[Federal Register Volume 63, Number 81 (Tuesday, April 28, 1998)]
[Notices]
[Pages 23321-23324]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-11211]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-39892; File No. SR-NASD-98-18]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by National Association of Securities Dealers, Inc. Relating to
Qualified Immunity in Arbitration Proceedings for Statements Made on
Forms U-4 and U-5
April 21, 1998.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ notice is hereby given that on April 21, 1998, NASD
Regulation, Inc. (``NASD Regulation'') filed with the Securities and
Exchange Commission (``SEC'' or ``Commission'') the proposed rule
change as described in Items I, II, and III below, which Items have
been prepared by NASD Regulation. The Commission is publishing this
notice to solicit comments on the proposed rule change from interested
persons.
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\1\ 15 U.S.C. Sec. 78s(b)(1).
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I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
NASD Regulation is proposing to add a new rule to the Rules of the
National Association of Securities Dealers, Inc. (``NASD'' or
``Association''), to provide members of the NASD with qualified
immunity in arbitration proceedings for statements made in good faith
in certain disclosures filed with the NASD on Forms U-4 and U-5, the
uniform registration and termination notices for registered persons.
Below is the text of the proposed rule change.
Proposed new language is in italics.
* * * * *
Rule 1150. Regulatory Form Disclosures
(a) Mandatory Disclosures
A member must make truthful and accurate statements on the covered
forms required under Article V, Sections 2 and 3 of the By-Laws.
(b) Qualified Immunity
(1) This paragraph shall apply to any arbitration proceeding
between a member or other party and a covered person relating to
statements made in response to an information requirement of a covered
form with respect to such covered person, to the extent that such
statements are contained in a covered form that has been or, at a
subsequent point in time, is (A) filed with a regulatory authority or
self-regulatory organization, and (B) disseminated by reason of such
filing, or otherwise disseminated orally, in writing, or through any
electronic medium to an appropriate person.
(2) A defending party shall not be liable in a proceeding to a
covered person for any defamation claim related to an alleged untrue
statement that is contained in a covered form if the statement was true
at the time that the statement was made.
(3) A defending party shall not be liable in a proceeding to a
covered person for any defamation claim related to an alleged untrue
statement that is contained in a covered form unless the covered person
shows by 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.
(c) Definitions
For purposes of this Rule:
(1) The term ``appropriate person'' means any federal or state
governmental or regulatory authority, and self-regulatory organization,
any employer or prospective employer of a covered person, or any person
who requests or is required to obtain information concerning the
covered person from the defending party and as to whom the defending
party has a legal obligation to provide such information.
(2) The term ``claim'' means any claim, counterclaim, third-party
claim, or cross-claim.
(3) The term ``covered form'' means any form or notice required
under
[[Page 23322]]
Article V, Sections 2 and 3 of the By-Laws, including Forms U-4 and U-
5. Disclosure Reporting Pages, and related explanatory materials.
(4) The term ``covered person'' means any present or former
registered person or other employee of a member who is a party to a
proceeding relating to a dispute within the scope of this Rule.
(5) The term ``defending party'' means any member who is a party to
a proceeding and who is adverse to a covered person who is a party, and
any associated person of such member.
(Rule 1150 is effective beginning on (Date) 1998 and ending on
(Date) 2002, and applies to claims relating to any covered forms, as
defined in Rule 1150, that are filed during that period.)
* * * * *
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with Commission, NASD Regulation included statements
concerning the purpose of, and statutory basis for, the proposed rule
change and discussed any comments it received on the proposed rule
change. The text of these statements may be examined at the places
specified in Item IV below. NASD Regulation has prepared summaries, set
forth in Sections A, B, and C below, of the most significant aspects of
such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
Summary. The proposed rule is designed to deal with the prospect
that member firms may be reluctant to make complete disclosures on
forms required to be filed with the NASD because of the potential for
lawsuits relating to defamation claims by former or present employees.
The proposed rule would create a uniform qualified immunity standard
for statements made in good faith in certain disclosures filed with the
NASD on Forms U-4 and U-5. To overcome this qualified immunity, a
registered person would have to prove in an arbitration proceeding by
clear and convincing evidence that the member firm knew at the time the
statement was made that it was false in any material respect, or that
the member acted in reckless disregard to the statement's truth or
falsity. For purposes of NASD arbitration, the rule would supersede
state law on the same subject.
Background. This issue arises primarily in the context of filings
made on Form U-5 following termination of employment of a registered
person. The NASD By-Laws (Article V, Section 3) require that the member
give notice of the termination to the NASD within 30 days after the
termination, and that the member provide a copy simultaneously to the
registered person. The By-Laws also require that the member notify the
NASD, and send a copy to the registered person, within 30 days if the
member learns of facts or circumstances causing any information in the
prior notice to become inaccurate or incomplete.
