Commentary: RR Magazine's Editor in Chief Dan Jamieson's Comment Letter to the SEC on the NASDR's Proposed TRO Rule
May 1, 2000 Securities and Exchange Commission Jonathan Katz, Secretary 450 Fifth St., N.W. Washington, D.C. 20549-0609 Comment to File No. SR-NASD-00-02, the Injunctive Relief Rule. Dear Mr. Katz: Thank you for taking comments on the proposed injunctive relief rule. As a journalist who covers retail employment practices on Wall Street, I have been following the injunctive relief (or TRO) rule for a number of years. I have no financial stake in the outcome of this controversy. I must respectfully say that it is disheartening to see this proposal come before the Commission. Never has so much time and effort been spent by the Commission and the NASD to accommodate the wishes of just a few powerful member firms to the disadvantage of other firms, registered representatives ("brokers"), other industry employees and investors. Section 15A(b)(6) of the ’34 Act directs the SEC to ensure that SRO rules are: "designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in securities, to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest; and are not designed to permit unfair discrimination between customers, issuers, brokers, or dealers. …" Section 15A(b)(9) of the Act directs the SEC to ensure that SRO rules: "do not impose any burden on competition not necessary or appropriate in furtherance of the purposes of this title." After several rounds of comment letters and years of debate, in July 1998 the NASD filed a rule proposing to amend Rule 10335 (SR- NASD-98-49, the "prior" proposed rule). This prior proposed permanent rule has been withdrawn in favor of the current filing. The prior proposal would have limited court TROs to 10 days and required a full arbitration hearing in 28 days. It was a step in the right direction because it limited what firms could do in court. Limits on court TROs and injunctions are necessary since these orders can prohibit brokers from making a living and from advising their customers, and often freeze customer accounts as well (see below). All of these results can easily violate the intentions of Sections 15A(b)(6) and 15A(b) (9) of the ’34 Act. Because the proposed rule eliminates any real limits on how TROs and injunctions are used—to the benefit of a few major brokerages that bring the majority of these suits--the proposed rule is unfairly discriminatory, fosters acrimony instead of cooperation and coordination, impedes an open market, erodes investor protection, and is an undue burden on competition. Injunctive requests are done for purely economic reasons. These cookie-cutter suits are cheap to bring and are quite effective in leveraging a settlement from the recruiting firm. Settlements are typically 20% or so of a broker’s trailing 12 months production--$100,000 for a $500,000 producer, for example. Suing brokers is therefore highly profitable. By more closely regulating injunctions, the prior proposed rule would have devalued the worth of TROs/injunctions. Firms that use the broker-suing strategy did not want to see the value of the TRO strategy eroded. As the Commission well knows, Merrill Lynch and American Express Financial Advisors (AEFA) made past-due, 11th hour comments to the Commission regarding the prior proposed rule. The NASDR claimed it felt compelled to consider these comments, since the SEC had accepted them. The NASDR could have dismissed these firms’ concerns or amended the prior proposed final rule in response. Instead, it set up a subcommittee of its arbitration committee to hatch up a new plan behind closed doors. Hence, the prior rule proposal, tediously crafted over several years, has been blown up by political maneuvering. Adding further insult to the interests of both brokers and public customers, the Commission has seen fit to publish this new rule with a stingy 21 days set aside for comments. The new proposal essentially wipes away any regulation of TROs/injunctions. While this is no doubt the desired goal of a few powerful brokerage firms, such an industry practice should be strictly regulated because unchecked, it can very easily violate industry and federal standards for just and equitable dealings. Why The Proposal Should Be Rejected Specifically, here is why the proposal should be rejected: The Proposal Would Violate Sections 15A(b)(6) and 15A(b)(9) of the ’34 Act. As noted, the Act requires rules that are fair and non-discriminatory, not a burden on competition, that foster cooperation and coordination, facilitate transactions, remove impediments, and protect customers and the public interest. The proposed rule violates each of these principles. Additionally, the process by which the rule was drafted was unfair and violated the SEC’s 1996 remedial sanctions order against the NASD. TROs serve only to inhibit broker and client mobility and extract settlements from competing firms. The proposal would continue, and probably increase, the roughshod treatment of clients and their accounts. In what seems to be a growing number of instances, clients are being handcuffed along with their brokers. They have been prohibited by courts from transferring their accounts, from making transactions with their established broker, and from getting financial advice from a trusted source—the broker they know and trust, the very same broker who knows the customer. Holding up transfers is a violation of NASD Uniform Practice Rule 11870 and NYSE Rule 412. Preventing