Terra Extraneus

As an Oklahoma based trial lawyer, I do not have the luxury of a continuous stream of cases all in the same genre or even area of law. Largely originating on one of the three coasts (including the Gulf Coast), cases usually come in waves. I just completed a three year group of 41 cases, ten of which were tried, against Goldman Sachs & Company. This particular wave of cases was actually the second tidal surge because during the three years prior to the just concluded three years, I was counsel against Goldman Sachs in a predecessor wave of cases.

Goldman Sachs manages its exposure somewhat idiosyncratically and not quite like the other wire houses or other member firms in the securities industry. For instance, Goldman Sachs is far more concerned about its image than it is winning or losing, or even the economics of any particular case. Because the securities industry effectively gags its associated persons thus creating a conspiracy of silence, Goldman Sachs can litigate endlessly with associated persons and face little risk that the image it jealously guards will be tarnished by inconvenient media exposure.

The news media has no effective means of penetrating this conspiracy of silence, because no member firm is going to allow its associated persons to speak freely to the media, even about other member firms (or previous employers). Also, one has to wonder if the media will even try to break the code of silence, because of the possible back lash by one or more member firms.

Abusive personnel practices have been a hall mark of about half the securities industry, and avoided by the other half. Goldman Sachs’ abuse of registered representatives was largely the result of institutional errors made when investment bankers attempted to “fix” the firm’s “brokerage” and “advisory” personal wealth management business. It reminded me of watching a newly minted teenage driver. You constantly have to remind them at first to look back over their shoulder while backing out of the driveway. Goldman Sachs was so intent upon socially engineering the lives of its registered representatives that it back over half of them.

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During the National Public Radio program Morning Edition, Liz Ryan, a columnist for Business Week, was interviewed by Steve Inskeep, and you can find the interview here. According to the NPR story, a company called Clarian Health first said it would dock the wages of employees who are overweight or who smoke. Then it backed away from that plan. When asked if such a wage withholding plan was lawful, Liz Ryan said it was.

She is wrong.

In most states, it would be illegal by statute to withhold wages without written consent. Thus, when or if someone objected to Clarian Health’s announced plan, Clarian Health no doubt got a refresher course on these little used statutes.

For in-house corporate lawyers who often must be “jacks of all trades,” Gordon E. Jackson’s book, Labor and Employment Law Handbook, Aspen Publishers, is a good desk reference to keep around to avoid such errors. Liz Ryan is a well-regarded human resourcees expert who writes a blog on workplace matters — and is a professional opera singer, as well! However, she is not an attorney. If Ms. Ryan is going to grant news interviews on employment law, she might want to grab a copy of Jackson’s handbook, too.

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Karen Donovan at Registered Rep reported the recent study issued by a Washington, DC law firm that concluded that fines and sanctions were less when the enforcement issues were litigated than when imposed by settling with FINRA (“Financial Industry Regulatory Authority”). FINRA, according to Donovan, rebutted the study by merely sloughing it off as a lawyer’s marketing dream.

I have not done a study. Indeed, the study that was issued by the law firm reported by Registered Representative only looked at 55 panel decisions from June 2006 through June 2007. That means the sweep of time was not considered and it means the recent merger of NASD enforcement with NYSE enforcement was not evaluated. In my own experience, there was a difference between the two.

FINRA investigations were usually conducted initially by a compliance professional that was not a trial lawyer and NYSE investigations were often conducted by lawyers, some of whom had enforcement trial experience. Both were relatively easy and fair to deal with prior to filing of a formal enforcement proceeding, and lots of matters could be settled at that stage. Once, however, the formal enforcement action was filed and pending, both were much more difficult.

My own experience has led me to believe the following about enforcement actions generally, and I believe this will generally be true of FINRA enforcement actions.

1. Enforcement proceeding panels usually have at least two industry members on the panel with an enforcement department attorney acting somewhat as an administrative law judge. Industry members are more likely to buffer the harshness of sanctions even in the presence of a stifling enforcement department panelist.

2. The real problem in enforcement actions for the licensed professional is financing the defense if the supervisor or employer will not do so. FINRA has finite resources to allocate, too, but in any given case the licensed professional is out classed. That does not mean that FINRA won’t be tempted to pick off the weak, the sick and aged like any good buffalo hunter, and avoid the bulls and mastodons running with the herd.

3. Most licensed professionals that end up in enforcement proceedings are probably there because of a lapse in integrity, but too many are there for an error in judgment that may not have been their fault. While the industry is retreating from its hand shake business model, that is still the dominate platform. It is a fertile ground for hindsight compliance reviews, customer complaints and disinterring the financial advice from the then prevalent circumstances.

