C. THOMAS MASON III, JD, CEBS, CFP
5000 E. CALLE CHUECA
TUCSON, ARIZONA 85718
-------
520-299-5900
FAX: 520-299-7757
CTM@CTMason.com
Attorney at Law
Certified Employee Benefits Specialist
Certified Financial Planner
31 March 2003
Secretary, Securities and Exchange Commission
450 Fifth Street, NW.
Washington, DC 20549-0609
Re: NASD Proposed Rule 2130 on CRD Expungement,
File No. SR-NASD-2002-168
Dear Sir:
I am writing to comment on and oppose the NASD's proposed Rule 2130 on CRD Expungement. I am attaching my recently published article, "CRD Expungement: Law, Proposed NASD Rules, and Lawyer Ethics," which addresses the issues in detail. The article and this cover letter together constitute my comments.
The NASD's proposed CRD Expungement Rule, if approved unchanged, will vastly expand the ability of bad brokers to whitewash their CRD records. Ultimately, it will destroy the usefulness of the CRD for regulators and for public investors.
The proposed rule is a disaster for investors and regulators alike. Ignoring the legitimate concerns of NASAA and claimants' lawyers, it condones industry respondents' practice of making coercive expungement demands in settlement. It will vastly complexify investor arbitrations, making pre-hearing motion practice (especially Motions to Dismiss) mandatory in nearly every case, and will encourage brokers to bring harassing counterclaims for "defamation" at every available opportunity.
Instead of being an exceptional remedy for genuine errors, expungement will become normal practice. Regulators' ability to track customer complaints against registered representatives and firms and to take action against repeat offenders will be severely compromised. The public will never know that their brokers have been able to buy a whitewash of their bad records.
My attached article provides a comprehensive analysis of why the proposed rule will will be a catastrophe for the CRD, broker regulation, investor protection, and customer arbitration, and why it should be rejected. It was published in the PIABA Bar Journal, in the December 2002 issue (vol. 9, no. 4, pp. 76-97). In my considered opinion, securities regulators-the NASD, NASAA, and SEC-will abdicate their responsibilities to the public if they approve the proposed rule.
NASD's Rule Proposal Is A Catastrophe In Waiting
The proposed rule poses huge dangers for regulators and public investors. It freely permits whitewashing the broker's record whenever the investor's complaint "lacks factual basis", or is dismissed on grounds equivalent to Fed.R.Civ.P. 12(b)(6), or results in a CRD entry that is considered "defamatory" (a bizarre concept for investor claims). It also permits expungement in every other circumstance where the NASD decides not to contest the request, and whenever the confirming court disregards the NASD's opposition.
If approved without significant changes, new Rule 2130 will blow the doors off the CRD.
(1) Expungement demands will appear in virtually every defense and every settlement discussion, vastly increasing the "litigation" component of arbitration and the ethical pressures on claimants' counsel. See pp. 5-11, 26-28 of my attached article copy.
(2) It will turn demanding and negotiating expungements into a free-for-all, leaving only the NASD to seek to block the eventual court order if, in its sole discretion, it chooses to make the attempt. See pp. 7-8.
(3) It will necessitate dispositive dismissal motions in every case. Respondents' counsel will probably commit malpractice if they don't make the attempt to get the arbitrators to dismiss investors' claims. See pp. 8-10.
(4) It legitimizes counterclaims that an investor's complaint somehow "defamed" the broker. Counterclaims are a serious deterrent for investors who are seeking redress for their losses and can't afford-financially or emotionally-the risk of having to pay more money. See pp. 10-11.
(5) Ultimately, it will destroy what's left of the reliability and integrity of the CRD.
The proposed rule does not prescribe any standards for arbitrators or courts who are asked to expunge a record. NASAA currently insists that expungement is permissible only when "it was factually impossible for [the respondent] to have been involved in the event (e.g., a person was named in an arbitration as a branch manager of a firm, and the person was working at a different firm at that time)." SEC Release No. 34-42402 (February 7, 2000). The new rule will permit expungement whenever the NASD doesn't oppose it.
Proposed Rule 2130 invites respondents to coerce customers into agreements to expunge the CRD via stipulated awards. In NTM 01-65, the NASD denounced such behavior as violating "high standards of commercial honor and just and equitable principles of trade" in Rule 2110. NTM 01-65 proposed that only a "clear error" criterion should be permitted in stipulated or agreed awards. That caution too has been abandoned. The proposed rule freely reopens the avenue of coercive misconduct, with little possibility that it can be adequately policed. The NASD's turnabout, whether from hypocrisy or naïveté, is astonishing. Expungements coerced through settlements will have a materially adverse effect on investor protection.
Expungement when the case was dismissed on grounds equivalent to Fed.R.Civ.P. 12(b)(6) inserts federal pleading standards and litigation techniques into arbitration. The NASD has no basis for assuming-implausibly-that arbitrators will consistently and properly apply such standards. That is difficult enough for lawyer arbitrators who are not litigators; it is a totally unrealistic task for non-lawyer arbitrators. The result will be widely varying standards of review resulting in improper expungements. It is virtually certain that some arbitrators will confuse "the complaint fails to state a claim" with "the investor failed to prove his case," leading to expungements whenever the claimant doesn't win an award. We can be confident that industry respondents will encourage that confusion.
Moreover, permitting expungement when a case is dismissed for failure to state a claim virtually mandates dispositive motion practice in arbitration, something that is not otherwise countenanced under the NASD or NYSE rules. NASD Rule 10303 guarantees investors an evidentiary hearing unless they waive that right in writing. Courts have interpreted participating in the motion practice as implicitly waiving the right to a hearing-a trap for unwary and pro se claimants. Even for the wary claimant, it vastly raises the cost of asserting a claim and will further dissuade lawyers from assisting small claimants.
The NASD's proposed rule will impose federal motion practice onto arbitration, turning arbitration into federal litigation without the benefit of a learnèd judge or the due process protections and rights of appeal inherent in the judicial system. The SEC should not approve a rule which gives respondents the benefits of oppressive litigation techniques, without any of the restraints and balances that protect claimants in court, all to the detriment of public investors. The NASD's proposed rule does not meet the statutory standard of investor protection.
Defamation is a bizarre concept with respect to customer claims, especially since customers themselves have no access to posting information into the CRD. Any allegedly defamatory statements must have been put into the CRD by the broker or the firm, not by the customer. Nonetheless, the NASD's proposed rule legitimizes counterclaims against the customer for defamation. This threatens the absolute privilege and immunity that ordinarily applies to statements made in the context of in judicial, quasi-judicial, and contractual arbitration proceedings. We cannot count on arbitrators to apply that privilege and immunity rigorously when the NASD's own rule appears to abrogate the protection. Further, it gives respondents an excuse to make counterclaims the general practice, even when asserted primarily to intimidate the investor. Respondents' counsel will feel the need to practice such tactics at every opportunity, if only to reduce their own malpractice exposure. The SEC should not approve a rule that condones and legitimizes intimidation of investors who bring claims.
The NASD's ability to police the proposed rule is very seriously in doubt. The NASD claims that it can oppose expungement confirmation proceedings in court whenever the basis for the expungement does not satisfy NASD's review. There are huge problems with this. First, NASD legal staff is already overwhelmed and does not have the resources to investigate hundreds of expungement orders. NASD's response in its rule filing was not to assure the public that it will beef up its legal staff to deal with the influx of extra work, but to offer the securities industry more ways to get the NASD to waive its opposition. Second, the NASD does not make any provisions for adequate legal staffing that it will need to appear in hundreds of court proceedings around the country to oppose confirmation and protect the CRD.
Third and fatally, even if the NASD does its investigation and appears in the court confirmation proceedings, there is no assurance whatever that courts will use the NASD's criteria in making their decisions. By the plain language of the rule, those criteria apply only to the NASD in determining whether it should oppose the expungement; they are not criteria for parties or arbitrators, and certainly do not bind the reviewing court. There is nothing to stop courts from ignoring them and confirming expungement awards that have no basis at all.
Amazingly, NASD touts the proposed rule as "limiting the removal of customer dispute information" from the CRD. That is clearly untrue when compared to NASAA's longtime standard of "factual impossibility." It is untrue even when compared to the ideas proposed in NTM 01-65. The proposals in NTM 01-65 were overly solicitous to bad brokers, but the current proposed rule goes way beyond what was presented in that concept release.
Also amazingly, NASD got NASAA to greenlight the proposal, or at least an earlier version of it. Comparing NASAA's public statements with the facts of the final rule, it is clear that the NASD and SIA pulled the wool over NASAA's eyes and sold them an empty bag.
PLEASE DO NOT APPROVE THIS RULE.
The NASD has failed to meet its statutory burden of showing that this rule promotes investor protection, or that the rule is necessary even to protect brokers. A bad representative or brokerage firm can do enormous damage to many people. My article explores the relative significance of Type I (accurate material wrongly whitewashed) and Type II (inaccurate material wrongly retained on the CRD) errors. (See pp. 23-24.) The fact that bad representatives or brokerage firms are able to continue preying on the public because adverse information was wiped off their record shows that such expungement cannot be permitted.
There is no question that brokers deserve a fair process. However, expungement is not the proper way to achieve it. In seeking to satisfy the brokerage community, the NASD forgets that its statutory mandate is investor protection. The SEC recites constantly that the NASD's rules 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's task in operating the CRD is to protect investors and the public interest. All other considerations must be subordinated to that responsibility.
Despite militant advocacy from the SIA and the NASD's persistence in trying to create a framework that will satisfy the industry, a convincing case for expungement has not been presented. Any expungement rule that creates the possibility for respondents to strong-arm claimants in settlement negotiations is clearly unacceptable. A rule that gives respondents powerful incentives to convert arbitration into federal style litigation-minus due process protections and the learnèd judge on the bench-should also be condemned.
The purpose of CRD is to provide and preserve information, not to conceal or whitewash it. It is preposterous to imagine someone going to the Clerk of the Court and asking the court to expunge the fact that they were sued for things they did in their professional capacity. No citizen can "expunge" the historical facts of civil lawsuits that were filed against them, no matter how frivolous or vexatious the claim may have been. The CRD is a state public record. Why should stockbrokers-alone among American citizenry-be able to change public records to whitewash their personal history?
Louis Brandeis famously wrote, "sunlight is said to be the best of disinfectants; electric light the most efficient policeman." The concept is one of the bedrocks of the federal securities acts. The NASD's proposed rule violates those principles. By compelling nearly all customer complaints into private arbitration, the securities industry successfully hides almost all evidence of its misconduct from the public record and public inspection. That secrecy is incalculably valuable to the industry. It has no right to ask for yet more exceptions to fundamental American principles by demanding to be able to rewrite history in its own favor.
If you have any questions, feel free to contact me.
Yours sincerely,
C. Thomas Mason
C. Thomas Mason, JD, CEBS, CFP
CTM:ssm
CRD EXPUNGEMENT:
LAW, PROPOSED NASD RULES, AND LAWYER ETHICS
C. Thomas Mason III, JD, CEBS, CFP1
In press, will appear in the PIABA Bar Journal, vo. 9, # 4.
INTRODUCTION
CURRENT EXPUNGEMENT CRITERIA
PROPOSED EXPUNGEMENT RULE
NASD'S RULE PROPOSAL IS A CATASTROPHE IN WAITING
NASD ENFORCEMENT UNCERTAIN
ACCURATE CRD IS VITAL
PROTECTING PRODUCERS VS. PROTECTING INVESTORS
LEGAL ETHICS: JUST SAY "NO"!
