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9th Circuit Voids California Arbitration
Standards
In an eagerly anticipated decision, the Ninth Circuit has held that California’s stringent standards for arbitrator disclosure conflict with the NASD Code and are therefore preempted by the Securities and Exchange Act of 1934. Credit Suisse First Boston v. Grunwald, 2005 WL 466202 (9th Cir. March 1, 2005). Absent reversal by the full 9th Circuit en banc or the U.S. Supreme Court, the decision means that the much-maligned California standards are inapplicable to NASD arbitrations, and that the NASD’s waiver provisions, first enacted after promulgation of the standards and extended several times since, should now be unnecessary. In 2002, the California Judicial Council imposed ethical standards applicable to all “neutral arbitrators” serving within the state. Among other things, the standards required arbitrators to make extensive disclosures concerning family or other relationships with the parties or lawyers in an arbitration and to reveal their membership in certain organizations. The standards also provided that if an arbitrator failed to make a required disclosure, he or she would be automatically disqualified once a party served a timely notice of disqualification, and that the arbitrator’s non-removal would be grounds for vacatur of an award. The court in Grunwald considered two questions in assessing whether the California standards were preempted: (1) Can SRO arbitration rules be considered the “Law of the United States” for purposes of the Supremacy Clause of the U.S. Constitution and thereby trigger a preemption analysis? (2) If the answer to (1) is yes, do the rules have preemptive effect, either because “it is impossible for a private party to comply with both state and federal law” or because the state law “stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress”? The court answered both questions in the affirmative. As to the first, it relied on the fact that the NASD arbitrator-selection procedures had been expressly approved by the SEC. As to the second, the court found two aspects of the California standards that conflicted with the NASD Code: · the disqualification rules: Disqualification is mandatory in California if an arbitrator fails to make a required disclosure, but disqualification in an NASD arbitration is at the discretion of the Director of Arbitration. · the disclosure rules: While the extensive disclosures required in California do not actually conflict with the NASD’s less burdensome requirements, the court was persuaded by the SEC’s view that the state’s approach unduly interfered with federal objectives, including Congress’s goal of “delegating nationwide, cooperative regulatory authority to the Commission and the NASD.” Because the Grunwald decision construed only the NASD rules, its application to the rules of the NYSE is uncertain. The NYSE, together with their NASD, sued in 2002 to declare the standards unenforceable. That case was dismissed in but is now on appeal before the 9th Circuit. Other court decisions have also declared the California standards preempted. One such case, Jevne v. Superior Court, was argued before the California Supreme Court on March 8.
New York Court Permits Private Agreements to Override U-4In another major arbitration decision construing CSFB’s arbitration program, the New York Court of Appeals has held that securities firms and their employees can reach private agreements that call for arbitration in a manner and forum other than as set forth in the U-4. Nonetheless, the court held that the specific terms of the company’s program did not override the U-4. CSFB v. Pitofsky, 2005 WL 309957 (N.Y. Feb. 10, 2005). The plaintiffs in Pitofsky were former employees who claimed that they were owed additional sums under their employment agreements. Although they had previously executed U-4s, their specific agreements incorporated the terms of CSFB’s Employment Dispute Resolution Program (“EDRP”). The EDRP establishes a progressive three-stage process for resolving employment claims: an internal grievance procedure, external mediation through JAMS, and arbitration through JAMS, the AAA or the Center for Public Resources Institute. After the first two steps failed to resolve their claims, the plaintiffs commenced arbitration proceedings with the NYSE. The New York Supreme Court granted CSFB’s application to stay the NYSE arbitration, but the Appellate Division reversed, holding that “employment agreements cannot supersede . . . previously executed Form U-4 agreements.” The Court of Appeals rejected that aspect of the Appellate Division’s decision. Observing that “arbitration is a creature of contract,” the court applied basic rules of New York contract law and held that “the arbitration provisions of an employment agreement between a broker-dealer and a registered representative may supersede an earlier arbitration agreement between the registered representative and a stock exchange.” It continued: “CSFB and its registered representatives were free to negotiate the terms by which they would arbitrate employment-related disputes, just as any two parties to a bilateral contract could agree to modify it.” In light of certain language in the EDRP, however, the Court of Appeals held that it did not supplant the U-4. Specifically, the EDRP contained a carve-out stating that its arbitration procedures are inapplicable if the employee is “subject to a legal requirement” to arbitrate “pursuant to particular rules or in a particular forum (for example, at or pursuant to the rules of a stock exchange), to the exclusion of other forums and rules.” The court held that the U-4 imposes such a “legal requirement” because it incorporates the NYSE rules, which in turn mandate arbitration of “any controversy” between a firm and a registered representative. The court also observed that CSFB had issued a notice to its registered representatives that appeared to acknowledge that SRO arbitration rules would “[take] precedence over the arbitration rules” of the EDRP.