transfers and forbidding communication harms the facilitation of transactions. Interfering with clients’ communication with the firm and broker of their choice is against the public interest. Indeed, many courts have stated that investors’ rights should be of foremost concern in these disputes. Because TROs and injunctions prohibit a broker from making a living for a period of time, because stalling tactics are often used, and because of the heavy burden of defending oneself simultaneously in both arbitration and court, this legal practice can be an undue burden on competition. Therefore, a very limited time frame for court-ordered injunctions/TROs is called for. But this proposal will do nothing to expedite an arbitration. While it provides for a hearing in 15 days, arbitrators are also specifically banned from expediting resolution of the court conflict. They can only request that parties seek to take action, and even then, only "after a full and fair presentation of evidence from all relevant parties. …" Thus the proposal appears designed to give plaintiffs no limits on the games they play in court. It is this gamesmanship that inspired rulemaking in the first place. By having no limits, and even handcuffing panels, this proposal would be discriminatory and an undue burden on competition. It would lead to less cooperation and coordination, harm facilitation of transactions, and be against the public interest. Furthermore, the ability of a broker to change employers and maintain contact with customers is crucial for investor protection. Contrary to the apparent bias of some regulators who understandably become jaded by dealing with the dregs of brokerage society, most brokers are actually the "good guys." Typically, they will speak out against practices they deem contrary to their clients’ (and therefore their own) interests. When there is a case of wrongdoing at a firm, an RR must be absolutely free to leave. The rep must be free to maintain contact with clients. And they must be free to blow a whistle or give evidence without the threat of undue legal action. As A.G. Edwards CEO Ben Edwards has said, broker mobility keeps managements honest. Mobility is a key element of investor protection. But the proposed rule would weaken broker and client mobility and erode the main goal of the ’34 Act-- investor protection. The proposal is also discriminatory against member firms. By the end of Oct. ’97, the NASDR’s comment period for NTM 97-59 had produced 17 letters--14 of those letters recommended eliminating the court option for TROs. Many of those negative commentators were member firms. This proposal is a complete turnaround from the prior proposed final rule that generally balanced all comments received by the NASDR. But this proposal eliminates the NASDR injunctive option and requires that TROs come from courts. Acting on the behest of a small minority of influential members is against the Act. NASDR staff should be commended for disclosing something about how the NASDR political process works: "In response to additional formal and informal comments received after the amendments and responses to comments were filed, the Injunctive Relief Rule Subcommittee of NASD Regulation's Inc's National Arbitration and Mediation Committee (``NAMC'') undertook to reconsider every aspect of the proposed rule change. In addition to its NAMC members, the Subcommittee included representatives from member firms that has [sic] expressed an interest in the rule, including all of the retail firms that commented negatively on the prior rule filing." (Emphasis added.) Merrill Lynch and AEFA were firms that commented negatively. They had access to backdoor, "informal" channels to force reconsideration of every aspect of the prior proposal that they did not like. To accommodate these firms, the NASDR created the new subcommittee, the members of which remain secret. The subcommittee then drafted this current proposal. As the NASDR admits, all member firms opposing the prior draft rule had representatives and input into the rulemaking process; brokers and investors had none. The process was inarguably discriminatory under the Act, and a violation of the remedial sanctions order (see below). A comparison of the prior proposed final rule and this one shows the result of the unfair process. Certain favored member firms got what they wanted, while the rest of the industry, employees and investors will be further disadvantaged. Instead of a 10-day limit on TROs, we now get no effective limit. In fact, the rule would add an explicit NASDR policy that allows court orders to stay in effect during the entire run of an NASDR arbitration hearing—a dangerous attempt by the NASD to supersede existing case law. The filing says: "NASD Regulation does not believe that arbitration panels have the authority to dissolve, modify or supersede a court order." Only "after a full and fair presentation of evidence from all relevant parties" are panelists allowed to seek action from parties related to court orders (emphasis added). Although not entirely clear, the language appears to say that arbitrators cannot do anything about a court order until a full hearing concludes. Even then, they can only ask the parties to take action. Full hearings often take many months. Seeking and appealing TRO and injunctive rulings itself can take many months. Therefore, the rule will be valuable ammunition for plaintiffs who seek to create lengthy bifurcated proceedings. While a respondent