Introduction
The NASD wants to bring expungement2 back with expanded breadth, posing huge dangers for public investors. This article explores the NASD's new proposed rule permitting expungement, what it means for arbitration procedures and settlement, and your ethical responses when the respondents come knocking with expungement demands.
Through expungement, associated persons3 and broker-dealers can totally erase adverse entries from their permanent licensing file. Expungement may be an essential element in maintaining accurate records in the Central Registration Depository (CRD). It is also a technique that has been seriously abused by industry respondents, often with the complicity or agreement of claimants' counsel.
Operated by the NASD and jointly administered with NASAA,4 the CRD is the primary resource for state and federal securities regulators and SROs for licensing and registration. Since the NASD's Public Disclosure Program began in 1992, regulators have promoted the CRD as a valuable source of information for the investing public.5
For instance, you can find out if brokers are properly licensed in your state and if they have had run-ins with regulators or received serious complaints from investors. You'll also find information about the brokers' educational backgrounds and where they've worked before their current jobs.6
SEC Chairman Arthur Levitt stated in testimony to Congress,
Investor protection also entails helping investors protect themselves. To do so effectively, I believe that investors need information about their registered representative before they open an account. It is essential that an investor be able to choose a registered representative who is trustworthy and reliable.7
The NASD brags that the online Public Disclosure Program "is the #1 resource tool for the general public and private investors for information about brokers, now receiving over 2.4 million searches per year and responding to most of them within minutes."8
However, the securities industry has undermined the CRD's accuracy and reliability by getting accurate material data expunged from the record. Industry respondents have heavily abused expungement in recent years. They have routinely inserted demands for wiping CRD records clean into their answers to statements of claim, and misused settlement negotiations to coerce claimants into granting improper expungements in return for settling the dispute.
Complaints about these abuses from state securities regulators and investors' lawyers prompted the NASD in January 1999 to impose a moratorium on expungements arising from customer complaints unless the order to expunge was issued by a court of competent jurisdiction.9 The securities industry vigorously opposed the restriction. Impelled by industry demands to broaden the ability to expunge brokers' records, the NASD undertook a multi-year effort to develop a rule or interpretation permitting expungement. This culminated in a formal rule filing advocating broad latitude for expungement. The NASD's proposed Rule 2130 went to the SEC in mid-November 2002 for publication in the Federal Register and comment through the SEC's public rule-making process.10
This article will demonstrate why Rule 2130, if approved as submitted, will be a catastrophe for the CRD, broker regulation, investor protection, and customer arbitration. Securities regulators-the NASD, NASAA, and SEC-will abdicate their responsibilities to the public if they approve the proposed rule.
To understand why the NASD's proposal is so terrible, we will carefully parse the text of the rule. We will also examine the CRD and expungement in their broader contexts, including the legal status of the CRD, why an accurate and unbowdlerized CRD is vital, and why highly limited expungement-if done right-can be a valuable corrective mechanism.
We will also examine important legal ethics concerns. Claimants' lawyers already face serious ethical challenges whenever expungement is raised. Rule 2130 will exacerbate the situation. Lawyers generally worry that they may not be serving their client if they reject expungement in settlement. That is a false reason to expunge. On the contrary, if lawyers agree to improper expungements, they will violate their professional duties and can expose themselves to discipline, court sanctions, and, in the worst case, criminal penalties.
Current Expungement Criteria
At present, under rules that have existed since the CRD began in 1981, NASAA's official position is that expungement is permitted only where the information is "factually impossible" and the expungement is ordered by a court. The SEC acknowledged this restrictive rule, describing factual impossibility in releases in 1999 and 2000:
NASD Regulation occasionally receives requests to expunge an event from CRD where the person who was the subject of the CRD filing can demonstrate to the NASD's satisfaction that it was factually impossible for him to have been involved in the event (e.g., a person was named in an arbitration as a branch manager of a firm, and the person was working at a different firm at that time). NASD Regulation and the North American Securities Administrators Association ("NASAA") agree that factually incorrect information can be expunged from the CRD if the person obtains a court order of expungement.11
Without that level of factual impossibility, expungement is impermissible. Until Rule 2130 or a variant is adopted, Respondents have no basis for asking for exoneration-and claimants are wrong to accede-except in that rare and obviously justifiable circumstance. A colorable claim founded in good faith on facts involving the registered person cannot be expunged under the current rules.
Proposed Expungement Rule
Proposed Rule 2130 will turn this situation upside down. It freely permits whitewashing the broker's record whenever the investor's complaint "lacks factual basis" or is dismissed on grounds equivalent to Fed.R.Civ.P. 12(b)(6), or results in a CRD entry that is deemed "defamatory". It also permits expungement in every other circumstance where the NASD decides not to contest the request, and whenever the confirming court disregards the NASD's opposition.
The proposed rule deals solely with customer disputes. Broker-employer disputes are not addressed, since the NASD says they are handled separately. The proposed rule states:
2130. Obtaining an Order of Expungement of Customer Dispute Information from the Central Registration Depository (CRD System)
(a) Members or associated persons seeking to expunge information from the CRD system arising from disputes with public customers must obtain an order from a court of competent jurisdiction directing such expungement or confirming an arbitration award containing expungement relief.
(b) Members or associated persons petitioning a court for expungement relief or seeking judicial confirmation of an arbitration award containing expungement relief must name NASD as an additional party and serve NASD with all appropriate documents.
(1) Upon request, NASD may waive the obligation to name NASD as a party if NASD determines that the expungement relief is based on judicial or arbitral findings that:
(A) the claim, allegation or information is without factual basis;
(B) the complaint fails to state a claim upon which relief can be granted or is frivolous; or
(C) the information contained in the CRD system is defamatory in nature.
(2) If the expungement relief is based on judicial or arbitral findings other than those described above, NASD, in its sole discretion and under extraordinary circumstances, also may waive the obligation to name NASD as a party if it determines that:
(A) the expungement relief and accompanying findings on which it is based are meritorious; and
(B) the expungement would have no material adverse effect on investor protection, the integrity of the CRD system, or regulatory requirements.12
NASD's Rule Proposal Is A Catastrophe In Waiting
If approved without significant changes, new Rule 2130 will blow the doors off the CRD.
(1) It will turn demanding and negotiating expungements into a free-for-all, leaving only the NASD to seek to block the eventual court order if, in its sole discretion, it chooses to make the attempt.
(2) Expungement demands will appear in virtually every defense and every settlement discussion, vastly increasing the "litigation" component of arbitration and the ethical pressures on claimants' counsel.
(3) It will necessitate dispositive dismissal motions in every case. Respondents' counsel will probably commit malpractice if they don't make the attempt to get the arbitrators to dismiss investors' claims.
(4) It will make counterclaims that your complaint "defamed" the broker the general practice rather than the exception.
(5) It will ultimately destroy what's left of the reliability and integrity of the CRD.
The discussion proposals in NTM 01-65 had presented a careful analysis of expungement criteria. They provided certain safeguards for the CRD as a public record, but substantially expanded the circumstances under which a registrant could wipe a nasty from the file. The final proposal is enormously broader than the concepts floated in NTM 01-65.
Amazingly, NASD touts the proposed rule as "limiting the removal of customer dispute information" from the CRD.13 That is clearly untrue when compared to the longstanding current rule. It is untrue even when compared to the concepts proposed in NTM 01-65.
NASD's comments accompanying the proposed rule assert, "NASD and other regulators participating in the CRD system agree that expungement is extraordinary relief."14 The rule itself completely undermines that principle.
NASAA added its support to the rule filing, apparently not realizing that the final rule is vastly different from the scheme proposed in NTM 01-65 or that litigation realities will cause it to produce tremendously adverse unintended consequences. Christine Bruenn, NASAA president and Maine's securities administrator, is quoted as saying, "This new rule will help protect investors by maintaining the integrity of the CRD system. These new standards will reduce the possibility that a broker would be able to use arbitration and the courts to get a clean CRD record."15 Unfortunately, reality will likely be the opposite of official expectations.
No Standards
There are so many defects in the proposed Rule 2130 that it's hard to decide which one to discuss first. One of the less obvious problems-but ultimately one of the most important-is the rule structure itself.
Look carefully at how it's organized. The rule does not prescribe any standards for arbitrators or courts who are asked to expunge a record. Paragraph (a) requires a court order directing expungement or confirming an arbitration award that granted expungement. Paragraph (b) requires the interested party-the member or associated person-to notify the NASD of a proposed court action. They can ask the NASD to waive its participation in the action. If the NASD does waive, the court action seeking expungement will be uncontested. If the NASD does not waive, they must name the NASD as an additional party.
The only standards in the rule apply solely to the NASD and its decision to participate in the court action. The criteria do not apply to the parties, or to the arbitrators, or to the courts! Under the plain language of the rule, they apply only to the NASD. They do nothing more than provide guidelines to the NASD for deciding whether to waive participation. The NASD is supposed to consider four possible criteria, including a catch-all:
(1) There are "findings" that --
(A) the item is "without factual basis";
(B) "the complaint fails to state a claim upon which relief can be granted or is frivolous";
(C) the information is "defamatory";
(2) or the NASD, in its sole discretion, determines that the findings are "meritorious" and expungement will have "no material adverse effect" on the CRD, regulators, or investor protection.
Nothing in the rule says that arbitrators or settling parties have to limit the award (including stipulated awards) to the criteria that interest the NASD. To the contrary, the catch-all in subpart (2) expressly envisions that the findings may be based on entirely different grounds. Conceivably, the expungement directive can come in an award with no articulated grounds at all.
NASD's commentary accompanying the proposed rule suggests that it may pursue disciplinary action against members who "seek to expunge any arbitration award that does not contain an expungement order and a finding of at least one of the criteria described in the Notice."16 That is an empty and unenforceable threat. Because the criteria on their face clearly do not bind members or arbitrators and since the rule expressly allows for expungement in additional undescribed circumstances, NASD would have no basis for such enforcement action.
Of course, while satisfying one or more of the specific criteria is not required, it is highly desirable. Being able to present the NASD with an award containing the right language will mean that the expunger is home free. The NASD will waive the requirement that it be named as a party to the court action, which can then proceed uncontested.
We'll examine the criteria separately. We will also examine whether the NASD can advocate its internal guidelines to a court, revealing some of the serious flaws that make the NASD's promise to protect the CRD look like a paper tiger. First, we look at the likely effects the Rule 2130 will have on investor arbitrations and negotiated settlements.
Expungement Brawl
The proposed rule will turn respondents' expungement demands into no-holds-barred combat. At present, NASAA's strict criteria and NASD's NTM 99-09 impose meaningful constraints on expungement in customer disputes. Any stipulated awards or agreed settlements that do not satisfy the standard of "factual impossibility" are tampering with public records, unethical for claimant's counsel, and a fraud on the court and the public.17
Proposed Rule 2130 would throw away that lid. In the absence of explicit and rigorous standards applying to the parties and to the arbitrators, respondents will be free to demand expungement in nearly all circumstances. The NASD's criteria are so broad that they provide no practical disincentive to respondents and virtually no restraint on any party.
Given the importance of a clean CRD record, both for longevity in the securities business and for defending against other customer complaints, claimants should assume that respondents will demand expungement in nearly all cases.
Respondents will surely insert CRD whitewashing into the picture at every opportunity, including settlement discussions and mediation. They will not wait and present their request only at the evidentiary hearing so the arbitrators can render an award. This constant pressure will significantly increase the ethical burdens on investors and their lawyers.