California Actions Challenge Status and Compensation of Securities BrokersThe surge of wage-and-hour class actions in California continues unabated, and increasingly has focused on the financial-services industry. In particular, several putative class actions have been filed against major brokerage firms in the last few months, challenging the companies’ alleged practices regarding the compensation of securities brokers. Some of these actions anticipate a class of affected California employees; others seek to certify a nationwide class. These class actions are still in their early stages, but they underscore that the financial-services industry has become a target for the plaintiffs’ wage-and-hour class action bar. The claims in these cases generally fall into two categories: (1) that brokers are not exempt from overtime requirements and/or (2) that brokers are subject to unlawful deductions from their wages. In the first category, the plaintiffs rely on two sources of statutory and regulatory authority: · The FLSA “commissioned employee” exemption: Section 7(i) of the FLSA provides an exemption from overtime for certain commissioned employees. However, the exemption applies only to employees of a “retail or service establishment.” The implementing regulations state that the requisite retail concept does not apply to “stock or commodity brokers.” 29 C.F.R. § 779.317. · State and federal “white collar” exemptions: The plaintiffs further contend that brokers do not qualify for a “white-collar” exemption, under either federal or California law, because they fail to satisfy the “salary basis” and/or the “duties” test. As to the salary basis test, the plaintiffs claim that brokers fail to receive the requisite minimum salary (e.g., commission-only employees) and/or that brokers are subject to deductions for routine business expenses, which, they argue, violate the salary basis test. As to the duties test, the plaintiffs principally contend that brokers are “production workers” who do not regularly exercise discretion and independent judgment in matters of consequence to the employer’s business. In the second category of cases, the plaintiffs claim that brokers are subject to illegal deductions and fines for trading errors and losses, are required to pay all or part of other employees’ compensation and/or are subject to disciplinary fines. They rely on California Labor Code sections 221 (which prohibits an employer from “collect[ing] or receiv[ing] from an employee any part of wages theretofore paid by said employer to said employee”) and 2802 (which provides that an employer “shall indemnify his or her employee for all necessary expenditures or losses by the employee in direct consequence of the discharge of his or her duties”). In both groups of cases, the plaintiffs also assert claims under California’s unfair business practices act (Cal. Bus. & Prof. Code § 17200), and several of the actions assert additional claims under California and/or other states’ labor laws. By way of relief, plaintiffs seek overtime pay for all hours worked in excess of forty per week or eight per day, restitution of allegedly unlawful deductions and fines, various statutory penalties and, of course, attorney’s fees.
