Labor & Employment Law

Texas Securities Industry Attorney: New York Gives Absolute Privilege for NASD Form U-5

By Robert Wood, David Ellis, and James Landon

Most companies, when they terminate an employee, refuse to disclose the reason for termination to a potential subsequent employer. Companies know that disclosing the reason for termination to a third party may subject them to a defamation suit. As a result, they typically reveal only the ex-employee’s dates of employment and position held.

For companies that are members of the National Association of Securities Dealers (NASD), however, silence is not an option. Pursuant to NASD rules, an employer member firm must file with the NASD a form stating the reason for terminating a registered representative (broker). This “Form U-5” must be submitted within 30 days of termination, and a copy of the U-5 must be given to the terminated broker.

The NASD stores the U-5 on its online registration and licensing database, which is accessible by other member firms and, upon request, by potential investors. Thus, a terminated broker’s potential future employers and any person contemplating doing business with the broker will be able to learn why the broker was terminated.

Because the information provided on a Form U-5 can adversely affect a terminated broker’s efforts to obtain future employment, as well as the broker’s ability to do business with potential clients, statements contained in U-5s are often the subject of defamation claims filed by brokers against their former employers. In such cases, brokers dispute the reasons given for termination, and they contend that the existence of the U-5 has caused them economic harm.

Some states provide an employer defending against a U-5 defamation claim a qualified privilege defense. The qualified privilege does not bar the former employee’s defamation claim. However, it does require the former employee, in addition to proving that the statements in the U-5 were false and harmful, to show that the employer acted with malice (i.e., that the employer knew or should have suspected that its proffered reasons for termination were false). Although Texas cases dealing with U-5s are few in number, it appears that NASD-member employers in Texas enjoy a qualified privilege.

Recently, the highest court in New York gave NASD member firms total protection from U-5 defamation claims. In Rosenberg v. MetLife, Inc., 2007 WL 922920, 2007 N.Y. Slip Op. 02627 (Mar. 29, 2007), the Court of Appeals of New York held that statements on an NASD Form U-5 are absolutely privileged. Unlike a qualified privilege—which constitutes a defense to a defamation claim—an absolute privilege bars the claim. Thus, in New York, there is no claim for defamation based upon a U-5 filing.

The New York court based its decision on several factors. First, the court acknowledged the strong public interest in knowing about brokers who engage in illegal or unethical conduct. The court noted that it had previously granted an absolute privilege to persons who submit grievance letters against attorneys, and it stated that “the regulation of registered brokers in the securities industry is of no less importance” than ensuring that attorneys comply with the law. Indeed, with an absolute privilege, employers may be more forthcoming about a broker’s wrongdoing (whereas currently an employer is well advised to be cautious about what it puts on the U-5).

The court also viewed the filing of the Form U-5 as a “first step in the NASD’s quasi-judicial process.” The court saw the form as “the first indication that the NASD receives regarding possible misconduct by members of the securities industry, and investigations of misconduct reported on the Form U-5 frequently lead to the initiation of disciplinary action by the NASD.” Because statements in a judicial or quasi-judicial proceeding were absolutely privileged, the court held, statements that naturally would result in such proceedings should enjoy the same degree of privilege.

The dissent disagreed, arguing that unlike complaints submitted to an attorney grievance committee, which are confidential, potential future employers in the securities industry must view an individual’s Form U-5 during the hiring process. Thus, a statement in a Form U-5 would represent a “danger of substantial harm to the individual about whom the statement is made.” Furthermore, the dissent was skeptical of the majority’s claim that a Form U-5 was a preliminary step to a quasi-judicial proceeding, noting that the filing of a U-5 imposes no duty upon the NASD to investigate the statements contained therein. In response to employer concerns, the dissent also observed that “truth is a complete defense to a defamation claim.”

Given New York’s preeminent role in the securities industry, other courts may adopt the majority’s reasoning. Potential investors have a significant interest in knowing about unscrupulous brokers. That right to know may be held to outweigh a broker’s ability to sue his former employer for defamation, particularly since the absolute privilege defense does not preclude the broker from filing an arbitration to expunge the alleged defamatory language. Also, if other states follow New York’s lead, the NASD may begin to more carefully scrutinize and investigate the U-5s they receive, and the NASD can penalize firms which include untruthful statements therein.

Full post as published by Texas Non-Compete Law Blog on June 13, 2007 (boomark / email).