Proposed Rule 2130 virtually invites respondents to coerce customers into agreements to expunge the CRD via stipulated awards. In NTM 01-65, the NASD denounced such behavior as violating "high standards of commercial honor and just and equitable principles of trade" in Rule 2110. Because of NASDR's and NASAA's concerns over the dangers of settlement coercion, NTM 01-65 proposed that only the "clear error" criterion should be permitted in stipulated or agreed awards.18
That caution too has been abandoned. The NASD's comment that "NASD is cognizant of the importance of ensuring that the expungement policy does not have an overly broad chilling effect on the settlement process" overtly condones respondents' inclusion of expungement demands in settlement.19
The proposed rule freely reopens the avenue of coercive misconduct, with little possibility that it can be adequately policed. The NASD's turnabout, whether from hypocrisy or naïveté, is astonishing.
Motions To Dismiss
Proposed Rule 2130 will effectively require respondents to file dispositive dismissal motions in every case. Respondents' counsel will probably commit malpractice if they don't make the attempt to get the arbitrators to dismiss investors' claims.
Criterion (1)(B), "the complaint fails to state a claim upon which relief can be granted", is virtually a verbatim recitation of the standard for dismissing a complaint in Fed.R.Civ.P. 12(b)(6). All a respondent needs for expungement is to win a motion to dismiss on that basis. This creates a host of problems.
First, dispositive motions are totally impermissible unless the claimant waives, in writing, the right to an evidentiary hearing prescribed in NASD Rule 10303(a).20 Proposed Rule 2130 seeks to dignify and render indispensable an illegitimate practice.
Second, even if the claimant knowingly and deliberately waives her right to an evidentiary hearing, there are no due process protections to ensure that the "motion to dismiss" is decided solely on Rule 12(b)(6) criteria. The standards for 12(b)(6) dismissal in court are well-established: The tribunal must accept the well-pleaded allegations in the complaint as true and draw all reasonable inferences in favor of the plaintiff. Dismissal is proper only where it is clear "beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief."21
The purpose of a motion to dismiss is solely to test the sufficiency of the complaint and not to investigate the substance of the claims;22 "importantly, it does not resolve contests surrounding the facts, the merits of a claim, or the applicability of defenses."23 Dismissal by motion is a "harsh remedy which must be cautiously studied, not only to effectuate the spirit of the liberal rules of pleading but also to protect the interests of justice."24
In arbitration, however, most panelists are not former federal judges. To review a motion to dismiss, the arbitrator must understand (a) the legal standard for review, (b) the necessary elements of each cause of action, (c) how to find those elements in the statement of claim under liberal pleading standards, and (d) the proper procedure of dismissing without prejudice, including permitting the claimant to amend the pleading unless amendment would be futile. Most arbitrators do not have the necessary skills to apply Rule 12(b)(6) standards consistently and accurately.25
In fact, many panelists have trouble separating respondents' contentious factual disputations from evaluating the bare sufficiency of the pleading. Respondents' counsel know this and attempt to take full advantage of arbitrators' ignorance and the absence of due process. Respondents' counsel are notoriously sloppy in their motion practice. They make no serious effort to meet the standards by which a tribunal would review such motions. They "forget" that a motion to dismiss can only question the sufficiency of the pleadings. They do not evaluate the complaint within its four corners, accepting its statements to be true, but persistently demand an evaluation of "evidence" relating to contested facts. They fill their memoranda with disputed facts and contentious defenses which have no place in a motion to dismiss. These "errors" that even a second year law student would not make are so common that they suggest deliberate efforts by respondents' counsel to bamboozle arbitrators who do not have legal training or extensive litigation experience.
Such misconduct could be sanctionable under Rule 11 or 28 U.S.C. § 1927 if presented before an experienced judge. Ironically, panelists' unfamiliarity with legal procedure-which makes respondents' abuse dangerous-also makes it difficult for claimants to get comparable sanctions in arbitration. How do you convince an arbitrator who doesn't realize that he's being hoodwinked to award sanctions against the hoodwinkers?
Third, dispositive motion practice mirroring Rule 12(b)(6) will introduce detailed pleading standards into a forum that promises that pleading will be minimal. The U.S. Supreme Court says that a complaint is sufficient if it provides "`a short and plain statement of the claim' that will give the defendant fair notice of what the plaintiff's claim is and the grounds upon which it rests."26 NASD Rule 10314 requires even less: "The Statement of Claim shall specify the relevant facts and the relief sought." Neither a complaint nor a statement of claim has to be self-proving, for "details of both fact and law come later, in other documents,"27 and in the hearing on the merits.
Introducing 12(b)(6) motion practice raises the ugly spectre of elaborate arguments over, for example, the applicable pleading standards for federal securities claims under the Securities Exchange Act and Rule 10b-5. This is a debate on which even the federal circuit courts of appeal cannot agree.28 Moreover, PSLRA imposes a freeze on all discovery until the motions to dismiss are resolved,29 forcing panels to render dispositive decisions before the claimant receives any discovery. Legitimizing dismissal motions on 10b-5 pleading standards will not only drag out the proceedings but also put a premium on respondents' stonewalling skills to keep relevant documents out of claimants' hands.
Motions to dismiss replicating Rule 12(b)(6) criteria do not belong in arbitration, and particularly not when the prize for winning is a wiped-clean CRD record. This is especially true while the SROs and the SEC preserve the philosophy that investors can represent themselves and vindicate their claims. The scheme of proposed Rule 2130 will take away several of the advertised benefits of arbitration: a guaranteed evidentiary hearing; minimal motion practice; informal pleading requirements; expeditious resolution; and the ability to proceed without counsel. To borrow PIABA member William Torngren's phrase, it is another stop on the boulevard of broken promises.
"Defamatory" Is Improper
There is no need or justification for a "defamatory" criterion with customer complaints. This is a slop-over from the broker-firm arena, where defamation of individual brokers on the CRD does occur, generally at the hands of former employers and supervisors. The NASD's rule filing gives no more justification than to say that the standard "has been used successfully in the arbitration forum in registered representative/member firm arbitrations, and NASD believes that it is appropriate as proposed."30
It is emphatically not appropriate. NASD's rule proposal totally ignores the absolute privilege and immunity that applies in judicial, quasi-judicial, and contractual arbitration proceedings.31 It will effectively communicate to the arbitrators that such immunity does not apply in arbitration. That is utterly false, but many arbitrators will not know that.
Including a "defamatory" criterion in NASD rules attempts to create a counterclaim which simply does not exist. Allowing purported defamation as an expungement criterion in investor complaints invites-indeed, virtually mandates-respondents' retaliatory counterclaims against the investor for alleged "defamation."
A "defamatory" criterion in Rule 2130 will have other negative consequences. Most importantly, it will seriously chill investors' ability to bring claims against their brokers. For respondents, that may be even more valuable than a clean CRD. Defamation counterclaims are an intimidation tactic that strikes at clients' worst fears: "Do you mean I could lose MORE money?" PIABA members already reported an upsurge in such counterclaims in 2002.32 Adding "defamation" as an accepted means of wiping the customer's complaint off the CRD is like throwing gasoline on a fire.
Counterclaims for defamation will vastly complicate arbitration proceedings. Claimants will have to educate the arbitrators about absolute immunity and seek to have the counterclaims dismissed.33 If that fails, claimants will pursue discovery requests seeking, among other things, the unredacted names and addresses of all of the broker's clients, since they will be in the best position to know what his business reputation is. Naturally, that will lead to a discovery fire-fight. If the case eventually gets before the arbitrators, there will be additional hearing dates and concomitant costs. The arbitrators will have to decide which state's law of defamation to apply, a particularly difficult problem when the broker and customer reside in different states and the CRD is a national publication. All of this complexity and expense is totally improper.
Defense lawyers advocating expungement state that "traditional defamation principles apply in arbitration just as they do in the rest of society."34 They evidently forget that in the rest of society, allegations in court pleadings get absolute privilege and immunity from suit. Furthermore, civil lawsuits are part of the permanent public record and are not expungeable.
Members of the securities industry are not entitled to greater protection from complaint or suit than other members of society. Nor do they have any greater right to retaliate for alleged "defamation" in the pleadings. Like other members of society, they have no right to claim that a customer's complaint "defamed" them.
Catch-Alls
The criterion of "without factual basis" is too vague. It is dangerous, both to those trying to maintain an accurate CRD and to brokers trying to correct legitimate errors.
The NASD says that it includes the "factually impossible" and "clear error" standards that presently exist, but offers no further explanation.35 Yet the phrase "without factual basis" is clearly much broader than the examples previously quoted for factual impossibility.
In arbitrators' minds, "without factual basis" could mean nothing more than the claimant failed to meet her burden of proof. Unless the arbitrators give more than just a one-sentence finding, neither the NASD nor state securities regulators will ever know otherwise. That is obviously not an adequate basis for expunging an investor complaint from the permanent record.
The NASD's own catch-all is even broader. The NASD permits itself to determine-in its sole discretion-that the findings supporting the expungement order are "meritorious". How will it know? Whom will it ask? What constitutes "meritorious"? This provision is nothing but a blank check to the NASD to expunge whatever it wishes.
Together with a blank check, the proposed rule has no accountability. There is no requirement for the NASD to maintain records of what action they take, so regulators and the public will never know what they did, who did it, why they did it, how many expungements were permitted to proceed unopposed, how those determinations were made and by whom, how many requests were opposed and on what grounds, and so on.
NASD Enforcement Uncertain
The meat of proposed Rule 2130 is in the NASD's participation in court proceedings, ostensibly to oppose improper expungements. The rule requires naming the NASD as an additional party in such confirmation and expungement proceedings. However, the rule proposal itself provides no assurances that NASD will actively oppose objectionable attempts to expunge, or that NASD's opposition will be effective. The entire enforcement side of proposed Rule 2130 is highly doubtful.
NASD's comments accompanying the rule filing assert, "The proposed rule will state that NASD will participate in such judicial proceedings and will oppose expunging dispute information in such judicial proceedings" unless the tribunal made specific findings satisfying the NASD's criteria.36 In fact, the proposed rule says no such thing.37 There is nothing in proposed Rule 2130 declaring or requiring that the NASD "will oppose" anything.
Former state securities administrators who have dealt with the NASD on CRD issues question the NASD's commitment to permitting expungement only in compelling and exceptional circumstances. One former state commissioner wrote privately,
[I] had to deal with the NASD on CRD matters from the day that CRD was proposed. No good can come from the NASD, on its own, being allowed to decide what is on the system and what is not. ... Trust me, the NASD will never fight to keep something in the records of CRD.38
Another former state commissioner and NASAA official, who has been intimately involved in the expungement controversy, is less pessimistic: "I honestly believe that the NASD will fight expungement in all but the most obvious cases. There is no way they will accept expungement if money changes hands."39
Not Binding On Courts
Even if we assume the most optimistic view, there is no assurance that the NASD's opposition will have one whit of impact on the courts. Simply put, the criteria in proposed Rule 2130(b) may be binding on the NASD, but they are not binding on federal or state judges.
The NASD's purported protections are predicated on its discretion to appear in court to oppose the expungement. (Let us suspend skepticism and assume for the moment that the NASD would rigorously oppose expungement proceedings that did not meet the highest standards of scrutiny.) But the success of its opposition may be highly doubtful.
What grounds would the NASD use to convince a court not to confirm the expungement order in an arbitration award?