More From the Golden State: Mandatory Sexual Harassment Training For SupervisorsEffective January 1, 2005, employers must provide sexual harassment training for their supervisors in California. Under the new law, any employer that regularly employs 50 or more persons (including independent contractors) must provide two hours of “effective and interactive” sexual harassment training to “supervisory” employees by January 1, 2006 and every two years thereafter. The law further requires that training be provided to any new supervisor within six months of his or her appointment to a supervisory position. Although the new law does not define the term “supervisor,” that term is broadly defined elsewhere in California law. Under the Fair Employment and Housing Act, a supervisor is any individual having “the authority to hire, transfer, suspend, lay off, recall, promote, discharge, assign, reward, or discipline other employees, or the responsibility to direct them, or to adjust their grievances, or effectively to recommend that action, if, in connection with the foregoing, the exercise of that authority is not of a merely routine or clerical nature, but requires the use of independent judgment.” California courts have interpreted this language liberally and have held that a “supervisor” includes any individual who simply directs an employee’s daily duties, even if the individual is not accountable or responsible for the employee’s performance and work product. The statute’s simplicity is deceptive. For example, it does not specify that the requisite 50 persons must be employed in California, and does not define “regularly employed.” This ambiguity raises many questions for employers with small California workforces. Similarly, the statute does not define the “effective and interactive” requirement, leaving unresolved whether on-line training is permissible, among other questions. Although full compliance with this law will not insulate an employer from liability in the event of a sexual harassment claim, the law provides that no finding of liability may result from the mere fact that such training is not provided. Nevertheless, any employer not providing such training will be faced with an order from the Department of Fair Employment and Housing, ordering them to comply with the law.
Update on Sawtelle v. Waddell & ReedWhen last we checked on the status of the long-running saga between Waddell & Reed and Stephen Sawtelle, a New York Supreme Court justice vacated the arbitration panel’s award of $25 million in punitive damages and sent the case to a new NASD panel. The court held that that the original panel had failed to consider whether the amount of punitive damages was proportional to the award of actual damages. On November 30, 2004, the court dealt another blow to Sawtelle. Concerned that he had already spent hundreds of thousands of dollars in fees and faced the prospect of a lengthy and expensive proceeding before a new arbitration panel, Sawtelle sought a “conditional remittitur” of the punitive damages award. While acknowledging that Sawtelle’s proposal “seems to make sense” and “would advance the purpose of arbitration by lessening the parties’ work and expense and by expediting the process,” the court nonetheless held that it had no such authority under the Federal Arbitration Act or New York law to order such relief in an arbitration. See 2004 WL 2732252 (Sup. Ct. New York Co. Nov. 30, 2004).
Proposed Changes to SRO Arbitration RulesFactual Explanations in Arbitration AwardsIn an attempt to increase “confidence in the fairness of the NASD arbitration process,” NASD Dispute Resolution (“NASD DR”) has proposed a rule that would allow customers or “associated persons” – but not member firms – to require a written explanation of the factual basis for an arbitration award. As practitioners are well aware, NASD arbitrators rarely provide any explanation of the rationale for their award. In circumstances where a customer or associated person loses, the absence of a written explanation “is one of the most common complaints.” In order to address such complaints, the proposal would allow those parties, at least 20 days before the hearings begin, to demand “a fact-based award stating the reason(s) each alleged cause of action was granted or denied.” The rule would not extend the same right to member firms. NASD DR explained that this limitation will allow customers and associated persons alone to assess “the potential costs” of an explained award “and the prospect that a reviewing court might find grounds in the explanation to vacate the award.” The limitation will also prevent “conflicts between co-respondents who may disagree on whether to request a decision.” Thus, while member firms can request an explained award (as they can do under current procedure), they will not be permitted to compel one. The rule would not require the arbitrators to provide their legal reasoning or damage calculations. NASD DR said that requiring such detail in awards would impose “additional costs and processing time” by fostering “complex and lengthy judicial-type decisions” and would in turn “require the payment of considerably more honoraria to arbitrators.” The proposal thus tries to strike a balance between “provid[ing] customers and associated persons with the information that they desire while at the same time maintaining the