4. Some enforcement actions are brought because of a lack of perspective. A lapse in judgment, i.e., a moment of carelessness, should not result in the same sanctions as intentional or even criminal conduct. If there was no loss attributable to the violative conduct, it almost always means the conduct resulted from unintentional rather than intentional conduct.

These are some, but not all, of the considerations that would create an environment in which enforcement proceedings might result in lesser sanctions or settlements result in harsher sanctions. Clearly, some have nothing to do with the facts of the case. None of them have to do with whether they are studied by lawyers or sociologists.

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The newest published decision regarding U-5 defamation of a terminated registered representative is like an aquarium, for once you can see all of the fish swimming about.

Deborah Galarneau v Merrill Lynch, Pierce Fenner & Smith, Inc. was issued by United States Court of Appeals for the 1st Circuit. The case did not go to industry arbitration because it included a federal discrimination claim. But, the only claim that survived motion practice was the claim that the Form U-5 filed by the employer was defamatory.

The case was tried and decided under the law of the state of Maine, which extended to the employer a qualified privilege, which required the employee to prove that the U-5 entry was false and that the entry was made with actual malice. On appeal, the employer sought 1st Amendment protection for its U-5 filing, but that rather bizarre argument was too little too late.

The 1st Circuit found that the record in the trial court before the jury, indeed, did contain evidence supporting the jury verdict. The employer on four occasions conducted management review of the trading, approved it each time, issued comfort letters to the customer and denied in written responses to regulators that the trading was in anyway improper.

Meanwhile, Ms. Galarneau was summoned to New York by her employer to be interviewed by the Office of the General Counsel. The lesson here for registered representatives: prepare for such an interview. Engage counsel to assist in the preparation, if necessary. Do not take counsel to the interview by the employer (employees that feel they need to take a lawyer to a meeting with their employer should prepare their resume). At the meeting, she allegedly admitted exercising time and price discretion.

But, on her U-5, in addition to listing exercise of time and price discretion as a reason for termination, the employer listed “inappropriate trading,” the same trading approved four times by management, as a reason for termination. The predictable result was that no other firm would consider her.

One of the interesting things contrasted in the opinion was the over reaction by in house counsel. In house counsel rebutted the state regulatory inquiry and then permitted the regulatory response to be contradicted in the U-5. In an awkward effort to defend it, the employer on appeal tried to argue that only after the employer received a report from its outside accounting vendor, Bates Capital, did it become clear that some of the trading was “inappropriate.” Because the employer is the largest broker dealer in the world, it is laughable to think its supervisory accounting systems cannot detect “inappropriate” trading, especially since that trading has to be approved one trade at a time by a local supervisor and further stretches credulity beyond the breaking point to think a multi-billion broker dealer and investment bank must rely on a tiny non-public accounting vendor to learn the truth.

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After the foregoing was posted, Investment News published its news blurb on the opinion which you can find here. While I have great respect for this publication, the title of the article implies the entire judgment was reversed. The article seems to spin the opinion (calling it a “report,” possibly indicating a lack of familiarity with the judicial system) favorably to the employer. However, the $850,000 verdict was sustained. The $2.1 million punitive damages award was reversed. The plaintiff was able to prove actual malice or the verdict for compensatory damages would not have been sustained. The plaintiff was unable to prove the U-5 defamation was intentionally designed to make the plaintiff unemployable, so the punitive damages award was not sustained.

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As everyone knows, Oklahoma but not Texas is in the 10th Circuit. Nevertheless, sometimes a federal court sitting in diversity jurisdiction in Oklahoma, for example, must apply Texas law because of a choice of law provision that is for some reason enforceable. Thus, it may not be all that helpful, as decisions go, for future guidance.

In Rash v J. V. Intermediate, Ltd, the 10th Circuit, under Texas law, held that a forfeiture of the fee owed to an agent is not to be automatically forfeited upon a finding of disloyalty to the principal, but is to be applied only to “clear and serious” violations of fiduciary duty. Not every agency relationship is fiduciary, but the one in this case was considered one by the district court and the 10th Circuit did not disagree.

Moreover, under Texas law, the 10th Circuit required that the forfeiture be considered the other relief accorded to the principal is a significant “equitable factor.” In other words, no double dipping allowed. However, the forfeiture might be appropriate to address damages not otherwise compensated.

This case is one more likely to be misquoted and over extended, and those faced with the typically draconian remedy of forfeiture of compensation should be alert to its limitations.