If it asks the court to vacate the award under normal procedures of the Federal Arbitration Act, it will fail. The NASD's opposition cannot be based on any of the statutory criteria for vacatur in 9 U.S.C. § 10(a), on the criteria for modifying an award in 9 U.S.C. § 11, or on manifest disregard of the law. Proposed Rule 2130 is not a law, just a rule of the SRO. Since the rule is in the 2000 series, it is not a rule of arbitration, it is not binding on the arbitrators, and it does not limit their powers. Arbitrators are free to issue expungement orders on any grounds they choose. Further, proposed Rule 2130 does not prescribe criteria to the court for determining whether expungement is permissible. As we have seen, it only defines the circumstances under which the NASD may waive participation in the court proceeding. Unless the NASD can show that the award was obtained by fraud, corruption, or misconduct of the arbitrators, there is no reasonable hope of blocking confirmation of the expungement.
Another theory suggests that the NASD could oppose the expungement in its capacity as administrator of the CRD responsible for protecting the public record.40 I have found some small support for this in labor cases, one by the National Labor Relations Board, another by the Connecticut State Board of Mediation and Arbitration.41 But again, the three criteria in 2130(b)(1) govern the NASD's choice to intervene, not the court's evaluation in confirming or denying the award. While the court might give some deference to the NASD's views,42 there is no assurance that the court would adopt the NASD's criteria for its own decision.
Factual Basis From Where?
Furthermore, unless the arbitrators give written explanations, how is anyone-including the NASD-going to know what criteria were applied? Since the arbitrators can't be deposed, what will the NASD do? Factual basis is also troublesome in stipulated awards, since the arbitrators may not have made an independent decision.
Will the NASD go to the parties' counsel and get affidavits? The rule filing suggests this possibility: "In connection with making the required arbitral findings in such cases, NASD will explore the use of telephonic versus in-person hearings, as well as the option of making a decision based on briefs and affidavits from the parties and relevant third parties."43
Will you as claimants' counsel swear under oath that the claim that you agreed to expunge, which you submitted in good faith and which you know in your heart to be meritorious (after all, they just paid you to settle it!) - will you swear that it was frivolous, or without factual basis, or failed to state a claim on which relief could be granted?? If so, you're in deeper trouble than the broker.
Any claimant's counsel who grants such an affidavit-or permits respondents' counsel to make such representations on her behalf-will commit a fraud on the court,44 violate the professional responsibility rule requiring candor toward the tribunal,45 and participate in a conspiracy to falsify or tamper with public records. Perjury carries civil and criminal penalties. So does tampering with public records.
No lawyer who values his or her liberty, property, ethical obligations, and license to practice law can participate in such a scheme and provide the NASD the "factual basis" that it seeks.46
Missed Opportunity
The enforcement situation would be very different if the expungement criteria were binding on members and arbitrators. For example, the proposed rule could have a counterpart or cross-reference in the NASD Code of Arbitration Procedure, limiting arbitrators' power to grant expungement except in specifically delimited circumstances and requiring reasoned findings substantiating such a recommendation. If arbitrators issued an award (including a stipulated award) that did not satisfy the requirements, the arbitrators would exceed their powers or render an imperfect award. The proposed expungement would be vacatable under 9 U.S.C. § 10(a)(4)47 or modifiable under § 11(c). The NASD's criteria would be directly imported into the judicial proceeding and would govern the court's decision.
The fact that the NASD did not write the rule in this manner causes us to question its commitment to opposing nonconforming expungements. Undoubtedly the NASD and NASAA folks who originally developed this proposal had a rational idea of how it would function. However, the way proposed Rule 2130 finally turned out, the NASD's purported protection of the CRD is mostly chimerical. Gertrude Stein would recognize the situation immediately - there's no There there.
Accurate CRD Is Vital
The ability to correct inaccurate or defamatory entries is very important. The CRD is-or should be-vital to the career of a broker. Regulators' "Rogue Broker" projects condemned the practice of hiring peripatetic bad brokers and retaining them despite numerous customer complaints.48 A massive overhaul of the CRD recommended by the "Large Firm Project" made it a more effective tool for firms trying to avoid problem brokers, for regulators in their investigations, and for public customers seeking information about their advisors. The NASD summarized the importance of the CRD in NTM 01-65:
Regulators use the registration information, and other information contained in the CRD system, to assist them in fulfilling their regulatory responsibilities, including making determinations about registration and licensing of firms and associated persons. Member firms use the CRD system to help them meet their registration, licensing, and certain other compliance obligations. Much of the information reported to the CRD system is made publicly available, either by NASD Regulation through its Public Disclosure Program (PDP) or by the SEC and individual state securities administrators pursuant to applicable law.
Negative information on the CRD can end brokers' careers and deprive them of their livelihood. "Ever try to switch brokerages with such a record? You are radioactive," writes a defense lawyer.49
Less measurably, CRD dings can adversely affect or can diminish of brokers a broker's ability to attract and retain conscientious clients. As investors become more aware of the online public disclosure information, flawed though it is, and the more complete paper record from state securities administrators, they can proactively screen potential advisor relationships and not do business with brokers whose records concern them. A broker may never know what good clients chose not to do business with him or her because of information on the CRD, but the effects are there.
It is therefore essential that CRD records be accurate, complete, and comprehensible. This is particularly significant because the CRD combines the worst features of self-reporting and adversary reporting with few of the cross-checks and protections that ordinary public records have.
CRD Is A Public Record
The CRD is a public record, literally and legally. Yet it differs from other "normal" public records in some significant ways. A broker's CRD record is very public. Most portions are available online,50 or by picking up the telephone and calling either the NASD Public Disclosure Program or-better-the state securities division.51 In this way, the CRD is more public than most public records, which have been slower to convert to online access.
More importantly, the CRD is legally a public record. NTM 99-54 acknowledged NASAA's longstanding insistence on this point:
NASAA has informed NASD Regulation that, in its opinion, according to various state laws, information submitted to the CRD system is deemed to have been filed with each state in which the subject person or entity seeks to be registered. Therefore, according to NASAA, information in the CRD system that may be the subject of an arbitrator-ordered expungement is in many cases a state record, and some state laws currently do not recognize the authority of an arbitrator to expunge a state record or do not otherwise permit such expungements because of state recordkeeping requirements.
In 1999, the SIA pooh-poohed that concept.52 In a letter responding to NTM 99-54 and advocating a return to the free-and-easy days of arbitrator-ordered expungements, the SIA claimed that the only support for "state record" status came from an opinion of the Florida Attorney General. The SIA did not do its homework before attempting to refute Florida's position. Its argument about state law is simply wrong.
The Florida Attorney General concluded that CRD records are state records and cannot be expunged except in conformity with Florida law. The opinion further stated, "An agency may not avoid its responsibility under the Public Records Act by transferring custody of a record to another entity."53
California statutes unambiguously designate CRD records as a "public record" which is available for public inspection. See Cal.Corp.Code § 25247 and Cal.Gov.Code § 6254.12. The latter reads:
Any information reported to the North American Securities Administrators Association/National Association of Securities Dealers' Central Registration Depository and compiled as disciplinary records which are made available to the Department of Corporations through a computer system, shall constitute a public record.
You can't get much clearer than that. And there are numerous other examples. The Oklahoma securities commissioner may designate filing depositories-including the CRD-for records required to be filed and maintained under the Oklahoma Securities Act.54 At the time of the SIA's letter, Arkansas treated securities agents' filings under the Arkansas State Records Management and Archives Act and permitted the state commissioner to participate in the CRD for maintaining and retaining such public records.55 Many other states authorize their securities commissioner to participate in the CRD for the purpose of centralizing and streamlining record-keeping, filing, and retention.
I have not found a state that has abandoned its own regulation of brokers and agents in favor of whatever the NASD unilaterally decides to keep in the CRD. Mr. Mark Sendrow, Director of the Arizona Securities Division and a member of the NASAA board, puts the matter in perspective: When the states and the NASD got together some twenty years ago to create the CRD, no state gave up its records simply by having asked the NASD to coordinate the national system.56
It's illegal to tamper with or falsify a public record.
Self-Reporting Problems
The CRD is essentially a self-reporting system. Associated persons are required to update their own U-4.57 Sometimes this is done by the registered representative himself, usually in conjunction with the firm's legal or compliance department. There is a structural incentive to disclose as little as possible and to spin it in the broker's favor. The results, as anyone who has received public disclosure information from the NASD has already noticed, are typically meaningless, self-exculpatory denials and blah-blah that are useless for investors. Self-reported entries on the CRD generally cannot be considered to be true and accurate disclosure of the investors' complaints.
In some ways, the CRD would be far more useful for investors if the complaining party were permitted to submit a summary of the complaint. This would at least counterbalance the one-sided self-interested reports that the CRD currently contains. However, it would open up brokers to genuine defamation by their unhappy customers. While NASDR could provide protections by having the Enforcement Division check the investor's proposed CRD entry to ensure that it accurately reflects the allegations in the complaint that the investor intends to prove, that could prove more troublesome than the current system.
Broker-dealers also have an incentive to obfuscate and exculpate on CRD entries regarding their brokers. They won't say anything that may concede wrongdoing by this registered representative or that may reveal a pattern of flawed supervision by the firm. In addition, when the broker is still a valued producer, the firm won't want to say anything that could cause the broker's clients or prospective customers to turn away.
Ex-Employers Can Become Adversaries
On the other hand, firms can become brokers' adversaries. Once a registered representative has left the firm, she becomes vulnerable to vicious, retaliatory, and ultimately defamatory entries on her CRD record. We see this particularly after the broker and firm have been hit with complaints or arbitration awards to investors. The U-5 filing is an opportunity for the firm-especially the branch office manager-to blame the departed representative for the supervisor's or firm's failings, or simply to vent personal conflicts between the representative and her superiors. Such instances are particularly pernicious when the personal conflict was sexual harassment or other civil rights violations by the superior.
When firms file ugly U-5s sliming the representative's record, prospective employers reading those reports can and do refuse to hire the representative. Negative reports can drive the representative out of the securities industry, costing her career and her livelihood.
These dangers, more than any other, motivate thoughtful advocacy of finding means to expunge inaccurate or defamatory information. The National Association of Investment Professionals (NAIP)58 has been at the forefront of this effort. Predictably, brokerage firms have a different idea of U-5 disputes. In their view of the world, "Disgruntled former employees not infrequently threaten groundless defamation actions based on these filings."59
In my experience, mean-spirited CRD filings by former employers do occur. For example, in the early 1990's, Prudential Securities was in the dock for its massive multi-billion dollar systemic corporate fraud in the creation and marketing of limited partnerships. The company lied to its employees about the safety and profitability of its limited partnerships; loyal and otherwise conscientious employees believed their company and unwittingly passed on the lies to their valued clients. The limited partnerships went down the tubes, taking investors' money with them and causing a national scandal. Investors sued, regulators investigated, and Prudential paid nearly $2 billion in awards, judgments, regulatory fines, and legal fees.
