Federal Register / Vol. 63, No. 81 /Tuesday, April 28, 1998 / Notices 23321

13 17 CFR 200.30–3(a)(12).

1 15 U.S.C. § 78s(b)(1).

utilized with respect to any

conventional equity options position,

not just that portion of the position that

was established pursuant to the NASD’s

Equity Option Hedge Exemption, will

enable market participants to establish

larger positions in conventional equity

options and, thus, will help to ensure

that participants in the OTC options

market are not placed at a competitive

disadvantage vis-a-vis the exchange

markets. In addition, NASD Regulation

believes that increasing the position

limits for conventional equity options

will afford market participants,

particularly portfolio managers, issuers,

and sophisticated institutional

investors, greater flexibility to employ

larger options positions when

effectuating their investment strategies.

B. Self-Regulatory Organization’s

Statement on Burden on Competition

The Association does not believe that

the proposed rule change will impose

any inappropriate burden on

competition.

C. Self-Regulatory Organization’s

Statement on Comments on the

Proposed Rule Change Received From

Members, Participants, or Others

No written comments were either

solicited or received.

III. Date of Effectiveness of the

Proposed Rule Change and Timing for

Commission Action

Within 35 days of the publication of

this notice in the Federal Register or

within such longer period (i) as the

Commission may designate up to 90

days of such date if it finds such longer

period to be appropriate and publishes

its reasons for so finding or (ii) as to

which the self-regulatory organization

consents, the Commission will:

(A) by order approve the proposed

rule change, or

(B) institute proceedings to determine

whether the proposed rule change

should be disapproved.

IV. Solicitation of Comments

Interested persons are invited to

submit written data, views and

arguments concerning the foregoing,

including whether the proposed rule

change is consistent with the Act.

Persons making written submissions

should file six copies thereof with the

Secretary, Securities and Exchange

Commission, 450 Fifth Street, N.W.,

Washington, D.C. 20549. Copies of the

submission, all subsequent

amendments, all written statements

with respect to the proposed rule

change that are filed with the

Commission, and all written

communications relating to the

proposed rule change between the

Commission and any person, other than

those that may be withheld from the

public in accordance with the

provisions of 5 U.S.C. 552, will be

available for inspection and copying at

the Commission’s Public Reference

Room, located at the above address.

Copies of such filing will also be

available for inspection and copying at

the principal office of the Exchange. All

submissions should refer to File No.

SR–NASD–98–23 and should be

submitted by May 19, 1998.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.13

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 98–11169 Filed 4–27–98; 8:45 am]

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–39892; File No. SR–NASD–

98–18]

Self-Regulatory Organizations; Notice

of Filing of Proposed Rule Change by

National Association of Securities

Dealers, Inc. Relating to Qualified

Immunity in Arbitration Proceedings

for Statements Made on Forms U–4

and U–5

April 21, 1998.

Pursuant to Section 19(b)(1) of the

Securities Exchange Act of 1934

(‘‘Act’’),1 notice is hereby given that on

April 21, 1998, NASD Regulation, Inc.

(‘‘NASD Regulation’’) filed with the

Securities and Exchange Commission

(‘‘SEC’’ or ‘‘Commission’’) the proposed

rule change as described in Items I, II,

and III below, which Items have been

prepared by NASD Regulation. The

Commission is publishing this notice to

solicit comments on the proposed rule

change from interested persons.

I. Self-Regulatory Organization’s

Statement of the Terms of Substance of

the Proposed Rule Change

NASD Regulation is proposing to add

a new rule to the Rules of the National

Association of Securities Dealers, Inc.

(‘‘NASD’’ or ‘‘Association’’), to provide

members of the NASD with qualified

immunity in arbitration proceedings for

statements made in good faith in certain

disclosures filed with the NASD on

Forms U–4 and U–5, the uniform

registration and termination notices for

registered persons. Below is the text of

the proposed rule change.

Proposed new language is in italics.

* * * * *

Rule 1150. Regulatory Form Disclosures

(a) Mandatory Disclosures

A member must make truthful and

accurate statements on the covered

forms required under Article V, Sections

2 and 3 of the By-Laws.

(b) Qualified Immunity

(1) This paragraph shall apply to any

arbitration proceeding between a

member or other party and a covered

person relating to statements made in

response to an information requirement

of a covered form with respect to such

covered person, to the extent that such

statements are contained in a covered

form that has been or, at a subsequent

point in time, is (A) filed with a

regulatory authority or self-regulatory

organization, and (B) disseminated by

reason of such filing, or otherwise

disseminated orally, in writing, or

through any electronic medium to an

appropriate person.