would get an arbitration hearing within 15 days under the proposal, instead of in 28 days under the prior proposal, this is hardly a worthwhile concession. Plaintiffs would be given a green light to stay in court for the duration of a hearing. The result will be more two-track litigation, discriminatory treatment of brokers and clients, more burdens on competition, less cooperation and coordination, restrictions and impediments on transactions, and a general disregard for the public interest. Instead of using existing practice to pick a panel, this proposal creates a new and complicated procedure for picking arbitrators who specialize in injunctive relief. These so-called specialists, if there is such a thing, will tend to be either public members or industry members aligned to member firms, further disadvantaging brokers and customers. Public panelists are more likely to rule based on narrow legal readings of contracts. Industry panelists who specialize in injunctive relief would most commonly be lawyers at member firms or at law firms that work for member firms. The injunctive defense bar, in contrast, is more limited in numbers and probably less likely to serve as arbitrators. The result will be a pool of arbitrators primarily made up of public and firm-aligned panelists. These panels will tend to focus on legal technicalities or the rights of firms. This will be discriminatory against brokers and customers. Ideally, these cases should be heard by neutral industry panelists whose industry savvy and common sense are more likely to result in decisions comporting to accepted industry practice, SRO rules and federal securities law. TROing firms understand that non-lawyer industry panelists are generally more likely to allow brokers the freedom to work, and clients the right to choose their advisers, with a minimum of restrictions. Tilting the panelist pool toward public and firm-aligned attorneys is discriminatory. As the Commission has noted, the proposed rule would restrict arbitrators’ abilities to allocate costs. The proposal would force brokers suffering falling incomes due to gag orders and account freezes--as well as mounting legal bills--to split the costs of an expensively produced injunctive panel as well as certain costs for the full hearing. Restrictions on arbitrators’ powers should never be approved by the Commission. Any such action will give potent ammunition to legal challenges to industry arbitration and decrease confidence in the fairness of NASDR-run forums. If the fee-splitting language is left in, it will also provoke further litigation as brokers will be forced to seek recovery in court for wrongful injunctions since panelists will be limited in their ability to fix any inequity. The fee-splitting language is discriminatory and an undue burden on competition. In addition, the process by which this proposal was drafted violated the 1996 remedial sanctions order. Under the SEC’s order, the NASD was directed to make rules "with any consultations with interested NASD constituencies made in a fair and evenhanded manner." The NASD later made representations to the SEC that all constituencies would have input at the early stages of any rulemaking process. The process by which this proposal was drafted obviously involved consultations with some interested constituencies. But it excluded consultations with TRO defense attorneys, registered representatives, other industry employees who may sign restrictive covenants, and investors--all of whom are affected by injunctions more profoundly than any member firm. The exclusion of key constituencies, together with the secrecy under which the rule was drafted, is a clear violation of the remedial sanctions order and is discriminatory under the Act. Further discrimination occurred when this proposal was put out for comment with a meager 21-day comment period. The Commission must give employee and investor interests at least a fighting chance to impact rulemaking. Surely the Commission understands that industry employees and investors do not have high-powered lobbying efforts. If anything, the Commission should error on the side of ensuring that these interests are over-represented. It is not too much to ask that non-member firm constituencies be given an opportunity to digest and critique this proposal--a backroom deal hatched with unusual speed that may have ignored prior debate and input. Ninety days for comments is a bare minimum. Anything shorter would be discriminatory treatment. Had employees and expert TRO defense attorneys been involved, a more balanced rule would have been likely, or the prior proposed rule would have been preserved, and a 21-day comment period may then have been appropriate. Unfortunately, that was not the case. The investing public and brokers were further disadvantaged because the proposal was not publicized on either the SEC’s or NASDR’s websites. The NASDR and Commission know well that the TRO process has generated much debate, controversy, press coverage and legal seminars on raiding. That both the NASDR and SEC omitted to publicize this entirely new proposal born from a confidential drafting process almost defies innocent explanation. Upon reflection, a fair-minded Commission must publicize the proposal and lengthen the comment period. To do otherwise would discriminate against industry employees as well as investors. Three months for comment does not seem unreasonable for a proposal many years in the making that can have grave effects