In numerous cases, investors deliberately did not name their financial consultant as a respondent, recognizing that the rep was also victim of Prudential's lies. They wanted simply to recover their money and did not want to harm their financial consultant. Where the broker had left Prudential Securities by the time the case was resolved, Prudential often reported the outcome on an amended U-5, even though allegations of wrongdoing were against the company itself and there were no allegations of sales practice violations by the rep. This practice was particularly offensive where the U-5 amendment resulted from an award through the SEC's expedited arbitration process, which recognized the corporate wrongdoing. Prudential had no reason to besmirch the CRD of its former employees, other than out of spite or retaliation for their having moved to more reputable firms and taken the tattered remnants of their client book, or to perpetuate Prudential's corporate fiction-which it maintained in spite of facts and evidence and regulatory findings-that the limited partnership debacle was simply the fault of irresponsible representatives.60
A second example comes from Prudential Insurance and its broker-dealer subsidiary Pruco Securities, and the product failure of its "vanishing premium" life insurance arising from systematic company-wide deceptive marketing.61 Once again, when clients complained, the company sought to blame the individual representative/agents, even when clients clearly stated that they had no complaints about the agent. In cases I worked on, the pattern was clear: if the agent was still with Pruco, there was no amended U-4 unless there was an unavoidable complaint that the agent's conduct exceeded the company's own mispractice. But after the agent left Pruco, there was no restraint. Managers filed amended U-5s retroactively to tarnish the agent with earlier complaints which, if they were reportable at all, should have been filed on the rep's U-4 many months earlier. A number of former representatives brought claims for defamation. They were often successful both in collecting money and in obtaining nonmonetary relief that can be even more valuable-they got the offending entries in their CRD record amended or expunged.62
The third example, involving cases of sexual harassment or other civil rights violations, is perhaps the ugliest. When the representative leaves the company, the branch office manager submits a U-5 with trumped-up reports of poor work habits, inability to deal with clients, failure to follow supervisor's instructions, etc. Violations of personal dignity are followed by actions that threaten her livelihood. Such statements on a U-5 are even more potent in jeopardizing an individual's career than customer complaints because of their content. The representative's only long-term remedy is to get the false report expunged from the CRD.
But Employer Defamation Is Already Covered
These abuses legitimately support appropriate mechanisms for expungement. However, it is important for us to recognize that they are totally unaffected by proposed Rule 2130. All of these problems, the primary impetus of the NAIP, are employee-firm disputes. By its own terms, proposed Rule 2130 expressly deals only with customer complaints and offers no solace or protection against wrongful actions by firms toward their own former employees.
The NASD's rule filing acknowledges this discrepancy. Under already existing policy, the NASD will honor-without a court order-expungement directives arising from employee-firm disputes "in which the arbitration panel states that expungement relief is being granted because of the defamatory nature of the information."63
Since correcting the greatest source of inaccurate or defamatory information is already in place and is not affected by the proposed rule, we have to question what genuine wrongs the proposed rule intends to address. None is apparent.
"Rogue Customers" and Frivolous Complaints
Some defense counsel complain of "rogue customers" whose irresponsible filings unjustly besmirch brokers' records.64 Of course, the number of times respondents' counsel cry that the claim is frivolous is several orders of magnitude larger than the number of cases in which the arbitrators agreed that was true. The databases are replete with awards reciting respondents' boilerplate in which the arbitrators found wrongdoing and entered awards against the respondent.
However, some investors have filed truly frivolous and harassing claims against brokers. Not only do arbitrators flatly reject such claims, some of the awards even assessed forum fees and/or attorney fees against the complainant as penalty for bringing a frivolous case.65 The awards are public, and the brokers certainly reported the successful outcome to the CRD, so there is no need for expungement.
Besides forum fees, attorney fees, and sanctions in the arbitration, the appropriate remedy for demonstrably frivolous and harassing claims is an action for malicious prosecution. Its functions are:
to recompense a defendant sued in a malicious and baseless legal action for: (1) his attorney fees; (2) his costs; (3) his psychic damage from the shock of the unfounded allegations in the pleadings; and (4) the loss of his reputation in the community as a result of the filing and notoriety of the base allegations in the pleadings which are public records.66
The basic elements of tortious wrongful prosecution are generally: "(1) favorable termination of the prior proceeding, (2) lack of probable cause to support the original action, and (3) malice in bringing that action."67 In most jurisdictions, an arbitration award terminated in favor of the broker will support such an action, even though arbitrators are not required to make detailed findings and the hearing records may be incomplete.68 "[A] malicious prosecution action involves not a review of the reasons for the decision in the prior action, but rather an analysis of the circumstances that led the [complainant] to pursue that action."69
Those well-recognized remedies-especially compensation for unfounded allegations and loss of reputation (items (3) and (4) above)-are the legitimate relief that aggrieved brokers are seeking through the jerry-rigged alternative of expungement. Such private relief can be obtained without the disadvantages of tampering with public records designed for investor protection.
De Facto Expungements
The securities industry already exercises its own de facto whitewashing of the permanent record simply by not reporting adverse events to the CRD. Distressingly many members-including biggest top-tier firms-continue to fail to comply with basic reporting requirements of CRD registration forms and NASD Rule 3070. NASD's occasional enforcement has been lackluster at best. The virtual absence of systematic enforcement is all the more incomprehensible since the NASD already gets full information regarding investors' arbitration complaints, as well as notices that cases have settled.
Historically, the right hand did not communicate with the left hand. Dispute Resolution did not communicate investor complaints or trends to Enforcement.70 Both the NASD and the NYSE have been amazingly lax in coordinating information they already received-statements of claim vs. U-4/U-5 filings; notices of settlement vs. U-4/U-5/BD-and instituting appropriate regulatory actions.
At the NASD's Fall Securities Conference, October 2002, Mary Shapiro, President of NASDR, Inc., informed me that those days are over at the NASD. Just as law enforcement and intelligence agencies discovered after September 11, 2001 that they didn't use information they already had and are now seeking better coordination, the NASD is developing information-sharing infrastructure to assemble data more meaningfully and ensure that the information is readily available for all departments to use. If the new discipline succeeds, the industry will be much less able to benefit from de facto whitewashing.
Ignoring Expungeable Complaints
Even the best coordination depends on someone getting the information in the first place. The proposed Rule 2130 gives additional incentive to brokers and firms simply not to comply with the U-4 reporting rules for customer complaints other than statements of claim. Those rules that are already inadequately observed and even more rarely enforced.
Consider what can happen if an investor submits a written complaint to the firm that triggers a "Yes" answer on the broker's U-4 or U-5.71 The firm aggressively and reflexively denies the complaint. The investor decides not to pursue the matter in arbitration. Maybe she got intimidated; maybe the claim wasn't large enough to attract competent counsel. The broker now has an unadjudicated ding on his record. Under the NASD's public disclosure rules, it will disappear from public view, though not from the permanent record, in 24 months.
But the broker doesn't want to wait. He wants it cleared off now, and he wants it permanently removed so that state regulators won't see it. What is to prevent him from filing a declaratory action in court seeking expungement on the grounds that the customer's "unsubstantiated" and unadjudicated allegations were "without factual basis"?
There will be only one voice speaking-the broker's-so the success rate of such actions should be high. The customer won't be there to contest the broker's self-serving rendition of the events. The NASD won't have any contrary facts of its own, and it certainly doesn't have the manpower to independently investigate the underlying merits of every investor complaint that brokers want to expunge. An affidavit from the firm averring that the customer's complaint was "without factual basis" will satisfy the provisions of Rule 2130 and should permit the expungement to go without NASD opposition.
Since uncontested expungement actions cost money and take time, why should the broker and firm report the customer's complaint at all? After all, it'll get expunged anyway if the customer doesn't follow through with a claim in arbitration. If there is an arbitration claim, it has to be reported under a different question, 14I(1), of Form U-4. So why bother? Just wait and see if you have to answer question 14I(1) and forget about reporting complaints on 14I(3).
Obviously, this behavior is wrong. But it is a low risk, high return, profit-maximizing choice. NASD enforcement of 14I(3) violations is virtually nonexistent. Even if the firm is caught, the penalties are negligible-generally less than the legal fees and the broker's lost production expended in formal expungement proceedings.
Protecting Producers Vs. Protecting Investors
A useful way to view the expungement question is as a choice of which mistakes are worse-Type I or Type II errors.
Type I: Accurate information about a broker or firm that was improperly expunged
Type II: Inaccurate information about a broker or firm that was unfairly retained without an adequate mechanism for correcting or removing it
From the perspective of securities industry members, it is clearly preferable to eliminate Type II errors. If a bad broker undeservingly gets a clean record, that's better than a good broker getting hurt by something false.
From the perspective of public protection, however, the scale is reversed. The NASD's and the state securities administrators' responsibilities under the securities laws require subordinating individual brokers' or firms' interests to the public welfare. Type II errors are less bad than Type I errors that can put the public in jeopardy.
A bad representative or brokerage firm can do enormous damage to many people. A bad representative or brokerage firm that was able to continue preying on the public because adverse information was wiped off their record is enough to show that such expungement cannot be permitted.
Such examples abound. PIABA members all too frequently see recidivists with cleansed records. Forbes magazine reported on one such repeat-victimizer and the huge harm caused to the public:
Investors in the last seven years have lost some $125 million in a Ponzi scheme allegedly conducted in part by brokers registered with a small California firm headed by Carl Martellaro. What many of those investors didn't know-in fact, couldn't know-was that Martellaro himself had been accused in a similar scheme five years ago. Then, two investors filed complaints claiming they had lost $1.75 million in investments with First Associated Securities Group, of which Martellaro was president. Why didn't investors know that? Because the information had been expunged-legally-from records of the [NASD]. Martellaro's attorney ... had offered to settle the earlier cases only if the investors allowed them to be deleted from Martellaro's record with the NASD.72
There is no justification for a system that allows such predators to continue operating. Type I errors of expunging genuine information and leaving the public at risk are far more objectionable than Type II mistakes.
NASD's "Balancing" Is Misguided
The NASD's rule filing and press release speak several times of trying to "balance" the interests of the public and securities regulators with brokers' interests. It claims that its duty as operator of the CRD
requires the NASD to balance three competing interests: (1) the interests of NASD, the states, and other regulators in retaining broad access to customer dispute information to fulfill their regulatory responsibilities and investor protection obligations; (2) the interests of the brokerage community and others in a fair process that recognizes their stake in protecting their reputations and permits expungement from the CRD system when appropriate; and (3) the interests of investors in having access to accurate and meaningful information about brokers with whom they conduct, or may conduct, business.
This is fallacious. NASD's scale is out of whack.
There is no question that brokers deserve a fair process. However, expungement is not the proper way to achieve it. In seeking to satisfy the brokerage community, the NASD forgets that its statutory mandate is investor protection. The SEC recites constantly that the NASD's rules 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."73 Properly viewed, there can be no "balancing" act - the NASD's task in operating the CRD is to protect investors and the public interest. All other considerations must be subordinated to that responsibility.
The bottom line is expungement is not required. The danger of expunging information which would benefit investors clearly offsets any detriment that a broker may suffer because the broker does not like the disclosure. The purpose of the CRD system is to protect the investing public. The function of NASDR in administering the system is to protect the investing public. Its objective should not be to protect the broker. Stockbrokers work in an extremely sensitive area, obtaining control over investors' personal assets, and the more information the investor can get about the broker, the better.74
The current rule is adequate to protect the CRD and public investors, as long as claimants' counsel understand and follow their legal and ethical duties.
Whitewashing Is Wrong
Is expungement a proper corrective solution for CRD errors? Despite militant advocacy from the SIA and the NASD's persistence in trying to create a framework that will satisfy the industry, a convincing case for expungement has not been presented.
Any kind of system that creates the possibility for respondents to strong-arm claimants in settlement negotiations is clearly beyond the pale. A system that gives respondents powerful incentives, as the proposed Rule 2130 does, to convert arbitration into federal style litigation-minus due process protections and the learnèd judge on the bench-should also be condemned.
We can again look to the public court system and the rights of ordinary citizens for guidance. As we've observed, citizens have no ability to "expunge" the historical facts of civil lawsuits that were filed against them, no matter how frivolous or vexatious the claim may have been. Why should stockbrokers-alone among American citizenry-be able to change public records to whitewash their personal history? No other person can do that in civil matters.
