wechsler & Cohen. Although the NASD doesn't keep data, many arbitration proceedings take place in New York. And you can bet that b/d lawyers in other states fighting defamation arbitrations will be brandishing the New York State Court of Appeals' logic.

To plaintiffs' attorneys, the ruling is best described as, “Shocking,” says Wechsler. “Even the vast majority of my adversaries were surprised by the Rosenberg decision and thought it was decided erroneously.”

Not that taking on b/ds was a walk in the park before this ruling. Plaintiffs' lawyers who represent reps in arbitrations aimed at cleaning up a rep's U5, known as “expungement” proceedings, have complained for many years that most reps don't have the resources — they say the legal fees for the proceeding cost $50,000, at a minimum, and can last months. That said, it has often been worth it. In the past, arbitration panels frequently ruled in favor of the rep in defamation cases, and sometimes awarded monetary judgments against firms who had defamed departing brokers to compensate them for their losses. Sometimes they even doled out punitive damages.

The Case

Now, in the wake of the New York Court of Appeals case — Rosenberg v. MetLife Inc. — the calculus has changed. Should a rep roll the dice to clean his record? If he wins, there will be no possibility of getting monetary damages for harm to reputation, loss of income or pain and suffering based on a defamation on a U5, lawyers say.

Bad cases sometimes make for bad law, and plaintiffs' lawyers contend that the rather unique facts of the Rosenberg case led to a devastating decision. Quite simply, lawyers who represent brokers say that this was not the best case for the industry to win absolute privilege status. Chaskie Rosenberg was not the typical high-producing broker, who, in jumping from one Wall Street house to another, got whacked on his U5 by a vindictive boss. Rosenberg was hired by MetLife as part of a short-lived, ill-fated attempt to market life insurance to the Hasidic Jewish community in Brooklyn. His practices, including letting clients pay for their premiums through the Gamesh, the free-loan society that is part of the Hasidic faith, eventually triggered an internal investigation and led to his firing in 2003. His U5 states that, at the time of his firing, Rosenberg “appeared to have violated company policies and procedures involving speculative insurance sales and possible accessory to money-laundering violations.”

So, Rosenberg now is tagged as being a potential money launderer, an accusation that could blackball the average rep. (Rosenberg did get another job, though.) Who could blame him — a man who no one thinks is actually a money launderer — for trying to expunge that mark? Still, observers say that Rosenberg's orthodox religious customs do, in this one instance at least, seem to rather neatly contradict modern financial services regulations; one can understand why MetLife filed the U5 that it filed in 2003. The irony is, by pressing so persistently to clear his name, Rosenberg has nearly ruined, however inadvertently, the process of expungement for every rep on Wall Street.

It's A Privilege

Until the Rosenberg case, most every court in the country that had examined the U5 issue had said that a “qualified privilege” is sufficient to balance the interests of protecting the investing public with the potential harm to a rep's reputation and livelihood. With a qualified privilege, b/ds could still ding someone in an effort to protect the public. They had some protection against frivolous defamation suits, because to win a defamation decision (and any potential monetary award), reps had to prove the firm acted with actual malice. Not surprisingly, the industry lobby, the Securities Industry and Financial Markets Association (SIFMA), prefers an absolute privilege and filed an amicus curiae brief urging the New York judges to find for an absolute privilege.

Wechsler, the plaintiffs' lawyer, sees a potentially corrosive impact: “It emboldens employers to stretch the truth or provide false information or misleading innuendo on form U5s, believing that, while they may be held accountable in terms of expungement, they will not have any financial liability for the damages that they cause,” he says. “It's a license to lie.”

Firms argue that they would never allow U5s to be used in personal vendettas by, say, angry branch managers against departing rainmakers, but b/d counsels do see the beauty in the ruling. Adam Safer of New York's Miller & Drubel, who defends broker/dealers in expungement actions, is planning to file a renewed motion to dismiss a defamation case now pending before an arbitration panel in New York, based on the decision in the Rosenberg case. “There's no basis for a defamation claim on a U5 anymore, so those cases ought to be dismissed,” he says. Safer expects that others in the defense bar will be bringing similar motions.

Past Success In Defamation Cases

The March 29 Rosenberg ruling came just days after a federal court in New York upheld a $14 million arbitration award, a huge win for Wechsler and his three former Merrill Lynch clients. The sum includes: $12.5 million for loss of income and pain and suffering resulting from what the NYSE arbitrators determined to be a defamatory remark placed on the U5 forms of three former Merrill financial consultants. The panel also ordered Merrill to amend the U5s of these reps to state that they were fired “not for cause.” The arbitration panel, in this instance, gave no explanation for its award and is not required to do so under the NYSE's rules.