on both brokers and customers. Injunctive relief has been described in this proposal and past proposals as an effort to deal with "raiding" cases. This is a misuse of the word "raiding." As used in the industry at least, a "raid" involves the capture of many employees or key managers from a competitor. Somehow, for purposes of proposed NASDR injunctive relief rules, defections of lone brokers have been tarred with the negative "raid" moniker, prejudicing brokers in this rulemaking process. This is discriminatory. For the above reasons, the proposal would violate the Act’s requirement that rules be fair and non-discriminatory, not a burden on competition, that they foster cooperation and coordination, facilitate transactions, remove impediments and in general protect customers and the public interest. Additionally, the process by which the rule was drafted was unfair and in violation of specific NASDR procedures. The NASDR Offers No Substantiation for the Proposal. The proposal is incomplete and cannot be approved as a result. The Commission has granted a number of delays of a permanent rule in order to allow the NASDR to gather more data about the current pilot program. Four delays have been granted by the agency based on this reasoning. But where is this data? The NASDR’s proposal is completely lacking in any factual information about injunctive cases. Such data does exist. Under the current pilot, not only must firms file for arbitration when they seek a court order, they must also immediately report to the NASDR when they get a court order. Why has the NASDR neglected to include updated data in this proposal? It is likely that certain member firms put pressure on the NASDR to refrain from disclosing such data. Disclosure of some 1996 data made clear that nearly all (96%) of theses cases settle. It became transparent that TROs and injunctions are used to extort a settlement from the recruiting firm, rather than preserve legitimate business interests from the "irreparable harm" of losing an employee. The 1996 NASDR data also made clear that industry-savvy arbitrators would not rubber-stamp injunctive requests. Aside from lack of basic data needed by the Commission to make an informed and fair policy decision, the NASDR offers up no detailed analysis of any problems with the current pilot or with the prior proposed permanent rule. The current proposal says only that: "users of the rule have complained that the bifurcated procedures and multiple layers of review provided by the current pilot rule are unnecessarily complex and confusing. The principal objectives of the proposed amendments are to simplify and expedite the procedures for seeking immediate injunctive relief in intra-industry disputes and to fairly and effectively integrate court-ordered initial injunctive relief with the arbitration of the underlying claims in the same disputes." The current pilot rule that has been in effect since 1996 does little more than to require the simultaneous filing of an arbitration claim when an injunction is sought. What is complex and confusing about it? How many cases have become bifurcated? How many cases went to hearings with a court order still in effect during a hearing? What exactly is the "multiple layers of review" problem? How much time was spent resolving these disputes? What have been the delays that justify an entirely new proposal? The NASDR provides no clue. These are all questions the Commission must get answers to before acting on this proposal. Recall, too, that the prior proposed final rule was drafted to end the bifurcation problems (with a 10-day TRO limit) and speed up resolution (with a full hearing in 28 days). But that rule was never implemented. Was it too complex? Why would the prior proposal not have solved the bifurcation problem and expedited the injunctive process? Why will this new proposal, whereby all injunctive cases go to court, help alleviate the bifurcation problem? Why will this new proposal, which explicitly forbids arbitrators from impacting a court order, help solve problems of bifurcation and delay? Being remiss in demanding any kind of substantiation for this new proposal would be a gross failure on the part of the Commission to follow through on its basic oversight duties. The SEC must either reject the current proposal outright, or send it back to the NASDR for proper substantiation. Upon accepting any new proposal, the Commission must then make more than a cursory attempt at critiquing the proposal and directing comment. The Proposal Would Constitute Illegal Rulemaking by the NASDR and the SEC. As noted above, the proposal would eliminate any authority over court orders that arbitrators now enjoy under controlling law. The proposal says that panelists can only order the parties to take action regarding an order after a hearing is complete. But according to Thomas Campbell, who apparently defends more of these cases than anyone, "Under controlling federal law, which would be superseded by the proposed rule, the courts may not enter preliminary injunctions or TROs that last beyond the commencement of hearings on the interim injunctive relief claim." Campbell further says, "there is no confusion as to the power of the arbitrators and the courts. The courts may not encroach on the arbitrators’ jurisdiction or authority." Neither the NASDR nor the SEC have the authority to override controlling law. Nor should they be weighing in on developing law in this area, other than to support arbitration