The purpose of CRD is to provide and preserve information, not to conceal or whitewash it. It is preposterous to imagine someone going to the Clerk of the Court and asking the court to expunge the fact that they were sued for things they did in their professional capacity.
Court records are open for full public inspection. This is a significant difference between the CRD and other public records. The public is not limited to reading a brief self-serving obfuscatory summary prepared by the defendant. "The public's right of access ... envisions a pervasive common law right to inspect and copy public records and documents, including judicial records and documents."75 Interested persons-including the press-can study the underlying documents, including the pleadings, moving papers, affidavits, and other items in the record. If someone (a doctor, a lawyer, for example) has a blot on their record in the form of a lawsuit by an unhappy client, the public record contains full details. If the claim is frivolous or harassing, that point will be made in abundance in the record.
There are extremely valuable reasons for public access that the SROs as arbitration forum sponsors should seriously consider. SRO arbitration would improve immeasurably as a genuine socially responsible dispute resolution system if these fundamental principles were heeded.
[T]he right of access strengthens confidence in the courts: The public's exercise of its common law access right in civil cases promotes public confidence in the judicial system by enhancing testimonial trustworthiness and the quality of justice dispensed by the court. As with other branches of government, the bright light cast upon the judicial process by public observation diminishes possibilities for injustice, incompetence, perjury, and fraud. Furthermore, the very openness of the process should provide the public with a more complete understanding of the judicial system and a better perception of its fairness. In addition, access to civil proceedings and records promotes public respect for the judicial process and helps assure that judges perform their duties in an honest and informed manner.76
In contrast to normal public records, investors examining the CRD know only that a complaint was filed. They do not know any of the genuine details, nor do they have any means of ascertaining the quality and seriousness or frivolousness of the claims. This, too, is a self-inflicted problem created by the securities industry, by insisting that all disputes by resolved by arbitration and by refusing to make arbitration pleadings and related documents available for investors to examine.
By compelling arbitration, the securities industry successfully hides almost all evidence of its misconduct from the public record and public inspection. That secrecy is incalculably valuable to the industry. It has no right to ask for yet more exceptions to fundamental American principles by demanding to be able to rewrite history in its own favor.
The industry has already determined that keeping secret all but the iceberg's tip of its wrongful conduct is more important than giving public access to documents correcting or explaining the occasional mistakes that may appear in the CRD records of individual members or associated persons. Having thus created a system that already gives it enormous benefits at the expense of investor protection, the securities industry is not entitled to yet another exceptional procedure of unwriting history, whitewashing employees' records, and allowing bad brokers and members to continue to prey on an unsuspecting public.
LEGAL ETHICS: JUST SAY "NO"!
Expungement is not and should never be a bargaining chip in settlement. Unable to get expungement under the existing NASAA criterion of "factual impossibility", the brokerage industry has taken matters privately into its own hands and for a number of years has been abusing the issue of expungement by using it as a settlement demand.
Both the sole standard at present (factual impossibility) and the proposed criteria (no factual basis, unable to state a claim or frivolous claim, defamatory filing) show clearly that your decision is not a matter of business negotiation, but instead one of professional responsibility. A decision regarding expungement is not your client's-it's yours. If the currently proposed criteria are adopted, your answer must be NO unless the situation meets one of those criteria. Until then, your answer must be NO unless it satisfies the standard of "factual impossibility."
Ethical and professional responsibility considerations prevent expungement from even getting to the settlement table just as surely as they prevent demands or agreements to limit lawyers' future practice.77 Lawyers who say that they'll negotiate over expungement because they're hired to represent their client, not the investing public, are missing that essential point. It's not a question of "getting the best deal for your client" - the issues are much bigger than that.
Unless you have made a genuine mistake, you must not agree to an expungement in settlement, since it means you agree that the claim was baseless, unmeritorious, even frivolous, ab initio. This is not the client's decision-it is yours as the lawyer. You signed the pleading, and in doing so you warranted that the allegations were well-founded in fact and law and that the complaint was not presented for an improper purpose. If you did not have adequate basis for that belief, you would rightly be subject to sanctions and/or discipline.
If you did not file a frivolous, meritless, baseless claim, you cannot agree to expunge in settlement. To expunge the record means that you now believe, and are willing to state under oath, that the broker did nothing wrong and that your complaint against him was totally improper. That would be a lie and an ethics violation. As we saw above, the NASD or the respondents may ask you for such a sworn declaration that can end up being presented to a court.
Moreover, the lie is not just between the parties-you would be lying to the court. There is never an excuse for that.
Further, as long as you cannot state, under oath, that your original claim was wholly without merit, by agreeing to an expungement you are falsifying a public record. As we saw above, any claimant's counsel who grants such an affidavit or permits respondents' counsel to make such representations on her behalf commits a fraud on the court, violates the rule requiring candor toward the tribunal, and participates in a conspiracy to falsify or tamper with public records. Perjury carries civil and criminal penalties, as does tampering with public records. No lawyer who values his or her liberty, property, ethical obligations, and license to practice law can participate in such a scheme.
If perjury and tampering with public records weren't enough, remember that federal and state regulators use the CRD as their primary source of information about registered persons. Filing false information or submitting documents with material omissions to the CRD is a federal crime. Individuals deliberately submitting inaccurate information have been criminally prosecuted for federal mail fraud, 18 U.S.C. § 1341, and for making a false statement to government, 18 U.S.C. § 1001.78 Do you really want to lie on behalf of the respondent broker and expose yourself to such penalties?
Under no stretch of any imagination can such behavior be justified or condoned. A lawyer's responsibility to advocate zealously for his client does not permit him to step outside the bounds of the law.79
Attorneys are officers of the court and their first duty is to the administration of justice. Whenever an attorney's duties to his client conflict with those he owes to the public as an officer of the court, he must give precedence to his duty to the public. Any other view would run counter to a principled system of justice.80
No amount of self-delusion to encourage settlement will suffice to change that reality.
These obligations make the decision easy-it's out of your hands, and out of your clients' hands. We cannot agree to acts that are illegal or contrary to the rules of professional conduct.
Another consideration should also give pause, though if violating your professional responsibilities and participating in criminal acts don't worry you, this won't either. By agreeing to an unmerited expungement, you will be lying to the entire investing public of America. You would be telling them-falsely-that the complaint you signed against this broker was meritless, and that they can confidently make a decision to invest with him knowing that your earlier allegations were so baseless that they deserved to be wiped off the record.
You know that's not true, the broker knows it, his lawyer knows it, and the firm knows it. But the innocent folks out there that you'd be lying to don't know it. How will you feel when they are hurt by your deception. And if you're inclined to say that you're not hired to represent the public, remember the lives and savings that have been wrecked by brokers like Carl Martellaro. Think of your own clients, put a face to the hurt, and realize that you may have enabled it.
When respondents come demanding expungement, JUST SAY NO!
____________________________
tr valign=top>| 1 | © 2003 by C. Thomas Mason III. I wish to thank Scot Bernstein for his many useful thoughts in improving this article. I appreciate the willingness of several present and former state securities administrators to speak with me. I also want to acknowledge Larry Schultz, of Driggers, Schultz & Herbst (Troy, Michigan), and Chuck Austin (Richmond, Virginia), for their diligent and dogged efforts opposing expungement and uncovering industry practices. The faults in this article and views I express here are my own, and do not necessarily reflect the positions of PIABA or its board of directors.
| | 2 | "To `expunge' means `to destroy; blot out; obliterate; erase; efface designedly; strike out wholly. The act of physically destroying information ... in files, computers, or other depositories.'" Snyder v. City of Alexandria, 870 F.Supp. 672, 683 (E.D.Va. 1994) (quoting Black's Law Dictionary 522 (5th ed.1979)).
| | 3 | "Associated person" is the official title of all persons who are, anticipate being, or should be registered with the NASD. NASD, Inc. By-Laws, Art. I, para. (ee); NASD Rule 1011(b). Most, but not all, associated persons are the folks we commonly refer to as registered representatives or stockbrokers.
| | 4 | Organized in 1919, the North American Securities Administrators Association "is the oldest international organization devoted to investor protection. It is a voluntary association whose membership consists of 66 state, provincial, and territorial securities administrators in the 50 states, the District of Columbia, Puerto Rico, Canada, and Mexico." NASAA, http://www.nasaa.org/nasaa/abtnasaa/overview1.asp; NASD News Release, October 2, 2002, http://www.nasdr.com/news/pr2002/release_02_049.html. (All websites cited in this article were visited between January 2 and 15, 2003.)
| | 5 | Congress mandated that the NASD publicly disclose the employment and disciplinary history of its members and their associated persons in the Securities Enforcement Remedies and Penny Stock Reform Act of 1990, section 15A(i), now 15 U.S.C. § 78o-3(i). It required the NASD to "establish and maintain, within one year of its enactment, a toll-free telephone listing to receive inquiries regarding actions involving its members and their associated persons and promptly respond to such inquiries in writing." Order Approving Proposed Rule Change Relating To Release Of Certain Information Regarding Disciplinary History Of Members And Their Associated Persons Via Toll-Free Telephone Listing, Release No. 34-30629, 51 S.E.C. Docket 488, 1992 WL 87786 (April 23, 1992). The NASD did not enter into the public disclosure program voluntarily or out of the goodness of its heart.
| | 6 | SEC, "Protect Your Money: Check Out Brokers and Advisers," http://www.sec.gov/investor/brokers.htm.
| | 7 | Testimony of Arthur Levitt, SEC Chairman, concerning the Large Firm Project, before the Subcommittee on Telecommunications and Finance, U.S. House of Representatives (September 14, 1994), 1994 WL 499982, also on the SEC website at http://www.sec.gov/news/studies/rogue2.txt.
| | 8 | http://pdpi3.nasdr.com/pdpi/Req_Type_Frame.asp.
| | 9 | NASD Notice to Members (NTM) 99-09, effective January 19, 1999, http://www.nasdr.com/pdf-text/9909ntm.txt.
| | 10 | See NTM 99-54, http://www.nasdr.com/pdf-text/9954ntm.txt; NTM 01-65, http://www.nasdr.com/pdf-text/0165ntm.txt; SR-NASD-2002-168, http://www.nasdr.com/pdf-text/rf02_168.pdf, and its preceding news release, http://www.nasdr.com/news/pr2002/release_02_049.html. As of mid January 2003, the SEC had not yet published the rule proposal in the Federal Register or posted it on the SEC website.
| | 11 | Amendments to the Public Disclosure Program, Release No. 34-42402, 71 S.E.C. Docket 1483, 2000 WL 143334, *3 (February 7, 2000) (emphasis added).
| | 12 | SR-NASD-2002-168, http://www.nasdr.com/pdf-text/rf02_168.pdf, pp. 18-19. (Citations to SR-NASD-2002-168 in this article are taken from NASD's proposed text of the SEC's release, pp. 17-31 of the rule filing.)
| | 13 | News Release, http://www.nasdr.com/news/pr2002/release_02_049.html (emphasis added).
| | 14 | SR-NASD-2002-168, p. 23.
| | 15 | News Release. The Securities Arbitration Commentator, usually perspicacious, similarly opined that "the road to actual expungement will be far more uncertain and expensive" and "even deserving brokers seeking expungement will be significantly affected." NASD Expungement Rule Teed Up With SEC, SAC Ref. No. 02-40-02, SAC Arbitration Alert 2002-40 (10/9/02). SAC's comments were apparently based on the news release, which preceded the rule filing by 6 weeks and did not give an accurate picture of the rule.
| | 16 | SR-NASD-2002-168, p. 30.
| | 17 | See the Legal Ethics section at the end of this article.