(2) A defending party shall not be

liable in a proceeding to a covered

person for any defamation claim related

to an alleged untrue statement that is

contained in a covered form if the

statement was true at the time that the

statement was made.

(3) A defending party shall not be

liable in a proceeding to a covered

person for any defamation claim related

to an alleged untrue statement that is

contained in a covered form unless the

covered person shows by clear and

convincing evidence that:

(A) the defending party knew at the

time that the statement was made that

it was false in any material respect; or

(B) the defending party acted in

reckless disregard as to the statement’s

truth or falsity.

(c) Definitions

For purposes of this Rule:

(1) The term ‘‘appropriate person’’

means any federal or state governmental

or regulatory authority, and selfregulatory organization, any employer

or prospective employer of a covered

person, or any person who requests or

is required to obtain information

concerning the covered person from the

defending party and as to whom the

defending party has a legal obligation to

provide such information.

(2) The term ‘‘claim’’ means any

claim, counterclaim, third-party claim,

or cross-claim.

(3) The term ‘‘covered form’’ means

any form or notice required under
23322 Federal Register / Vol. 63, No. 81 /Tuesday, April 28, 1998 / Notices

2 ‘‘Defamation’’ has been defined as an

‘‘intentional false communication, either published

or publicly spoken, that injures another’s reputation

or good name.’’ Black’s Law Dictionary 417 (6th ed.

1990). ‘‘Libel’’ (written defamation) and ‘‘slander’’

(spoken defamation) are both methods of

defamation. Id at 1388.

3 Defamation claims may also arise with respect

to disclosures on Form U–4, which is required to

be filed by registered persons upon the occurrence

of certain events, but which in practice is often

drafted by the member firm with which the

individual is associated.

4Herzfeld & Stern, Inc. v. Beck, 572 N.Y.S.2d 683

(N.Y. App. Div. 1991), appeal dismissed, 79 N.Y.2d

917 (1992). The court reasoned that federal law had

established a comprehensive system of oversight

and self-regulation by the NYSE in order to ensure

adherence by members of the industry to both the

statutory mandates and ethical standards of the

profession, and concluded that the NYSE’s

disciplinary function conforms to the requirements

of a quasi-judicial administrative proceeding.

Therefore, statements made on a Form U–5 and

later used as the basis for an NYSE investigation

were considered ‘‘statements uttered in the course

of a judicial or quasi-judicial proceeding [which

are] absolutely privileged so long as they are

material and pertinent to the questions involved

notwithstanding the motive with which they are

made.’’ Id. at 683. But see Fleet Enterprises, Inc. v.

Velinsky, No. 604462/96 (N.Y. Sup. Ct. Jan. 16.

1997), in which a lower court in New York rejected

a brokerage firm’s petition, on absolute privilege

grounds, to stay the arbitration of Form U–5

defamation claims, and ordered arbitration to

proceed, applying the Federal Arbitration Act as to

the issue of arbitrability. The court stated that

‘‘whether New York substantive law will apply to

Velinsky’s claims in arbitration is for the arbitrator

to decide.’’ Slip op. at 5. See also Fahnestock & Co.,

Inc. v. Waltman, 935 F.2d 512 (2d Cir. 1991); Culver

v. Merrill Lynch & Co., Inc., 1995 U.S. Dist. Lexis

10017 (S.D.N.Y. 1995).

Article V, Sections 2 and 3 of the ByLaws, including Forms U–4 and U–5.

Disclosure Reporting Pages, and related

explanatory materials.

(4) The term ‘‘covered person’’ means

any present or former registered person

or other employee of a member who is

a party to a proceeding relating to a

dispute within the scope of this Rule.

(5) The term ‘‘defending party’’ means

any member who is a party to a

proceeding and who is adverse to a

covered person who is a party, and any

associated person of such member.

(Rule 1150 is effective beginning on

(Date) 1998 and ending on (Date) 2002,

and applies to claims relating to any

covered forms, as defined in Rule 1150,

that are filed during that period.)

* * * * *

II. Self-Regulatory Organization’s

Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule

Change

In its filing with Commission, NASD

Regulation included statements

concerning the purpose of, and statutory

basis for, the proposed rule change and

discussed any comments it received on

the proposed rule change. The text of

these statements may be examined at

the places specified in Item IV below.