in general. Any final injunctive relief rule must remain absolutely neutral as to arbitrators’ powers over court orders. To do otherwise puts the Commission in the role of a final judge on this issue. Recommendations for a New Rule The following steps should be part of the process and the content of any revised injunctive relief rule: --The NASDR should be encouraged to submit the prior proposed final rule for approval. Alternatively, NASDR staff and executives should be sent back to the drawing board to redraft a new proposal. This time, a truly balanced sample of representatives should be included on any committee charged with formulating a rule. TRO defense attorneys should be included, as well as brokers and customers. The process should be public, and open debate encouraged. --Consideration should be given to retaining the NASDR injunctive process and to other alternatives for panel formation. While parties may have legitimate needs for court injunctions in unique situations, the NASDR injunctive process may be best for purely contractual disputes, and for disputes where the main claim is contractual but where various torts may be asserted as a pretext for getting into court. The NASDR should consider other ideas on panel formation, such as a three-person industry panel that would have a current or former broker, branch manager and securities attorney, or a specialized pool of single arbitrators who hear injunctive relief cases. These single panelists need not be public members or "injunctive specialists." Panelists could easily become familiar with these cases’ almost identical facts and circumstances, which would help ensure fairness and consistency. Another option is that the party being enjoined should have the option of an all-industry panel to hear the case. Such an option would make NASDR arbitration code consistent with NYSE procedure, and ensure equitable treatment of these contractual disputes. If the NASDR retains an injunctive option, all NASDR injunctive decisions should be made public regardless of ultimate disposition. --The right to go to court can be maintained, but with strict limits. The prior proposal’s 10-day limit on TROs should be retained. Some type of arbitration should occur within the 10 days. Courts could well ignore this rule, but at least an NASDR/SEC policy on getting these disputes to arbitration in 10 days ensures that brokers and customers get a bit of bargaining power, while ensuring firms can protect legitimate business interests. --NASDR must remain neutral on arbitrator authority. Eliminating powers arbitrators might otherwise have is unfair. Any final rule must be neutral on panels’ powers over court orders or allocations of costs. The current Code’s Section 10335(g) should be amended to maintain neutrality regarding the powers of courts and panels. --Under no circumstances should a member firm be able to enjoin or seek to enjoin or inhibit customers, the transfer of their accounts, or customers’ contact and communication with a broker of their choice. A rule must be developed to ensure protection of investors’ rights in this area. --Require full disclosure. Customers of brokers who are subject to a restrictive covenant should be informed of the implications. Further, when a firm gets an injunction, the NASDR should require that a standard NASDR-written letter be sent to all affected customers explaining the dispute, and advising the customer of his right to do business with any firm or broker of his choice, and giving the contact information for his established broker as well as for any newly assigned broker at the enjoining firm. The letter should make clear which party is responsible for the gag order and/or account freeze. --The NASDR should convene a committee, with broker and investor representatives, to study whether restrictive covenants for retail brokers are a violation of the securities acts and SRO rules. The committee should consider what might be acceptable industry standards for "confidentiality" of customer information such as names, phone numbers and addresses, and to what extent if any the duties of a broker to a client can be interfered with. The practices of firms that sue defecting employees may conflict with law and procedure in several states. For example, under California law stockbrokers are considered fiduciaries, bringing into question any restrictive covenant that would prohibit communication with clients. In Wisconsin, departing registered representatives are allowed to copy records of the customers they personally served. Conclusion The proposed Rule is defective and must be rejected by the Commission or sent back to the NASDR. It fails to regulate TROs and injunctions and as such would violate Sections 15A(b)(6) and 15A(b)(9) of the ’34 Act. Any final rule should strictly regulate injunctions and TROs, and maintain neutrality in allowing arbitrators to handle court orders and cost allocations as they deem appropriate and legal. A reasonable compromise may have been achieved with the prior proposed rule, subject of course to public comment and Commission consideration of those comments. Several simple, but key elements should be a part of any final injunctive rule. Sincerely, Dan Jamieson Public Investor Editor's note: For any comments regarding this article, or to suggest a story idea for RRDaily or Registered Representative Magazine, contact Online Editor Rick Weinberg at [email protected] or Editor in Chief Dan Jamieson at [email protected].
