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Tied Tight

When brokers change firms, they can get sued. The losing dealers sometimes go to court seeking a temporary restraining order (TRO). This "injunctive relief" prohibits a rep from contacting customers and prevents customers from transferring accounts.Attorneys on both sides of these disputes acknowledge that it is simply a legal tactic to leverage a settlement from the recruiting firm. In the meantime,

When brokers change firms, they can get sued. The losing dealers sometimes go to court seeking a temporary restraining order (TRO). This "injunctive relief" prohibits a rep from contacting customers and prevents customers from transferring accounts.

Attorneys on both sides of these disputes acknowledge that it is simply a legal tactic to leverage a settlement from the recruiting firm. In the meantime, the process can tie up both customers and brokers.

That's why the NASDR has attempted to put limits on court-ordered TROs. The goal is to get the cases out of court and quickly before arbitration panels familiar with industry practice. After five years of debate, including a formal comment process, the NASDR was set to go with a rule at the beginning of 1999 that would have restricted how TROs could be used.

But then Merrill Lynch and American Express Financial Advisors (AEFA) stepped in. The firms made last-minute objections and the rule was derailed.

"That rule was too broker-friendly and Merrill went nuts," says a brokerage firm official who requests anonymity. Merrill pushed the NASDR to delay the rule, he says, and succeeded.

AEFA deserves some credit as well. In a Dec. 3, 1998, response to the SEC, the NASDR said no delay was necessary. Yet two weeks later,NASD chief Frank Zarb wrote to David Hubers, AEFA CEO, telling Hubers the rule had been delayed. Hubers wrote back and expressed appreciation to Zarb and his staff for hearing the firm's concerns. Delaying the rule would "allow time for further discussion," Hubers said.

By the following month, the NASDR had a new subcommittee set up to reconsider the rule. The subcommittee scrapped the old proposal and released an entirely new rule in April 2000.

The new proposal eliminates the option of getting injunctions via an NASDR arbitrator, and sets few, if any, limits on court-ordered TROs. Attorneys who defend reps say it's a step backward.

And little wonder. As the new rule filing says, "all of the retail firms that had commented negatively on the prior rule filing" had representatives on the subcommittee, including both Merrill and AEFA.

Is it another case of the NASDR being unduly influenced by powerful members?

"I would deny that emphatically," says Linda Fienberg, the NASDR's executive vice president for dispute resolution. "We had what we believe to be a fully balanced subcommittee. ... We do not believe that this has been unduly influenced by anybody, and I take strong objection to that characterization. It's not the kind of forum I run, and those are not the kind of rule proposals that I submit."

Fienberg refuses to name the members of the subcommittee, but RR has learned that in addition to a representative from Merrill, the subcommittee included Gerald Rath, a Boston attorney who confirmed that he was the committee's chair; Gary Irwin, vice president and group counsel at AEFA, who confirmed his participation; New York attorney Roger Dietz, who refused to confirm or deny his participation; and representatives from A.G. Edwards, Salomon Smith Barney and PaineWebber, all of whom refused comment.

(A.G. Edwards has consistently opposed TROs. SSB's and PaineWebber's positions are unknown.)

Not a Pretty Picture The outcome isn't pretty for brokers. With the end of the NASDR injunctive option, brokers can no longer argue that if a firm wants a TRO, it can seek one from an arbitrator--an argument that's sometimes been successful in keeping these cases out of court and before arbitrators, where brokers tend to be more successful.

Though never in effect, the prior proposed rule prohibited firms from returning to court to seek an extension of a TRO. Instead, any extension had to come from an NASDR arbitrator. The earlier rule proposal also prohibited seeking evidence (discovery) through a court. But the new proposal is silent on these issues. Both of the earlier limitations were seen as favorable to brokers.

The prior proposal required a full arbitration hearing to begin within 28 days. Under the new proposal, once a firm gets a TRO in court, an arbitration hearing on a "request for permanent relief" is required within 15 business days. This is not a full hearing, but an initial review of the court-ordered injunction.

On the surface, the tighter time limit would appear positive for brokers. But the new proposed rule forbids arbitrators from taking direct action to dissolve or modify a court TRO. Panelists could only ask the parties to seek action from the court, and even then only after all evidence is heard in arbitration.