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Investment News reported that New York’s highest court granted absolute immunity to multi-billion dollar MetLife, Inc. for filing a U-5 termination statement. In the retail securities industry, broker dealers must file a form U-5 with the Central Registration Depository operated by the National Association of Securities Dealers, Inc. every time a registered representative (persons that can sell securities to the public) departs from their employment. The form U-5 must contain the employer’s version of the reason for the termination.

In Rosenberg v. MetLife, Inc., the United States Court of Appeals for the 2nd Circuit certified a question from one of its cases to the highest court of New York and inquired whether MetLife had absolute immunity from a defamation suit for its entry on the Form U-5. The New York high court held that MetLife was entitled to absolute immunity for its U-5 entry.

MetLife was immunized under the new doctrine even though MetLife stated for public consumption that its former employee was a “possible accessory to money laundering violations.” MetLife was not required to state whether its investigation established the accusation as fact or more than merely “possible.” Indeed, MetLife was not required to complete the investigation, no matter that its statement on Form U-5 might destroy its former employee, even if he was in fact innocent.

MetLife’s former employee was an Hasidic Jew and was hired by MetLife specifically for the purpose of reaching that community. The Hasidic Jews routinely relied on a free loan society to pay premiums, probably on variable insurance products that included securities investments in the variable accounts of the products, resulting in third party checks being used to pay premiums. MetLife, like most broker dealers, prohibits acceptance of third party checks for securities purchases. But, MetLife, knowing it was dealing with a cultural problem as much as anything else, did not set up monitoring procedures so that the loan society checks could be accepted. MetLife simply fired the employee.

Moreover, to conduct an actual investigation of the allegations in the Form U-5, MetLife could have retrieved copies of every check, inquired of some or even all of the policy owners and payors whether the check was part of a money laundering scheme. By so doing, MetLife could have avoided stating the former employee was a “possible accessory to money laundering violations.”

Of course, individual employees are fungible. Company profits, company costs, and company convenience are more important. MetLife’s policy owners and shareholders are probably well served by a management willing to destroy the life of an employee rather than spend the money to conduct and complete an investigation.

The New York high court noted that an employee still has a remedy. The employee can initiate legal proceedings to obtain expungement of the untruthful statements on Form U-5. Of course, because the out of work employee cannot collect any damages for defamation, the out of work employee has no way to pay for such a proceeding (the NASD filing fee would be hundreds of dollars and legal fees would likely be at least $7,500 for such a proceeding, and double or triple that amount on the coasts).

The CRD system was set up to protect the public from rogue brokers. In this instance, if the former MetLife employee was guilty of money laundering, MetLife apparently did not complete its investigation and amend the U-5 to remove the word “possibly,” and did not thereby inform the public of the risk. MetLife mostly likely did not refund any of the illegally accepted premiums. If the money was part of a money laundering scheme, should not MetLife be forced to disgorge the money or turn it over to the government? In the last analysis, all that happened was that MetLife was allowed to defame its former employee under a cloak of absolute immunity.

New York’s highest court has now issued a license to much of the industry to do the same. Does anyone think honestly they will refrain?

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I was rather stunned today by the data reported by Gruntled Employees, a blog site that seems to be focused on the successful representation of employers. The data suggested that litigation brought by employers to enforce non-compete clauses was becoming so common that the incidence of such cases was exceeding the incidence of Sarbanes – Oxley cases, the cases complained about most vociferously by lobbyists to Congress. Indeed, the data indicated the incidence of these types of cases reported in the legal literature has literally doubled in the last decade.

Employers, according to the Gruntled Employees article, claim this type of litigation is necessary to protect trade secrets. That may be the party line employers use. But, as an apologetic it is simply bogus.

Most of the cases do not involve the types of employees that know trade secrets. They are typically not engineers or processing personnel. They are typically not corporate decisionmakers. Indeed, almost always, they are sales personnel of one type or another that have significant client contacts, sometimes have a title, but are not usually actual corporate officers. The client contacts range from client contacts given to the employee by the employer to client contacts developed solely by the employee for the employer. Some of the client contacts were developed when the employer was salaried but just as many client contact cases involve commission only sales personnel. The result of this collage of fact patterns is the inescapable conclusion that these types of cases are brought for one reason only in most cases, especially those involving sales personnel, to forestall or prevent competition.