Form U-5, which is entitled the ``Uniform Termination Notice for
Securities Industry Registration,'' is a form used throughout the
securities industry at both the federal and state level. It requires
that the member indicate the reason for the termination by checking one
of the blocks labeled Voluntary, Deceased, Permitted to Resign,
Discharged, or Other. If one of the last three blocks is checked, the
member must provide an explanation. Regardless of the block checked,
the member also must indicate whether the registered person, during the
period of his or her association with the member, was involved in
certain types of disciplinary actions, the subject of a customer
complaint, convicted of certain crimes, or under investigation or
internal review.
In recent years, registered persons have brought, primarily in
arbitration, a number of defamation \2\ claims for allegedly untrue or
misleading statements made on the Form U-5.\3\ Because of the financial
interests at issue the potential for substantial damages may exist in a
number of cases. The NASD believes that the potential for liability, or
for inconsistent standards of liability, is a significant disincentive
for firms to provide full and fair disclosure. Failure to make full
disclosure of disciplinary problems has the potential to compromise the
integrity of the Central Registration Depository, and hinders
enforcement action by the NASD and other regulators. At the same time,
the NASD believes it is important that any solution provide adequate
protection to employees from statements designed to penalize unfairly a
departing employee, or to prevent him or her from obtaining new
employment or attracting existing customers to another member firm
where the person has subsequently become employed.
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\2\ ``Defamation'' has been defined as an ``intentional false
communication, either published or publicly spoken, that injures
another's reputation or good name.'' Black's Law Dictionary 417 (6th
ed. 1990). ``Libel'' (written defamation) and ``slander'' (spoken
defamation) are both methods of defamation. Id at 1388.
\3\ Defamation claims may also arise with respect to disclosures
on Form U-4, which is required to be filed by registered persons
upon the occurrence of certain events, but which in practice is
often drafted by the member firm with which the individual is
associated.
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Development of the Rule Proposal. The NASD met periodically during
1997 to discuss defamation issues with representatives of member firms,
the Securities Industry Association, the New York Stock Exchange
(``NYSE''), the North American Securities Administrators Association,
and attorneys who often represent registered representatives in court
litigation and in arbitration proceedings.
Many members of the industry favored a regulatory standard
providing for absolute immunity. Most state court decisions that have
considered this issue in the Form U-5 or in similar contexts have
adopted a qualified immunity standard. However, one New York state
court decision has expressly recognized an absolute immunity standard
with respect to statements contained in the Form U-5.\4\ Those states
that, by court decision or statute, have adopted a qualified immunity
standard in the same or similar contexts, require that falsity or
recklessness be proved either by ``preponderance of the evidence'' or
by ``clear and convincing evidence,'' as discussed below.
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\4\ Herzfeld & Stern, Inc. v. Beck, 572 N.Y.S.2d 683 (N.Y. App.
Div. 1991), appeal dismissed, 79 N.Y.2d 917 (1992). The court
reasoned that federal law had established a comprehensive system of
oversight and self-regulation by the NYSE in order to ensure
adherence by members of the industry to both the statutory mandates
and ethical standards of the profession, and concluded that the
NYSE's disciplinary function conforms to the requirements of a
quasi-judicial administrative proceeding. Therefore, statements made
on a Form U-5 and later used as the basis for an NYSE investigation
were considered ``statements uttered in the course of a judicial or
quasi-judicial proceeding [which are] absolutely privileged so long
as they are material and pertinent to the questions involved
notwithstanding the motive with which they are made.'' Id. at 683.
But see Fleet Enterprises, Inc. v. Velinsky, No. 604462/96 (N.Y.
Sup. Ct. Jan. 16. 1997), in which a lower court in New York rejected
a brokerage firm's petition, on absolute privilege grounds, to stay
the arbitration of Form U-5 defamation claims, and ordered
arbitration to proceed, applying the Federal Arbitration Act as to
the issue of arbitrability. The court stated that ``whether New York
substantive law will apply to Velinsky's claims in arbitration is
for the arbitrator to decide.'' Slip op. at 5. See also Fahnestock &
Co., Inc. v. Waltman, 935 F.2d 512 (2d Cir. 1991); Culver v. Merrill
Lynch & Co., Inc., 1995 U.S. Dist. Lexis 10017 (S.D.N.Y. 1995).