speed and thrift of arbitration.” Multi-Jurisdictional PracticeNASD DR has proposed a change to the Code of Arbitration Procedure under which a party may be represented in an arbitration or mediation by an attorney admitted in any United States jurisdiction, not necessarily the jurisdiction in which the proceeding takes place. The proposal reflects the current trend toward acceptance of multi-jurisdictional practice – that is, permitting lawyers (particularly in-house lawyers) to represent parties outside the state in which they are licensed. The proposal would amend rules 10316 (concerning arbitration) and 10408 (concerning mediation) by expressly permitting parties to “be represented by an attorney at law admitted to practice before the Supreme Court of the United States or the highest court of any state of the United States, the District of Columbia, or any commonwealth, territory, or possession of the United States.” In explaining its proposal, NASD DR stated that the change is intended “to reflect current practice,” in which out-of-state attorneys commonly represent parties in mediation and arbitration. The proposal also embodies NASD DR’s view that “the level of knowledge, training and skill of an attorney affects the outcome of an arbitration hearing, not the jurisdiction from which the attorney received his license to practice.” Because attorney licensing and discipline is a state-by-state matter, however, NASD DR stated that the proposed rule “is not intended to prevent a state from deciding that an out-of-state attorney may have violated a state’s unauthorized practice of law provision by representing a party in an NASD arbitration.” Thus, the proposal states that “[i]ssues regarding the qualification of a person to represent a party in arbitration are governed by applicable law and may be determined by an appropriate court or other regulatory agency.” Discovery AbuseA proposed amendment to the NYSE arbitration rules would state that the failure of a member or associated person “to appear or to produce any document in their possession or control” could “be deemed conduct inconsistent with just an equitable principles of trade” and serve as the basis for disciplinary action by the Exchange. The proposal, which is similar to an existing provision of the NASD Code, is designed to address “situations wherein it has been alleged that member organizations have not fulfilled their discovery obligations as prescribed by NYSE Arbitration Rules.”
ALJs Begin to Address Remedies for SOX WhistleblowersTwo-and-a-half years into Sarbanes-Oxley, Department of Labor Administrative Law Judges (“ALJs”) are beginning to consider the relief available to individuals who prevail on whistleblower claims. Two recent decisions illustrate the range of remedies that ALJs can award in such cases. Welch v. Cardinal Bank Shares, 2003-SOX-15 (ALJ Feb. 15, 2005): Welch, who filed a Sarbanes-Oxley whistleblower claim after he was terminated for complaining to Cardinal’s President and CEO about the company’s accounting practices, became the first Sarbanes-Oxley claimant to win an order of reinstatement, in addition to an award of back pay, costs and attorneys’ fees. In ordering reinstatement, the ALJ stated that “[r]einstatement is a drastic remedy and will frequently pose difficulties, but reinstatement as a remedy is generally appropriate to further the stated remedial goals of Sarbanes-Oxley, i.e. to make complainants whole.” Cardinal argued that reinstatement was inappropriate because it had independent grounds for Welch’s termination based on evidence acquired after his termination, and because Cardinal’s shareholders supported the termination. Cardinal further argued that reinstatement was unsuitable due to the “distrust and enmity” that had developed between Cardinal and Welch, and because Welch’s reinstatement would displace a subsequently hired individual. The ALJ rejected Cardinal’s after-acquired evidence argument, finding that Cardinal knew of the evidence prior to Welch’s termination. The ALJ also rejected Cardinal’s shareholder-support argument and found that Welch’s intent to make his return “productive for all concerned” outweighed Cardinal’s concerns about “distrust and enmity.” Finally, the ALJ rejected Cardinal’s displacement argument because Cardinal had filled the position despite Welch’s legal claim to the position and because the incumbent CFO likely was aware of Welch’s pending claim. Jayaraj v. Pro-Pharmaceuticals, Inc., 2003-SOX-32 (ALJ Feb. 11, 2005): Jayaraj, who was terminated after complaining that her employer was using an unregistered broker to bring investors to his employer for private deals in exchange for a commission, in violation of the Securities and Exchange Act of 1934, also was awarded monetary damages under Sarbanes-Oxley. The ALJ ordered Jayaraj’s employer to pay her attorneys’ fees and other costs, to eliminate any reference of termination from her personnel file, and to revise her personnel records to show that her performance was satisfactory. Nonetheless, the ALJ refused Jayaraj’s request for compensation for forfeited stock options and for special damages, including damages for humiliation and for “career impact resulting from her termination.” Because Jayaraj suffered from a medical condition that prevented her from working, she did not seek to be reinstated or to recover back pay. |