The three brokers were fired in October 2003 for allegedly engaging in illegal market timing of mutual funds, a scandal stoked by the aggressive enforcement of then-New York Attorney General Eliot Spitzer. Merrill sought to “vacate” the arbitrators' award with the federal trial court in New York. In its motion, Merrill made a host of arguments. For one, Merrill claimed that the three brokers were “libel-proof,” a doctrine in the law that applies to those who have such bad records that their reputations could not possibly be tarnished by any false allegations that Merrill placed on their U5 forms. In her March 23 decision, U.S. District Judge Loretta Preska rejected that contention out of hand, relegating it to a footnote in a ruling that goes on for 53 pages.

From the start of the court proceeding, Merrill also pressed the argument that statements placed on U5s were “absolutely privileged.” The Merrill brokers came from New Jersey, where a qualified privilege applies, but Merrill still tried to argue that the law of New York should apply, and that that law should give them absolute privilege. But Merrill withdrew that claim last August, when the Second U.S. Circuit Court of Appeals, the federal appeals court in Manhattan, made it clear that the law in New York was not settled, calling it an “important question,” because an absolute privilege would “leave former employees without a remedy in tort for even the most egregious and abusive statements made by former employers.” The Second Circuit then sent the case to the appeals judges in Albany to decide the matter once and for all. That led Merrill to withdraw any claim that the absolute privilege applied to the market-timing allegations on the U5s of the three New Jersey brokers.

Motions to vacate arbitration awards are rarely, if ever, granted, and the Merrill market-timing case was no exception. On March 23, Judge Preska rejected all of Merrill's claims that it should not have to turn $14 million to the three brokers. She wrote: “An arbitration award may be vacated only if procured by corruption or fraud, if the arbitrators exhibited evident partiality, were guilty of misconduct or exceeded their power.” Preska found none of those problems.

Merrill chose not to appeal Judge Preska's decision denying its bid to vacate the award, and paid the brokers on April 19.

Jurisdiction Arguments

So, where do these two court cases leave registered reps? Well, if you are not in New York, be thankful. But, on the other hand, given that New York is the hub of financial activity, many New York-based firms will try to drag their far-flung arb cases to New York (as Merrill tried to do with its New Jersey reps). In fact, many arbitration hearings are conducted in New York. From now on, if a broker lives in, say, New Jersey and works in New York, he will fight to argue that New Jersey law ought to apply to the case. Arguments of this kind are called “conflicts of law.” And it is a fair bet that conflicts of law arguments are going to become a lot more heated in these arbitration proceedings, as brokers try to get out from under the Rosenberg ruling.

Jeffrey Liddle, who filed a friend-of-the-court brief on behalf of Chaskie Rosenberg, is absolutely apoplectic over the ruling. Liddle, who is a veteran expungement lawyer, says using U5s in vendettas is in fact a regular occurrence. In his friend-of-the-court brief, Liddle offered a list of such cases: Liddle found that for NASD proceedings from 2000 to the present, there were 157 cases in which reps' U5s were amended to reflect corrections of false statements. In the NYSE from 1989 until the present, there were 53 such cases. Much of what he said when called for comment were deemed unprintable owing to libel concerns, though they are his own opinions on the merits of the case. He vented at length about the judges who sit on the New York Court of Appeals, which sits in Albany. “The seven dwarfs up there in Albany seem to be extremely naïve on the issue of how these things get on these forms,” Liddle says.

Consider the experiences of Smith Barney rep Mitchell Slater, who was a big producer at Merrill Lynch for 17 years. After an altercation with a new manager, Slater, according to his lawyer Brian Neville, made the painful decision to leave Merrill Lynch for Smith Barney. Merrill marked his U5, claiming that a customer had initiated a complaint alleging that Slater had churned his account. The U5 also made reference to an internal review that Merrill had conducted, making Slater appear to have churned his clients accounts without written authorization. The firm also noted on his U5 the “possible mismarking of order tickets as unsolicited.” At the time, Slater was angling to score a new job at Smith Barney. Not surprisingly, Slater fought back to clear his name by bringing an arbitration proceeding before the NASD — and won.

The NASD arbitrators, like their colleagues in the NYSE system, are not required to explain their rulings. But the NASD, at the urging of lobbyists for customers and brokers who face off against Wall Street, has proposed a rule that would give brokers or customers the option of requesting an explanation of decisions in arbitration. Legions of lobbyists from Wall Street firms have opposed this change with vigor. The rule would allow this option only for the “plaintiffs,” meaning the aggrieved customer or broker, and that, firms claim, is “one-sided” and “unfair.”