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In order to obtain as many views as possible, the NASD published a
draft of the proposed rule change in a Notice to Members (``NTM 97-
77'') that was mailed to member firms and other subscribers, and was
also posted on the NASD Regulation Web site and sent to a group of
attorneys who represent employees, to registered representatives
[[Page 23323]]
groups, and to others. That proposal included a provision that would
require member firms to give notice of the contents of a Form U-5 (and
amendments) to the subject of the form at least ten days prior to
filing the form, and would require members to provide immediate
notification to employees of material revisions to be filed on Form U-
5. Fifty-three comments were received and considered by the NASD. The
advance notice provision was the subject of almost universal criticism,
as described below. A revised proposal was approved by the NASD
Regulation and NASD Boards in January 1998.
Details of the Proposed Rule. The proposal rule would provide that
members and associated persons will not be liable to an employee for a
claim that is related to an alleged untrue statement contained in Form
U-4 or U-5 pertaining to the employee, unless the employee can prove by
clear and convincing evidence that the defending party knew that the
statement was false in any material respect, or acted in reckless
disregard as to its truth or falsity.
As noted above, state law standards generally provide for some type
of qualified immunity for statements of the type that are required by
the covered forms, and therefore the rule may not represent a
substantial change in the standard that would apply in a given case,
but will instead provide a uniform standard to which parties and
arbitrators can look for guidance. NASD Regulation in concerned,
however, that the proposal not signal a willingness to tolerant false
or malicious statements by member firms with respect to their
employees, either through disclosures on the covered forms or through
other venues. Any such statements clearly violate the obligation of
members to provide accurate information to NASD Regulation and are
inconsistent with just and equitable principles of trade.
In particular, NASD Regulation is concerned with the potential that
disclosures contained on covered forms may be used deliberately by one
member to limit the mobility of registered persons who have determined
to find employment with another member, or to delay the effectiveness
of the transfer of employment.\5\ As noted, such conduct would be
grounds for disciplinary action, and during the rule's pilot period,
NASD Regulation intends to consider and investigate evidence of misuse
of covered forms other forms, or regulatory processes for improper
purpose. In addition, NASD Regulation will provide a mechanism through
its Internet Web Site to obtain input from employees, member firms, and
others as to the operation of the pilot program and to report potential
abuses. To the extent that NASD Regulation determines that misuse of
regulatory processes has increased during the pilot period, it may
determine to modify or terminate the rule prior to the end of that
period. Finally, NASD Regulation will provide training to arbitrators
to ensure that they are cognizant of these concerns, that they
understand the application of the rule, and that the rule is applied
only with respect to appropriate types of claims.\6\
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\5\ NASD Rule 10335 of the Code of Arbitration Procedure
contains special provisions for injunctive relief in circumstances
where fast interim relief is necessary.
\6\ Because the rule as proposed would apply only to claims for
defamation, it would not affect other claims, e.g., tortuous
interference with contractual relations, to the extent that such
claims would constitute substantially different causes of action and
not merely recharacterization of defamation claims.
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Paragraph (a) of the proposed rule states that members must provide
truthful and accurate statements in response to the information
requirements of the forms required under Sections 2 and 3 of Article V
of the Association's By-Laws, i.e., Forms U-4 and U-5 and attachments
to those forms. This paragraph make clear that the purpose of the
proposed rule is to further the goal of accurate disclosure, and is
intended to reaffirm the existing disclosure obligation of NASD members
as set forth in the By-Laws. The word ``complete'' was deleted from the
draft version of the proposed rule, to address the concern of some
commenters that this language could be construed as adding a new but
vague requirement of ``completeness'' and could create liability beyond
that contemplated by the By-Laws.
The proposed rule would apply to statements made on ``covered
forms.'' Covered forms are defined in paragraph (c)(3) to include forms
or notices required under Article V, Sections 2 and 3 of the By-Laws,
including Disclosure Reporting Pages and other explanatory materials
attached to the forms or notices. Although the area of greatest focus
has involved the filing of Form U-5 in connection with employee
terminations, members of the industry have indicated that required
disclosures pertaining to employees on Form U-4 provide the same
potential for liability, and NASD Regulation believes that the same
regulatory interests in complete disclosure apply to statements on that
form. The rule would apply to statements made by a member firm on a
covered form with respect to a present or former employee of the firm.
The rule would also apply to the liability of both member firms and
associated persons, and accordingly would apply to both the signatory
of the form or other persons involved in the preparation of the form as
well as the member itself.
The rule as proposed in NTM 97-77 would have required members to
provide employees with copies of proposed language on Form U-5
describing the reason for termination at least ten days before the
filing of the form or an amendment to the form. In addition, members
would have been required to provide to the employee immediate notice of
revisions to the proposed language. The purpose of these provisions was
to provide employees with an opportunity to seek amended disclosure
language when they could demonstrate obvious inaccuracies.