NASD Regulation has prepared

summaries, set forth in Sections A, B,

and C below, of the most significant

aspects of such statements.

A. Self-Regulatory Organization’s

Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule

Change

1. Purpose

Summary. The proposed rule is

designed to deal with the prospect that

member firms may be reluctant to make

complete disclosures on forms required

to be filed with the NASD because of the

potential for lawsuits relating to

defamation claims by former or present

employees. The proposed rule would

create a uniform qualified immunity

standard for statements made in good

faith in certain disclosures filed with

the NASD on Forms U–4 and U–5. To

overcome this qualified immunity, a

registered person would have to prove

in an arbitration proceeding by clear

and convincing evidence that the

member firm knew at the time the

statement was made that it was false in

any material respect, or that the member

acted in reckless disregard to the

statement’s truth or falsity. For purposes

of NASD arbitration, the rule would

supersede state law on the same subject.

Background. This issue arises

primarily in the context of filings made

on Form U–5 following termination of

employment of a registered person. The

NASD By-Laws (Article V, Section 3)

require that the member give notice of

the termination to the NASD within 30

days after the termination, and that the

member provide a copy simultaneously

to the registered person. The By-Laws

also require that the member notify the

NASD, and send a copy to the registered

person, within 30 days if the member

learns of facts or circumstances causing

any information in the prior notice to

become inaccurate or incomplete.

Form U–5, which is entitled the

‘‘Uniform Termination Notice for

Securities Industry Registration,’’ is a

form used throughout the securities

industry at both the federal and state

level. It requires that the member

indicate the reason for the termination

by checking one of the blocks labeled

Voluntary, Deceased, Permitted to

Resign, Discharged, or Other. If one of

the last three blocks is checked, the

member must provide an explanation.

Regardless of the block checked, the

member also must indicate whether the

registered person, during the period of

his or her association with the member,

was involved in certain types of

disciplinary actions, the subject of a

customer complaint, convicted of

certain crimes, or under investigation or

internal review.

In recent years, registered persons

have brought, primarily in arbitration, a

number of defamation 2 claims for

allegedly untrue or misleading

statements made on the Form U–5.3

Because of the financial interests at

issue the potential for substantial

damages may exist in a number of cases.

The NASD believes that the potential for

liability, or for inconsistent standards of

liability, is a significant disincentive for

firms to provide full and fair disclosure.

Failure to make full disclosure of

disciplinary problems has the potential

to compromise the integrity of the

Central Registration Depository, and

hinders enforcement action by the

NASD and other regulators. At the same

time, the NASD believes it is important

that any solution provide adequate

protection to employees from statements

designed to penalize unfairly a

departing employee, or to prevent him

or her from obtaining new employment

or attracting existing customers to

another member firm where the person

has subsequently become employed.

Development of the Rule Proposal.

The NASD met periodically during 1997

to discuss defamation issues with

representatives of member firms, the

Securities Industry Association, the

New York Stock Exchange (‘‘NYSE’’),

the North American Securities

Administrators Association, and

attorneys who often represent registered

representatives in court litigation and in

arbitration proceedings.

Many members of the industry

favored a regulatory standard providing

for absolute immunity. Most state court

decisions that have considered this

issue in the Form U–5 or in similar

contexts have adopted a qualified

immunity standard. However, one New

York state court decision has expressly

recognized an absolute immunity

standard with respect to statements

contained in the Form U–5.4 Those

states that, by court decision or statute,

have adopted a qualified immunity

standard in the same or similar contexts,

require that falsity or recklessness be

proved either by ‘‘preponderance of the

evidence’’ or by ‘‘clear and convincing

evidence,’’ as discussed below.

In order to obtain as many views as

possible, the NASD published a draft of

the proposed rule change in a Notice to

Members (‘‘NTM 97–77’’) that was

mailed to member firms and other

subscribers, and was also posted on the

NASD Regulation Web site and sent to

a group of attorneys who represent

employees, to registered representatives
Federal Register / Vol. 63, No. 81 /Tuesday, April 28, 1998 / Notices 23323

5NASD Rule 10335 of the Code of Arbitration

Procedure contains special provisions for injunctive

relief in circumstances where fast interim relief is

necessary.

