Terra Extraneus

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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The United States Court of Appeals for the DC Circuit held yesterday in an employment case that it is unconstitutional for the government to tax damages paid for damage to reputation by an employer. Murphy v. Internal Revenue Service (DC Cir 08/22/2006). Hat tip to Professor Ross at LawMemo.com.

There are other instances in employment law where the fangs of the tax vampire are blunted. 26 USCA §62(e)(18) expressly excludes attorney fees and costs from taxable income in many income recovery cases. I suspect many tax practitioners do not latch on to this because they have to scroll so far down to see the text, which reads: “Any provision of Federal, State, or local law, or common law claims permitted under Federal, State, or local law–(i) providing for the enforcement of civil rights, or (ii) regulating any aspect of the employment relationship, including claims for wages, compensation, or benefits, or prohibiting the discharge of an employee, the discrimination against an employee, or any other form of retaliation or reprisal against an employee for asserting rights or taking other actions permitted by law.” Paragraph (ii), “regulating any aspect of the employment relationship,” brings numerous statutes and common law claims within reach of this exclusion from taxable income.

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As a Christmas gift, my father gave me a subscription to Money Magazine, published by Time, Inc. Money Magazine is no doubt a good source of learning for the average individual, and it, and others like it, should be required reading for the young and anyone who did not major in finance as undergraduates. But even so, as a lawyer practicing in the financial services area, some omissions in recent issues were troubling.

BUSINESS ETHICS SIMPLICITY
The March 2006 issue contained its monthly column on business ethics and in this installment reviewed the ethical implications of the abrupt resignation after only a six-month tenure of an employee who accepted a signing bonus of $10,000. The employee was a newly minted MBA and the employer was a small company, but the employment contract did not preclude what the employee did or protect the employer. The article concluded that the employer should not have been so naïve and the employee should have remained longer or refunded part of the signing bonus. The article indicated the employer could retaliate by how it responds to inquiries from anyone reviewing the employee’s resume.

The article seemed so far off the mark that a correction seemed in order.

1. The article did not mention that if an employer retaliated in such a manner, litigation might result. That is the reason most companies will not allow anyone but a skilled HR department to respond to inquiries regarding former employees.

2. The article did not consider the reason for the departure of the employee, only whether the employee had a duty to repay part of the signing bonus. The ethics column is designed to respond to reader inquiries. Because the initiating communication was from the employer regarding the ethics of the abruptly departing employee, the column leaned in favor of condemnation of the employee. The employer may have painted a rosier picture than was warranted.

3. While I am not unsympathetic to the employer, especially a small business, the employment contract could have stated how long the employee was expected to stay, at the least, or the bonus could have been paid out over a year or some other time frame. The employer should have known that a newly minted MBA might need some time to reach a final plateau of stability, and therefore might not stay in a first job.

The use of forfeiture provisions in employment contracts is rapidly expanding. Some public companies have recovered so much money and stock by looting their former employees that they must report such recoveries on their filings with the Securities and Exchange Commission. The amount of money and stock that must be involved to require a disclosure on financials in public filings is enormous, because to be “material,” no small amount would qualify for disclosure. It is amazing that the news media has focused so little attention on forfeitures of compensation or the “ethics” of wholesale forfeitures imposed on employees.

The probable explanation is that so many large public companies are engaged in the practice that financial services news sources cannot respond without risking retaliation. Not every company loots its former employees. Business ethics still exists.

CHANGING JOBS WITH 401(K) PLAN ACCOUNTS
The April 2006 issue addressed the question of what to do about a 401(k) plan account when changing jobs. Money Magazine suggested that the 401(k) plan account could be left with the prior employer, could be moved to a new employer’s plan, or be rolled over to an IRA. Money Magazine, however, naively failed to address the most important factor in determining which of those options to choose.

Leaving a 401(k) account with a former employer can be problematic. Corporate America is no longer the ethical or moral center of the nation, but rather is in desperate need of reformation. Corporate America must contend with only two powers in maintaining its hegemony: political, and that force is primarily deflected through campaign contributions, and competition. Corporate America is a jealous god, and employees who go to work for competitors are usually considered traitors, even though the corporation will vigorously maintain the employee was “at will.” Like any other organization that hates traitors, Corporate America will punish and retaliate against traitors. Former employees are often shocked to find that former co-workers are forced to distance themselves from former employees, and may even turn on them.

Also, Money seems unaware that businesses fail, suffer data losses, and even inadvertently hire embezzlers, thieves and pirates. Surely, the readers of Money Magazine are not just employees of ethical Fortune 500 companies. A few years ago, it was reported that there were 65,000 businesses with fewer than five employees in Oklahoma City. Most likely, that number has increased.

Former employees are not in the loop as to changes in 401(k) plan terms, changes in choices, and changes in trustees and other responsible persons. Thus, leaving 401(k) accounts behind with former employers is not risk free. The only alternative if something goes wrong is litigation, something Money Magazine would no doubt find abhorrent.

Moving the 401(k) account to the new employer’s plan has the same potential for risk. It might be lessened by a successful employment relationship, but as often as people seem to be forced to change jobs in this society, it is a risk. Money Magazine does not seem to know that.

Rolling the account over to an IRA at a financial institution, preferably one with more than a billion dollars in publicly reported assets or a bank, is clearly the best option in most cases. Competent financial advice is available, and the readers of Money Magazine are not without independent resources. Just following Money’s advice most months will probably lead to safe and successful investing. Anyone unable to read Money Magazine and follow its advice should restrict their investments to Certificates of Deposit at federally chartered and insured banks. But, the real benefit is control. IRAs are typically self-directed accounts, typically insured to one extent, in one manner or another, and under the control of the owner.

Money Magazine seems to take the position that only persons with more than $1 million in liquid assets should enjoy the benefits of retail securities firms that offer “full service.” That is clearly wrong, too.

The problem of choices and guidance that might be created by moving an account from a 401(k) program to a rollover IRA is better solved by consulting a Certified Public Accountant at the same time that a financial institution is engaged to administer the account. CPAs are not just tax preparers, and an hour of their time once a year to review investment decisions, either in advance or after the fact, would be worth the relatively small bill for their time. Anyone “cheaping out” by failing to engage a CPA would also be better off in Certificates of Deposit at a bank or simply following Money Magazine’s advice.

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