| | 18 | Despite the numerous complaints of coercion that led to NTM 99-09, NASD in NTM 01-65 pretended to believe that "it is unlikely that claimant or claimant's counsel would agree that the claim or information at issue was lacking in legal merit or was defamatory in nature." SR-NASD-2002-168, p. 29, reiterating the statement from NTM 01-65. NASDR has ample facts showing that its "belief" is ill-founded.
| | 19 | SR-NASD-2002-168, p. 23. Freeing respondents to obtain expungement through settlement was a major point in the SIA's comment letter on NTM 01-65. http://www.sia.com/2001_comment_letters/pdf/CRDInfo.pdf (Dec. 31, 2001), at pp. 6-7.
| | 20 | See Scot Bernstein, Your Clients' Right To A Hearing, 9.1 PIABA B.J. 42 (Spring 2002); C. Thomas Mason III, Challenging Experts In Securities Arbitration, Securities Arbitration 2000 725 (Practising Law Institute, Corp. Law & Pract. Course Handbook Series #1196, vol. B0-00KP, 2000), at pp. 739-741 (describing what constitutes a "hearing" in Rule 10303).
| | 21 | Conley v. Gibson, 355 U.S. 41, 45-46 (1957).
| | 22 | Graham v. Sauk Prairie Police Commission, 915 F.2d 1085, 1100 (7th Cir. 1990); Republican Party of North Carolina v. Martin, 980 F.2d 943, 952 (4th Cir. 1992).
| | 23 | Edwards v. City of Goldsboro, 178 F.3d 231, 234 (4th Cir. 1999); see 5A Charles A. Wright & Arthur R. Miller, Federal Practice and Procedure § 1356 (1990).
| | 24 | Morse v. Regents of University of Colorado, 154 F.3d 1124, 1127 (10th Cir. 1998).
| | 25 | Occasionally we find a sophisticated exception. See Birkelbach v. Boston Group, NASD Docket 99-00813, 2000 WL 1919800, *3 (Nov. 16, 2000), in which the arbitrators permitted amendment in response to a motion for more definite statement, granted the respondents' motion to dismiss the first amended complaint without prejudice, permitted a second amended complaint, and ultimately dismissed the entire case without prejudice under Rule 10305(a) and referred the parties to their remedies at law. All three arbitrators are experienced lawyers, and two are PIABA members.
| | 26 | Leatherman v. Tarrant County Narc.Intell. & Coord.Unit, 507 U.S. 163, 168 (1993), quoting Fed.R.Civ.P. Rule 8(a)(2).
| | 27 | Mid America Title Co. v. Kirk, 991 F.2d 417, 421 (7th Cir. 1993).
| | 28 | "[T]here is 'widespread disagreement among courts as to the proper interpretation of the PSLRA's heightened pleading requirement.'" Phillips v. LCI Int'l, Inc., 190 F.3d 609, 620 (4th Cir. 1999) (quoting In re Silicon Graphics, Inc. Sec. Litig., 183 F.3d 970, 973 (9th Cir. 1999)). See Brent Wilson, Pleading Versus Proving Scienter Under The Private Securities Litigation Reform Act Of 1995 In The Ninth Circuit [...], 38 Willamette L. Rev. 321, 324-329 (2002) (reviewing circuit decisions).
| | 29 | "In any private action arising under this chapter, all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss...." 15 U.S.C. § 78u-4(b)(3)(B).
| | 30 | SR-NASD-2002-168, pp. 28-29.
| | 31 | "A party to a private litigation ... is absolutely privileged to publish defamatory matter concerning another in communications ... during the course and as a part of, a judicial proceeding in which he participates, if the matter has some relation to the proceeding." Restatement of Torts 2d, § 587 (1977). "`Judicial proceedings include all proceedings in which an officer or tribunal exercises judicial functions ... an arbitration proceeding may be included.'" Bushell v. Caterpillar, Inc., 291 Ill.App.3d 559, 562, 683 N.E.2d 1286, 1288 (Ill.App. 1997) (quoting Restatement of Torts 2d, § 587, comments b and f) (emphasis added by the court). "[P]rivilege for communications made in the context of judicial, quasi-judicial, or legislative proceedings [is] a complete immunity from suit, not a mere defense to liability." Shanks v. AlliedSignal, Inc., 169 F.3d 988, 992 (5th Cir. 1999); see also Hugel v. Milberg, Weiss, Bershad, Hynes & Lerach, LLP, 175 F.3d 14, 16 (1st. Cir. 1999) ("A statement falls outside the privilege only if it is 'so palpably irrelevant to the subject matter of the controversy that no reasonable man can doubt its irrelevancy or impropriety'").
See M. Schneiderman, Libel and slander: application of privilege attending statements made in course of judicial proceedings to pretrial deposition and discovery procedures, 23 A.L.R.3d 1172 (1969); W. E. Shipley, Libel and slander: privilege applicable to judicial proceedings as extending to administrative proceedings, 45 A.L.R.2d 1296 (1956); Gary D. Spivey, Libel and slander: privileged nature of communications made in course of grievance or arbitration procedure provided for by collective bargaining agreement, 60 A.L.R.3d 1041 (1974). (John B. Lewis & Lois J. Cole, Defamation Actions Arising From Arbitration And Related Dispute Resolution Procedures-Preemption, Collateral Estoppel And Privilege: Why The Absolute Privilege Should Be Expanded, 45 DePaul L. Rev. 677 (1996), observe that the rule is not absolute in labor arbitrations under a collective bargaining agreement.) See also Sheri L. Marvin, Libel and Slander: Deposition testimony and other statements taken in connection with private, contractual arbitration proceedings are protected from tort liability by the absolute immunity granted under California's litigation privilege, 22 Pepp. L. Rev. 1322 (1995).
"This absolute privilege shields speakers from liability even if their motives were malicious, or they knew the statement was false, or their conduct was otherwise unreasonable." Imperial v. Drapeau, 351 Md. 38, 44, 716 A.2d 244, 247 (Md.App. 1998); see Odyniec v. Schneider, 322 Md. 520, 588 A.2d 786 (Md. 1991) (expert witness' allegedly defamatory statements made in connection with arbitration are absolutely privileged, just as they would be in court, even when the remarks may have been gratuitous, unsolicited, and said outside the actual hearing); Sturdivant v. Seaboard Service System, Ltd., 459 A.2d 1058 (D.C. 1983) (absolute immunity to complaining witness' statement).
| | 32 | Correspondence on file with the author.
| | 33 | Ironically, this will reverse the usual roles of customers and respondents regarding dismissal under Rule 10303. Claimants will have to argue that pre-hearing dismissal is legitimate, and respondents may find themselves contending that Rule 10303 gives them an absolute right to an evidentiary hearing on their claims.
| | 34 | Mark J. Astarita, Rogue Customers, http://www.seclaw.com/docs/1097.htm (Oct. 1997). The statement by itself is true-but only when it means the opposite of what Mr. Astarita intended.
| | 35 | SR-NASD-2002-168, p. 28.
| | 36 | SR-NASD-2002-168, p. 20.
| | 37 | The reader wonders if NASD changed the text of the proposed rule after the comments were drafted - and after NASAA gave its nihil obstat to those concepts.
| | 38 | Private communication, Jan. 6, 2003 (on file with the author). This commissioner was horrified to discover NASD's sloppy controls over CRD information. For example, "13 people had authority to enter fingerprint information directly into the CRD without a tracking mechanism even though only 2 people actually handled the fingerprint cards - it would have been worth a $1000 bucks for a felon to have one of these people enter that they had a clean rap sheet and no one would have known."
| | 39 | Private communication, Jan. 6, 2003 (on file with the author).
| | 40 | I thank Scot Bernstein for this suggestion. The NASD itself is silent on the entire question.
| | 41 | See International Longshoremen's and Warehousemen's Union, Local 32 v. Pacific Maritime Ass'n, 773 F.2d 1012, 1020 (9th Cir. 1985) (NLRB may intervene to oppose an award that, if enforced, would undermine a section 10(k) NLRB work assignment); City of Milford v. Local 1566, Council 4, AFSCME, 200 Conn. 91, 510 A.2d 177 (Conn. 1986) (although State Board did not have interest in whether award was ultimately vacated or confirmed, it had significant interest in protecting validity of procedures used to determine award).
| | 42 | Littman v. Morgan Stanley Dean Witter, 337 N.J.Super. 134, 143, 766 A.2d 794, 799 (N.J.Super. 2001) (NASD's rule filing commentary is entitled to deference); First Heritage Corp. v. NASD, 785 F.Supp. 1250, 1251 (E.D.Mich. 1992) (same). We should note that in other cases, courts have routinely disregarded the commentary in SEC rulemaking. They did this repeatedly in Rule 10304 / Sec. 15 eligibility rule decisions contravening the 1984 rule amendment that expressly intended to "make the Code's time limitation co-extensive with various state statutes of limitations and permit all securities-related disputes which are eligible for a judicial disposition to be resolved by arbitration." SEC File No. SR-NASD-84-16, Release No. 34-21188, 31 SEC Docket 31 (Aug. 2, 1984). See C. Thomas Mason III, Irreducible Disagreements: The Six-Year Rule Revisited, 1 Securities Arbitration 1997 557 (Practising Law Institute, Corp. Law & Pract. Course Handbook Series #998, vol. B4-7195, 1997), at p. 578; contrast Bayley v. Fox, 671 N.E.2d 133 (Ind.App. 1996), discussed at pp. 695-696, which supported its decision with the SEC's release but without giving it deference.
| | 43 | SR-NASD-2002-168, p. 29.
| | 44 | See, among many, Hongsermeier v. C.I.R., --- F.3d ----, 2003 WL 132992 (9th Cir., Jan. 17, 2003) (conduct designed to prevent the court and public from learning of settlement agreements was a fraud on the court, and no showing of prejudice is required).
| | 45 | See ABA Model Rule 3.3; C. Thomas Mason III, Lawyers' Duties of Candor Toward the Arbitral Tribunal, 1 Securities Arbitration 1997 59 (Practising Law Institute, Corp. Law & Pract. Course Handbook Series #998, vol. B4-7195, 1997).
| | 46 | See the Legal Ethics section at the end of this article.
| | 47 | One court questioned, without deciding, whether an award can be partially vacated using the standards of § 10. Legion Ins. Co. v. VCW, Inc., 198 F.3d 718, 721 n. 5 (8th Cir. 1999). However, the issue appears more theoretical than real, since courts routinely do exactly that. See, e.g., Lummus Global Amazonas S.A. v. Aguaytia Energy del Peru S.R. LTDA., --- F.Supp.2d ----, 2002 WL 31401996 (S.D.Tex. 2002) (rejecting the restriction); Davis v. City and County of San Francisco, 984 F.2d 345 (9th Cir. 1993) (vacating just the award of expert fees); United Food & Commercial Workers v. National Tea Co., 899 F.2d 386 (5th Cir. 1990) (vacating injunctive portion of award); Landy Michaels Realty Corp. v. Local 32B-32J, Service Employees Intern. Union, AFL-CIO, 954 F.2d 794 (2nd Cir. 1992) (vacating damages portion of arbitration award).
| | 48 | See "Joint Regulatory Sales Practice Sweep: A Review of the Sales Practice Activities of Selected Registered Representatives and the Hiring, Retention, and Supervisory Practices of the Brokerage Firms Employing Them" (March 1996). The Sweep combined the resources of the SEC, NASD, NYSE, and NASAA to review problem brokers and the hiring, retention, and supervisory practices of firms employing them. The report is available at http://www.sec.gov/news/studies/sweeptoc.htm. The Sweep followed "The Large Firm Project: A Review of Hiring, Retention and Supervisory Practices" by the SEC's Division of Market Regulation and Division of Enforcement (May 1994), http://www.sec.gov/news/studies/rogue.txt.