6Because the rule as proposed would apply only

to claims for defamation, it would not affect other

claims, e.g., tortuous interference with contractual

relations, to the extent that such claims would

constitute substantially different causes of action

and not merely recharacterization of defamation

claims.

groups, and to others. That proposal

included a provision that would require

member firms to give notice of the

contents of a Form U–5 (and

amendments) to the subject of the form

at least ten days prior to filing the form,

and would require members to provide

immediate notification to employees of

material revisions to be filed on Form

U–5. Fifty-three comments were

received and considered by the NASD.

The advance notice provision was the

subject of almost universal criticism, as

described below. A revised proposal

was approved by the NASD Regulation

and NASD Boards in January 1998.

Details of the Proposed Rule. The

proposal rule would provide that

members and associated persons will

not be liable to an employee for a claim

that is related to an alleged untrue

statement contained in Form U–4 or U–

5 pertaining to the employee, unless the

employee can prove by clear and

convincing evidence that the defending

party knew that the statement was false

in any material respect, or acted in

reckless disregard as to its truth or

falsity.

As noted above, state law standards

generally provide for some type of

qualified immunity for statements of the

type that are required by the covered

forms, and therefore the rule may not

represent a substantial change in the

standard that would apply in a given

case, but will instead provide a uniform

standard to which parties and

arbitrators can look for guidance. NASD

Regulation in concerned, however, that

the proposal not signal a willingness to

tolerant false or malicious statements by

member firms with respect to their

employees, either through disclosures

on the covered forms or through other

venues. Any such statements clearly

violate the obligation of members to

provide accurate information to NASD

Regulation and are inconsistent with

just and equitable principles of trade.

In particular, NASD Regulation is

concerned with the potential that

disclosures contained on covered forms

may be used deliberately by one

member to limit the mobility of

registered persons who have determined

to find employment with another

member, or to delay the effectiveness of

the transfer of employment.5 As noted,

such conduct would be grounds for

disciplinary action, and during the

rule’s pilot period, NASD Regulation

intends to consider and investigate

evidence of misuse of covered forms

other forms, or regulatory processes for

improper purpose. In addition, NASD

Regulation will provide a mechanism

through its Internet Web Site to obtain

input from employees, member firms,

and others as to the operation of the

pilot program and to report potential

abuses. To the extent that NASD

Regulation determines that misuse of

regulatory processes has increased

during the pilot period, it may

determine to modify or terminate the

rule prior to the end of that period.

Finally, NASD Regulation will provide

training to arbitrators to ensure that they

are cognizant of these concerns, that

they understand the application of the

rule, and that the rule is applied only

with respect to appropriate types of

claims.6

Paragraph (a) of the proposed rule

states that members must provide

truthful and accurate statements in

response to the information

requirements of the forms required

under Sections 2 and 3 of Article V of

the Association’s By-Laws, i.e., Forms

U–4 and U–5 and attachments to those

forms. This paragraph make clear that

the purpose of the proposed rule is to

further the goal of accurate disclosure,

and is intended to reaffirm the existing

disclosure obligation of NASD members

as set forth in the By-Laws. The word

‘‘complete’’ was deleted from the draft

version of the proposed rule, to address

the concern of some commenters that

this language could be construed as

adding a new but vague requirement of

‘‘completeness’’ and could create

liability beyond that contemplated by

the By-Laws.

The proposed rule would apply to

statements made on ‘‘covered forms.’’

Covered forms are defined in paragraph

(c)(3) to include forms or notices

required under Article V, Sections 2 and

3 of the By-Laws, including Disclosure

Reporting Pages and other explanatory

materials attached to the forms or

notices. Although the area of greatest

focus has involved the filing of Form U–

5 in connection with employee

terminations, members of the industry

have indicated that required disclosures

pertaining to employees on Form U–4

provide the same potential for liability,

and NASD Regulation believes that the

same regulatory interests in complete

disclosure apply to statements on that

form. The rule would apply to

statements made by a member firm on

a covered form with respect to a present

or former employee of the firm. The rule

would also apply to the liability of both

member firms and associated persons,

and accordingly would apply to both

the signatory of the form or other

persons involved in the preparation of

the form as well as the member itself.

The rule as proposed in NTM 97–77

would have required members to

provide employees with copies of

proposed language on Form U–5

describing the reason for termination at

least ten days before the filing of the

form or an amendment to the form. In

addition, members would have been

required to provide to the employee

immediate notice of revisions to the

proposed language. The purpose of

these provisions was to provide

employees with an opportunity to seek

amended disclosure language when they

could demonstrate obvious

inaccuracies.