Courts prejudicially devoted to supporting employers do not even take this into account. In many states, statutes preclude non-compete agreements that stifle competition or act as a restraint on trade. Even in those states, courts prejudicially devoted to supporting employers may ignore the restraint on trade, the over reaching and unequal bargaining power inherent in the non-compete clauses, and the disproportionate impact on the employee rather than the employer. Even a court inclined to enforce a non-compete clause that is a restraint of trade should consider the disproportionate impact and award fair compensation to the employee precluded from competing. Courts that do not do so risk becoming used in unseemly scrambles over customers that have nothing to do with trade secrets and only to do with protecting short term profits and economic inefficiency.

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Indiana appears to enforce the at will employment doctrine even when the employer allegedly fails to actually pay withheld taxes to federal and state taxing authorities. Then, when the employee made a claim, the employer fired the employee.

The Indiana Supreme Court opinion, Myers v J. Myers Construction, Inc., No. 29504-0609-CV-326 (February 2007), does not provide any rationale for the decision other than a review of the stare decisis of Indiana. The stare decisis of Indiana was not so clear as to require such a conclusion. Indeed, the law of Indiana, like most states, makes actionable for wrongful termination a termination in retaliation for whistleblowing based on the illegal conduct of the employer. The failure of an employer to pay taxing authorities the wages withheld to pay those taxes seems to be about as violative of public policy as could be imagined and in most states would have justified a wrongful termination claim for termination in retaliation for reporting unpaid employment taxes.

Beyond the tax law implications, the other and more disturbing implication is that if an employer breaks the trust conferred on the employer by law to collect taxes and then fires the employee that reports it or makes a claim about it, the employer does so with impunity under the cloak of the at will doctrine in Indiana. Clearly, the at will doctrine was supposed to be an articulation and explanation of the employment contract. But, in Indiana, it is being distorted into some sort of shield law for employers.

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Karen Barrows, a public school teacher, sent her children to a private Christian school. When she applied for the job of Assistant Principal, at the suggestion of the Superintendent, her boss, the Superintendent subverted her application because her children were in still in a private school. The Superintendent denied the reason was religious, but there seemed to be little doubt that the Superintendent made it clear that Ms. Barrows had no future in the school district as long as her children were enrolled in a private school.

The United States Court of Appeals for the 5th Circuit held, in an opinion you can find here, that Barrows could not state a §1983 claim for violation of her property rights in her governmental employment because an essential element of the claim, that the Superintendent was a policymaker and that his policy violated her rights, was not legally possible. The court held that the Superintendent was not a policymaker because under the laws of Texas, the policy making function was vested solely in the school board and the Superintendent was merely an agent of the Board.

There is absolutely no doubt the Circuit Court was right, the Superintendent was not the policymaker under Texas law. However, the Circuit Court was absolutely wrong. Clearly, under the facts both the trial court and the Circuit Court should have considered questions of fact for a trial, the Superintendent had usurped some policymaking authority, implemented it ultra vires, and in violation of the property rights of Ms. Barrows, added a job requirement that precluded her application. Also, the teacher, Ms. Barrows wanted her children to have a religious education. She told the Superintendent that was her motive. Nevertheless, the Superintendent imposed his policy anyway and the school board turned a blind eye.

Also, the Circuit Court was being intentionally obtuse. It is the rare school board that controls the Superintendent. That the school board can legally rein in the Superintendent is technically true but usually irrelevant. Ignoring reality, such as who was actually setting policy and implementing policy, harms the credibility of the Courts and in this case, denied the right of a school teacher to make a lawful parental choice about schooling her children without sabotaging her own career.

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The State of Oregon has a statute that requires that 60% of any punitive damages awarded to a plaintiff be paid into a victim’s compensation state fund. For a couple of reasons, it sounded like a “taking” of “property.” In the particular case in which it was enforced by the State of Oregon, the State of Oregon was also the defendant and wrongdoer.

This statute was reviewed by the United States Court of Appeals for the 9th Circuit arising in a federal trial court employment case, Enquist v Oregon Department of Agriculture, in which the wrongfully discharged employee was awarded compensatory damages, punitive damages and attorney fees. The award of the jury became a judgment of the court.

The plaintiff then became a judgment creditor. Wouldn’t a judgment creditor be a property owner? In order to find the statute constitutional, the 9th Circuit had to and did determine that the plaintiff was not a “property owner” of the punitive damage award so that the 9th Circuit could conclude there was no unconstitutional “taking without just compensation” by the state. Clearly, the 9th Circuit had to turn nearly all of the law regarding judgments into Gumbies that could be twisted and turned into any desirable shape. This type of legal reasoning, getting to the desired end by torturing fundamental legal principles until they surrender, brings our courts into disrepute and makes all of our rights subject to political and social expediency. That this happens in employment cases with regularity is of no small concern, either.

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