After further review, NASD Regulation has determined to delete
these provisions in light of the comments received. The comments of
both members and registered representatives were overwhelmingly
negative with regard to this part of the proposal. Many commenters
expressed the view that these provisions would lead to ``negotiated''
or ``watered down'' disclosure, and some suggested that it could
compromise ongoing internal investigations. Some commenters stated that
the period was too short for meaningful review of the Form U-5, while
other commenters felt that the period was too long in that it left
broker/dealers only 20 days within which to prepare the forms and mail
them to employees, since Form U-5 must be filed with the NASD within 30
days after termination. Some commenters pointed out that employees
already have an opportunity to comment on certain reportable events
through filing of an amended Form U-4.
The proposed rule would provide qualified protection to statements
only to the extent that they are contained in a covered form that has
been or, at a subsequent point in time, is filed with any federal or
state regulatory authority, or self-regulatory organization, and are
disseminated to ``appropriate persons.'' Therefore, oral statements are
covered by the qualified immunity only to the extent that they track
language that is already or later incorporated into the covered form.
In this context, paragraph (c)(1) of the proposed rule defines
``appropriate persons'' to include, in addition to regulatory
organizations, current or prospective employers and others who
affirmatively request information concerning the employee
[[Page 23324]]
and as to whom the member has an obligation to provide the information.
The latter provision is designed to ensure that the rule would apply to
requests from persons as to whom applicable legal standards require the
disclosure of the information.
Paragraph (b)(2) of the proposed rule provides that a defending
party shall not be liable for a defamation claim if the statement was
true at the time that the statement was made. As noted above, Article
V, Section 3 of the NASD By-Laws already requires that the member
notify the NASD, and send a copy to the registered person, within 30
days if the member learns of facts or circumstances causing any
information in the prior notice to become inaccurate or incomplete.
Paragraph (b)(3) of the proposed rule contains the basic legal
standard found in federal and state court decisions that recognize a
qualified immunity in various contexts. The courts do not, however,
consistently define the burden of proof that a plaintiff must meet in
order to show that a false statement was made knowingly or recklessly.
Some decisions apply the ``preponderance of the evidence'' standard
that most commonly applies to claims and defenses in civil litigation.
Others apply a stricter ``clear and convincing'' standard. In some
cases, decisions in the same jurisdiction conflict on this point. The
NASD believes that, because no one standard is dominant, the standard
applied should be the one that will reach best the goals to which the
proposed rule is addressed. The NASD has determined that the ``clear
and convincing'' standard provides a good balance, in that it provides
some protection to member firms against defamation claims for
statements they are required to provide, while still providing that
members are liable for clear cases of abusive or malicious disclosure.
NTM 97-77 asked for comment as to whether NASD Regulation should
seek to provide a mandatory pre-filing or arbitration procedure to
resolve termination disputes prior to the 30-day period following
termination in which the Form U-5 is required to be filed. Most of the
comments addressing this issue suggested that such a procedure could
not effectively resolve disputes within this time frame. NASD
Regulation has determined that a mandatory procedure would raise too
many difficult practical and timing issues to be useful, but will
endeavor to provide mediators on an expedited basis when both parties
are interested in resolving disputes at an early stage.
The proposed rule would apply for a pilot period of four years.
Prior to the end of that period, the staff will review a sample of
filings made during the period of the rule's effectiveness to attempt
to gauge the nature and quality of disclosure that has been provided,
in contract with forms filed prior to the pilot period.
2. Statutory Basis
NASD Regulation believes that the proposed rule change is
consistent with the provisions of Section 15A(b)(6) of the Act, which
requires, among other things, that the Association's rule must be
designed to prevent fraudulent and manipulative acts and practices, to
promote just and equitable principles of trade, and, in general, to
protect investors and the public interest. The NASD believes that the
proposed rule change will encourage fuller disclosure by member firms
of any regulatory problems concerning a registered representative and
thus provide more complete information to the investing public through
the Public Disclosure Program and to other broker/dealers through the
Central Registration Depository.
B. Self-Regulatory Organization's Statement on Burden on Competition
NASD Regulation does not believe that the proposed rule change will
result in any burden on competition that is not necessary or
appropriate in furtherance of the purposes of the Act, as amended.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
The proposed rule change was published for comment in NASD Notice
to Member 97-77 (November 1977). Fifty-three comments were received in
response to the Notice.
III. Date of Effectiveness of the Proposed Rule Change and Timing
for Commission Action
Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
A. By order approve such proposed rule change, or
B. Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning for foregoing, including whether the proposed rule
change is consistent with the Act. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for inspection and copying in the
Commission's Public Reference Room. Copies of such filing will also be
available for inspection and copying at the principal office of the
NASD. All submissions should refer to file number SR-NASD-98-18 and
should be submitted by May 19, 1998,
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\7\
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\7\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-11211 Filed 4-27-98; 8:45 am]
BILLING CODE 8010-01-M