The three-person arbitration panel that heard Slater's case chose, on its own, to write a decision expunging the mark on his U5. In it, they concluded that there had been “no customer-initiated complaint,” as Merrill Lynch had alleged, and ordered Slater's U5 to be amended to delete all references to the internal review because, as the panel stated, “said internal review was initiated for competitive purposes.” Merrill, in a written statement commenting on the ruling, noted, “During the hearing, one of Mr. Slater's clients testified that he, the client, had come to our offices with his accountant and complained to Merrill Lynch that Mr. Slater had mishandled his account. While the panel ordered the U5 changed, it also refused to award Mr. Slater damages.” (An interesting statement, considering it contradicts the panel's findings.)

Slater didn't win damages, but Neville attributes that fact to the defense lawyers, who proved, quite successfully, that Slater got a cool, six-figure sign-on deal from Smith Barney, so Slater's business could hardly be considered “damaged.” (And the defamation by Merrill didn't apparently hurt Slater's media bookings; he continued to be a sometime guest on cable channels to hold forth on trading and personal finance.)

The cost for Slater to clear his name? The forum fees alone, meaning the mere cost for the hours that the three arbitrators spent vetting his case, were $13,000. In many cases, the dueling sides split the cost of such fees. In Slater's case, the arbitrators issued a bill to Merrill for the entire tab. In total, Neville says his client spent more than $100,000 and one-and-a-half years on the expungement process.

Which begs the question, Why bother? If you're Slater, you've got a new job, you're doing well, why take on the hassle, since there really wasn't any practical harm done to him by the U5? Why did he pursue the remedy of expungment? To hear Neville, Slater's lawyer, tell it, the reason was quite simple: His kids could Google him and find their father's U5. “And it reads rather horribly,” Neville adds.

But what of the investing public — the public that, after all, was at the heart of the New York Court of Appeals' decision to grant the broker/dealer community “absolute immunity” for the statements they make on U5 forms? Their protection, after all, is at the root of the CRD system.

When contacted for comment about the Rosenberg case, the NASD was quick to point out that the agency had nothing to do with his saga. He chose to air his grievance, not before a three-person panel at the NASD, but with a federal jury. He was entitled to do that because Rosenberg claimed his civil rights in the practice of his Hassidic faith had been violated, a claim that, even in the rules that now force arbitration of most disputes in the b/d world, he was entitled to air before a jury of his peers at trial. The jury found against him. And he appealed, leading, eventually, to the ire of Liddle and the confusion of others.

Striking A Balance

For its part, the NASD recognizes that the U5s that form the backbone of the CRD system result in an imperfect balancing act. And in the NASD's view, expungement is “extraordinary relief that should be granted only in limited circumstances,” as spelled out in one key “Notice to Members.” Since 1999, in cases where the allegation on the U5 involves a customer dispute, the NASD has required a rep to go to court to “confirm” an arbitrators ruling before the U5 can actually be amended to take out the defamatory language. That adds an extra layer of cost for the broker. The reforms came to a boil in 2001, when the NASD ordered arbitrators to make three findings before a rep could prevail in an expungment case. (The information is false, that it is without legal merit and that it is defamatory. )

The NASD regulators find an irony in the age-old complaints raised by reps and their lawyers. The enforcement division, which vets the U5s for possible investigations, believes that broker/dealers, in some cases, have been hedging their bets when deciding to ding a rep's U5, fearing reprisals from reps seeking damages for defamation in arbitration proceedings. Emily Gordy, deputy director of enforcement at the NASD, says the issue is on the agency's radar screen, and acknowledges an “inherent tension” between the NASD's mission to protect the investing public and the rights of reps to protect their names.

When Rosenberg's case came before the New York judges, several of the judges on the panel, sitting questioned the lawyers for both sides about the process of expungement. “You can't simply write a letter to the NASD? ” asked Judge Eugene Pigott. He wrote a dissenting decision in the Rosenberg case. “The majority focuses on the fact that accurate and forthright responses on the Form U5 are critical to the securities industry,” he wrote. But he also pointed out that these forms can be used to “blackball former employees.” He concluded that a qualified privilege — which would require the rep to show that false statements were made by the b/d with malice, a very heavy burden for any person pursuing defamation damages — would be the appropriate balance.

The current standard makes it difficult to correct small, honest mistakes, such as an address or time of employment — without going through arbitration, says Michael Fortunato, a New Jersey lawyer who frequently defends Merrill Lynch against expungement cases.“They simply prohibit a firm from saying that a mistake was made and we need to change the language,” Fortunato said. “I don't see how current rules protect the public when you are merely trying to correct mistakes.”

Fortunato said the NASD rules should be changed to account for that kind of error. But otherwise, he thinks that most firms don't make a practice of using the U5 for strictly anti-competitive purposes. “In my 25 years practicing in this area, I don't think that's common,” he says. Rosenberg, who declined to discuss his case or be photographed, indicated that he has decided to move on, to put this four-year saga behind him. For other reps, the nightmare may only just be beginning.

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