| | 49 | Bill Singer, Street Legal: Charged, Therefore Guilty, Registered Rep. (Feb. 1, 2002), http://registeredrep.com/ar/finance_street_legal_charged/index.htm.
| | 50 | In 2002 the NASD decided to limit public online access through the internet to specified hours during the day and early evening: "The web site is available from 7.00 a.m. to 11 p.m. ET Monday through Friday and 8.00 a.m. to 8.00 p.m. ET Saturday and Sunday." http://pdpi.nasdr.com/pdpi/ (after hours). For totally unexplained reasons, NASD shuts off access during the hours when working investors with children finally have free time to get onto their computers. This particularly affects investors in western and Pacific states, since the system closes down at 8 PM Pacific time on weekdays and 5 PM on weekends. For investors overseas, the problem is even worse. NASD's computers don't sleep; they certainly don't sleep 8-12 hours a night. There is no rational explanation for this denial of service, except to make it difficult for some members of the public to obtain valuable information.
| | 51 | The NASD's PDP summaries often have significantly less information than printouts from state securities administrators. Seasoned practitioners refer to the online report as "CRD-Lite" and, whenever appropriate, get the full report from their state securities division. A full critique of the online disclosure system is beyond the scope of this article.
| | 52 | http://www.sia.com/1999_comment_letters/html/nasd99-7.html (July 30, 1999).
| | 53 | Advisory Legal Opinion by Robert A. Butterworth, Attorney General of the State of Florida, AGO 98-54 (August 28, 1998), http://legal1.firn.edu/ago.nsf/aaee37715760bbce852563cc001bacf7/ d3d4288d6bfa789085256671004cada9!OpenDocument
| | 54 | 71 Okl.St. § 411.
| | 55 | Ark.Code § 23-42-206. The entire State Records Management and Archives Act was repealed in 2001 for reasons that have nothing to do with the CRD. Acts 2001, No. 1252, § 1.
| | 56 | Personal communication, Jan. 15, 2003.
| | 57 | "We wish to reiterate that the responsibility for maintaining the accuracy of the Form U-4, by updating the information in the filing, as necessary, lies with the registered representative." Frank R. Rubba, Release No. 34-40238, 67 S.E.C. Docket 1305 (July 21, 1998)
| | 58 | See http://www.naip.com/ (not to be confused with http://www.naip.org/, the National Association for Indexed Products). (The website is not kept up to date very well.)
| | 59 | Daniel L. Goelzer, Baker & McKenzie, Statement of the Securities Industry Association concerning the Securities Litigation Reform Act before the Telecommunications and Finance Subcommittee of the House Committee on Commerce, February 10, 1995, 1995 WL 57110, at n. 34 (advocating legislation to grant firms absolute immunity for their statements on former employees' U-5s).
| | 60 | Prudential denies all this, of course, but the defamation claims against the company speak for themselves.
| | 61 | See In re Prudential Insurance Company America Sales Practice Litigation, 148 F.3d 283 (3rd Cir. 1998) and related decisions.
| | 62 | Prudential was certainly not the only firm to engage in such practices. Dawson v. New York Life Ins. Co., 135 F.3d 1158, 1163-4 (7th Cir. 1998), responded to concerns that giving securities firms absolute privilege for remarks on the U-5 "will invite vindictive brokerage firms to embellish customer complaints so as to harm the reputations of agents who have fallen into disfavor." The court rejected the employer's plea for absolute immunity and stated that "while even meritless complaints against agents must be reported on Forms U-5, individual agents can rest assured that securities firms do not have free rein to report customer complaints in any way they like, exaggerating complaints or inventing them wholesale with absolute immunity to do so."
| | 63 | SR-NASD-2002-168, p. 22 n. 4.
| | 64 | See Mark J. Astarita, NASD Expungement Order Proposal Release, http://www.seclaw.com/docs/expungement1201.htm (Dec. 17, 2001) (criticizing NTM 01-65), and his earlier editorial, Rogue Customers, http://www.seclaw.com/docs/1097.htm (Oct. 1997), in which he complained of customers "who send complaint letters, file regulatory complaints, commence arbitrations and start federal lawsuits, accusing their brokers of a wide variety of fraudulent activity, when the customer himself knows that the complaint is without merit." It might be noted that in the 1990s, Mr. Astarita's law firms represented some of the most unsavory members of the securities community.
Another frequent defender of boiler-room brokers makes a similar unsubstantiated charge: "customers routinely concoct complaints against registered reps and broker/dealers in an effort to force a cash payment." Bill Singer, Street Legal: Charged, Therefore Guilty, supra note 49. Mr. Singer is with Singer Frumento LLP.
| | 65 | For example: "In awarding attorney's fees, the panel considered the claim brought against Respondent to be frivolous in nature." Texvest Factors & Financial Svcs Corp. v. Shearson Lehman Brothers, Inc., NASD Docket 91-02519, 1993 WL 147553, *2 (Feb. 12, 1993). "Claimant is liable to and shall pay to Respondent Mercer $15,000.00 for attorney's fees and legal expenses incurred as a result of the frivolous and defamatory nature of the claim." Redwing Robin L.P. v. Southern Financial Group, Inc., NASD Docket 99-02504, 2000 WL 1278039, *4 (June 12, 2000) (also ordering expungement, conditioned on confirmation from a court of competent jurisdiction). The Securities Arbitration Commentator, Inc. has an entire package of awards in which the arbitrators have awarded sanctions of various kinds. P.O. Box 112, Maplewood, NJ 07040; 93 Riggs Place, So. Orange, NJ 07079; 973-761-5880, fax 973-761-1504.
| | 66 | Walford v. Blinder, Robinson & Co., Inc., 793 P.2d 620, 623 (Colo.App. 1990) (quoting Stanley v. Superior Court, 130 Cal.App.3d 460, 181 Cal.Rptr. 878 (Cal.App. 1982)), cert. dismissed sub nom. Keller v. Walford, 498 U.S. 977 (1990). (PIABA member Steve A. Miller of Denver represented the Walford plaintiffs.)
| | 67 | Andrus v. Estrada, 39 Cal.App.4th 1030, 1039, 46 Cal.Rptr.2d 300, 305 (Cal.App. 1995); see also Restatement of Torts 2d, § 674. The Andrus decision gives a fascinating history of wrongful civil prosecution, showing that the cause of action has existed in the common law since before 1269.
Some American courts prefer to call the tort action arising from civil disputes "abuse of process" or "wrongful use of civil proceedings", leaving "malicious prosecution" to complaints arising from criminal matters. In some of those states, the difference is more than just nomenclature. "Under New York law, an abuse of process claim 'has three essential elements: (1) regularly issued process, (2) an intent to do harm without excuse or justification, and (3) use of the process in a perverted manner to obtain a collateral objective.'" PSI Metals, Inc. v. Firemen's Ins. Co., 839 F.2d 42, 43 (2nd Cir. 1988) (quoting Curiano v. Suozzi, 63 N.Y.2d 113, 116, 469 N.E.2d 1324, 1326 (1984). The NY Court of Appeals also wrote that "the institution of a civil action by summons and complaint is not legally considered process capable of being abused." Id. This is an emphatic substantiation that claimants are immune from defamation for allegations made in the course of an arbitration claim.
| | 68 | E.g., Walford v. Blinder, Robinson & Co., Inc., 793 P.2d at 623; Neely v. First State Bank, Harrah, Okla., 975 P.2d 435 (Okla. 1998); Taylor v. Peoples Gas Light & Coke Co., 275 Ill.App.3d 655, 656 N.E.2d 134 (Ill.App. 1995); Eurotech, Inc. v. Cosmos European Travels A.g., 189 F.Supp.2d 385 (E.D.Va. 2002); Luppo v. Waldbaum, 515 N.Y.S.2d 871 (N.Y.App.Div. 1987); see also Pujol v. Shearson/American Express, Inc., 877 F.2d 132 (1st Cir. 1989); International Medical Group, Inc. v. American Arbitration Ass'n, Inc., 312 F.3d 833, 845 (7th Cir. 2002).
However, the remedy is not available in California: "Whether the underlying action started in court or in arbitration, if it ends in contractual arbitration, that termination will not support a malicious prosecution action." Brennan v. Tremco Inc., 25 Cal.4th 310, 314, 20 P.3d 1086, 1088, 105 Cal.Rptr.2d 790, 792 (Cal. 2001). To the extent that this disadvantages brokers in California, it is a self-inflicted problem that the securities industry has created by insisting that even its own employees give up their legal rights and submit all disputes to arbitration. It does not justify expungement.
| | 69 | Walford v. Blinder, Robinson & Co., Inc., 793 P.2d at 623.
| | 70 | This was evident in the Prudential Securities limited partnership scandals, where the NASD had the earliest and best knowledge of the breadth and depth of the problem, yet did nothing with it. The massive enforcement case was later developed by state securities administrators, which Johnny-come-lately NASD joined at the tail end. See Kurt Eichenwald, Serpent on the Rock (HarperBusiness, 1995).
| | 71 | Question 14I(3) of Form U-4, ver. 2002, requires disclosure of investment related, customer initiated written complaints alleging sales practice violations and damages of at least $5,000, or theft, forgery, misappropriation, or conversion. Current Forms U-4, U-5, BD, BDW, and associated instructions are available on the NASDR website at http://www.nasdr.com/3420d_adopted.asp.
| | 72 | Michael Freedman, The X-ed Out Files, Forbes, Dec. 25, 2000, http://www.forbes.com/forbes/2000/1225/6616280a.html.
| | 73 | E.g., Release No. 34-42402, 71 S.E.C. Docket 1483, supra note 11, citing Securities Exchange Act § 15A(b)(6), 15 U.S.C. 78o-3(b)(6).
| | 74 | Laurence S. Schultz, Letter to Richard E. Pullano, NASDR, July 28, 2000.
| | 75 | In re Cendant Corp., 260 F.3d 183, 192 (3rd Cir. 2001) (internal quote marks omitted).
| | 76 | Id. (internal quote marks and citations omitted).
| | 77 | Compare your state's version of ABA Model Rule 5.6.
| | 78 | U.S. v. Turner, 22 Fed.Appx. 404, 2001 WL 1216987 (6th Cir. 2001). Sixth Circuit rules permit citing unpublished opinions if a party believes that it "has precedential value in relation to a material issue in a case, and that there is no published opinion that would serve as well...." U.S.Ct. of App. 6th Cir. Rule 28(g), 28 U.S.C.
| | 79 | See State v. Turner, 217 Kan. 574, 538 P.2d 966, 87 A.L.R.3d 337 (Kan. 1975); Hitch v. Pima County Superior Court, 146 Ariz. 588, 708 P.2d 72 (Ariz. 1985); State ex rel. Oklahoma Bar Ass'n v. Tweedy, 52 P.3d 1003 (Okla. 2000). The duty of the lawyer as an advocate is to represent his client "zealously within the bounds of the law." C.P.R. Canon 7. We are not discussing conscientious civil disobedience here, but note that even in such cases, the lawyer cannot act with impunity but must be prepared to accept the legal consequences of his acts.
| | 80 | Van Berkel v. Fox Farm and Road Machinery, 581 F.Supp. 1248, 1251 (D.Minn. 1984), citing Theard v. U.S., 354 U.S. 278, 281 (1957).
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