In the meantime, while the arbitration plays out under the new proposal, firms could go back to court to extend an injunction, gather evidence and have hearings.

The court would essentially judge the entire case, says Tom Campbell, a partner in the New York law firm of Smith Campbell & Paduano, which is active in defending these cases. The result would be "a serious retreat from previous [NASD] policy in favor of arbitrating industry disputes," he says.

An Attempt to Simplify Two members of the NASDR subcommittee that created the rule say the proposal is simply an attempt to simplify the injunctive process.

"You're in court for 15 days, and then you're in arbitration," Irwin says. Rath, the subcommittee chairman, adds that firms "don't get to stay in court with this [new rule]."

Irwin says the subcommittee's sense is that "cases of all sorts have gone on too long, and that's no good for anybody, except for the lawyers." So the subcommittee came up with the 15-day limit in court. He feels that, if anything, the subcommittee had "a lot more of the viewpoint of the registered reps than the kinds of people in favor of enforcing contracts."

Yet, it's not clear that the 15-day limit is really a restriction.

"For the way this [15-day requirement] is written, you have no idea of how long [the arbitration panel on injunctive relief] could take," Campbell says. There is nothing in the proposal to expedite a conclusion, unlike the prior proposal's expedited full hearing in 28 days, he says.

Fienberg says the rule doesn't need a time limit for a full hearing on the merits. "Rarely do these cases ever go to a hearing on damages," she says. "The damages issues don't require expedition. What requires expedition is whether or not there's going to be permanent injunctive relief." The issue of damages "gets resolved based on what happens ... with respect to permanent injunctive relief," she says.

Fienberg's comment reinforces what attorneys in the industry have always said: If a firm succeeds in getting an injunction, it can usually force the firm recruiting the broker to pay a settlement. Therefore, few cases ever get as far as a hearing on the merits.

Why Go to Court? One longstanding question remains: Why do firms get to go to court at all when their customers are bound to mandatory arbitration?

"The courts are better equipped to deal with [injunctions] on a Friday to Monday basis," Fienberg says.

Baltimore attorney Dana Pescosolido, who defends reps in TRO suits, has another take on why court is now being proposed as the only option. "The NASDR got bogged down and couldn't handle [the requests for injunctive relief] as quickly as they wanted," he says. "Instead of fixing the system to handle the requests efficiently, it has bailed out on stage one."

Fienberg says, though, that "our experience is that most of these cases did not come to us for TROs; most of these cases went to court."

That's not surprising, given the statistics the NASDR released during the first phase of a pilot injunctive-relief rule begun in 1996, which is still in effect.

For the first nine months ending Sept. 30, 1996, the NASDR got 91 requests for TROs, but only 30 were granted--a 33 percent success rate. Since this data was released, the NASDR has not disclosed any more statistics.

But according to attorneys who defend reps, the odds for plaintiff firms are better in the courts. That's why ending arbitrator-granted injunctions is seen as a big win for Merrill and AEFA.

Indeed, courts and arbitration panels have gone both ways in granting or denying TROs against brokers. But if this new proposed rule goes through, one thing's for sure: Brokers are going to be in court initially where the advantage belongs to their former firms. A court is more likely to grant an initial TRO, and it's probably more likely to enjoin account transfers. And with an explicit hands-off policy toward court orders and no set time limit on a full hearing, firms will be free to ensnare reps and customers in court proceedings.

As Pescosolido notes, "There's nothing in the [latest] proposed rule that sets any standards about protecting customers' interests."

As of May 18, five comment letters had been filed with the SEC regarding the NASDR's new proposed rule on injunctive relief. None of them were from the firms that had members on the NASDR subcommittee that drafted the rule (A.G. Edwards, American Express Financial Advisors, Merrill Lynch, PaineWebber and Salomon Smith Barney). All of the letters were overwhelmingly negative.

Dana Pescosolido, from the Baltimore law firm of Saul Ewing Weinberg & Green, filed the lengthiest letter. He is opposing the new proposed rule on behalf of regional firms Ferris Baker Watts, Janney Montgomery, Legg Mason, Morgan Keegan and Raymond James.

Attorney Jeffrey Ziesman, of Berkowitz Feldmiller Stanton Brandt Williams & Stueve in Kansas City, Mo., filed negative comments on behalf of Sutro & Co.

Thomas Campbell, a defense attorney and partner in the New York firm of Smith Campbell & Paduano, filed on his own behalf. Campbell has been the defense attorney on many TRO cases brought by American Express Financial Advisors and Merrill Lynch.

The fourth letter was from the Minneapolis-based National Association of Investment Professionals (NAIP), submitted by Boca Raton, Fla., attorney Alan Foxman and NAIP President T. Sheridan O'Keefe.

The fifth was from Dan Jamieson, the editor in chief of this magazine (see "From the Editor," RR, Page 14). Text of the letter is at in the Front Page section.

The NAIP took the NASDR to task for failing to include individual brokers and investors on the subcommittee that drafted the rule. Under the NASD's 1996 settlement with the SEC, the SRO has a legal obligation to include all constituencies--not just member firms--in its rulemaking processes, the NAIP says. The NAIP also notes that the NASDR offered no data to support the new proposal.

Pescosolido questions language in the proposal that prohibits arbitrators from modifying or dissolving a court TRO until after a full hearing concludes. He recommends that the rule be amended to make clear that panelists can rule on injunctive relief at any time.

Campbell suggests the SEC require the NASD to adopt a rule prohibiting any interference with account transfers. He also recommends limiting TROs to no more than 20 days.

In a similar vein, the law firm representing Sutro recommends that parties be barred from seeking injunctive relief for longer than 15 days from a court.

The SEC will forward the comments to the NASDR for its response. Officially, the comment period ended April 28, but the SEC will continue to accept comments as long as it hasn't yet taken action on a proposed rule. An original pilot rule, which is still in effect, has been extended through the start of 2001, so the SEC doesn't have to make a decision until later in the year.

How often are brokers sued when they change employers? The NASDR won't say.

When the NASDR initiated a pilot injunctive-relief rule in January 1996, the key requirement was that if a firm gets a TRO in court, it must file for arbitration simultaneously with the NASDR. This pilot rule is still in effect.

Therefore, the NASDR knows how many TRO cases there are and who's bringing them. But it won't part with the data, despite repeated requests by RR.

The most an NASDR spokesperson would say is that 179 is "the number of injunctive relief hearings in the NASD forum" in 1999, versus 90 in 1998, 109 in 1997 and 115 in 1996.

But it is unclear what these numbers are. They could be NASDR injunctive hearings or full hearings on the merits of the case. The NASDR also won't say how many TROs were obtained in court versus from an NASDR arbitrator, or how many TRO cases were settled.

"It is just not possible to sort the data so that it indicates what kind of hearings were being administered," the NASDR spokesperson says.

A Freedom of Information Act request of the SEC by RR found that, as of May, the agency had no data on the use of TROs in the industry.

The NASDR has consistently declined to say which firms are the most active in suing brokers. Merrill Lynch and American Express Financial Advisors are widely believed to be the most aggressive.

Merrill reps don't always sign noncompetes, but that's no guarantee they can leave scot-free.

Lawrence Milton, a 1.1 million dollars producer formerly of Merrill Lynch's Las Colinas, Texas, branch, resigned April 30, 1999. Milton "refused to sign [a noncompete] agreement when he was hired in 1990, because he wanted the freedom to compete with Merrill Lynch if he ever left," according to documents filed in a Texas federal court.

Milton escaped being TRO'ed.

In another case--with a twist--Phoenix broker Stephen Callahan left Merrill for PaineWebber this past November. Merrill sought a TRO in court and filed a copy of Callahan's noncompete as evidence.

The only problem was Callahan never signed an agreement. The 900,000 dollar producer says the firm asked him to sign one in March 1999, but he refused. Merrill quickly dropped its action against Callahan, and admitted to the court that Callahan's signature may have been forged.

Does refusing to sign a nonsolicitation agreement put you in the clear? Not necessarily.

Merrill, for example, has always said it does not need a noncompete contract to prevent brokers from soliciting clients. The firm can and does claim that defecting brokers violate a promise to keep client data confidential. Confidentiality language is typically found in firms' employee manuals.

But lack of a nonsolicitation agreement can weaken the case for a TRO. And some Merrill reps--good producers anyway--can get away without signing a restrictive employment contract.

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