After further review, NASD

Regulation has determined to delete

these provisions in light of the

comments received. The comments of

both members and registered

representatives were overwhelmingly

negative with regard to this part of the

proposal. Many commenters expressed

the view that these provisions would

lead to ‘‘negotiated’’ or ‘‘watered down’’

disclosure, and some suggested that it

could compromise ongoing internal

investigations. Some commenters stated

that the period was too short for

meaningful review of the Form U–5,

while other commenters felt that the

period was too long in that it left broker/

dealers only 20 days within which to

prepare the forms and mail them to

employees, since Form U–5 must be

filed with the NASD within 30 days

after termination. Some commenters

pointed out that employees already have

an opportunity to comment on certain

reportable events through filing of an

amended Form U–4.

The proposed rule would provide

qualified protection to statements only

to the extent that they are contained in

a covered form that has been or, at a

subsequent point in time, is filed with

any federal or state regulatory authority,

or self-regulatory organization, and are

disseminated to ‘‘appropriate persons.’’

Therefore, oral statements are covered

by the qualified immunity only to the

extent that they track language that is

already or later incorporated into the

covered form. In this context, paragraph

(c)(1) of the proposed rule defines

‘‘appropriate persons’’ to include, in

addition to regulatory organizations,

current or prospective employers and

others who affirmatively request

information concerning the employee
23324 Federal Register / Vol. 63, No. 81 /Tuesday, April 28, 1998 / Notices

7 17 CFR 200.30–3(a)(12).

1 15 U.S.C. 78s(b)(1).

and as to whom the member has an

obligation to provide the information.

The latter provision is designed to

ensure that the rule would apply to

requests from persons as to whom

applicable legal standards require the

disclosure of the information.

Paragraph (b)(2) of the proposed rule

provides that a defending party shall not

be liable for a defamation claim if the

statement was true at the time that the

statement was made. As noted above,

Article V, Section 3 of the NASD ByLaws already requires that the member

notify the NASD, and send a copy to the

registered person, within 30 days if the

member learns of facts or circumstances

causing any information in the prior

notice to become inaccurate or

incomplete.

Paragraph (b)(3) of the proposed rule

contains the basic legal standard found

in federal and state court decisions that

recognize a qualified immunity in

various contexts. The courts do not,

however, consistently define the burden

of proof that a plaintiff must meet in

order to show that a false statement was

made knowingly or recklessly. Some

decisions apply the ‘‘preponderance of

the evidence’’ standard that most

commonly applies to claims and

defenses in civil litigation. Others apply

a stricter ‘‘clear and convincing’’

standard. In some cases, decisions in the

same jurisdiction conflict on this point.

The NASD believes that, because no one

standard is dominant, the standard

applied should be the one that will

reach best the goals to which the

proposed rule is addressed. The NASD

has determined that the ‘‘clear and

convincing’’ standard provides a good

balance, in that it provides some

protection to member firms against

defamation claims for statements they

are required to provide, while still

providing that members are liable for

clear cases of abusive or malicious

disclosure.

NTM 97–77 asked for comment as to

whether NASD Regulation should seek

to provide a mandatory pre-filing or

arbitration procedure to resolve

termination disputes prior to the 30-day

period following termination in which

the Form U–5 is required to be filed.

Most of the comments addressing this

issue suggested that such a procedure

could not effectively resolve disputes

within this time frame. NASD

Regulation has determined that a

mandatory procedure would raise too

many difficult practical and timing

issues to be useful, but will endeavor to

provide mediators on an expedited basis

when both parties are interested in

resolving disputes at an early stage.

The proposed rule would apply for a

pilot period of four years. Prior to the

end of that period, the staff will review

a sample of filings made during the

period of the rule’s effectiveness to

attempt to gauge the nature and quality

of disclosure that has been provided, in

contract with forms filed prior to the

pilot period.

2. Statutory Basis

NASD Regulation believes that the

proposed rule change is consistent with

the provisions of Section 15A(b)(6) of

the Act, which requires, among other

things, that the Association’s rule must

be designed to prevent fraudulent and

manipulative acts and practices, to

promote just and equitable principles of

trade, and, in general, to protect

investors and the public interest. The

NASD believes that the proposed rule

change will encourage fuller disclosure

by member firms of any regulatory

problems concerning a registered

representative and thus provide more

complete information to the investing

public through the Public Disclosure

Program and to other broker/dealers

through the Central Registration

Depository.

B. Self-Regulatory Organization’s

Statement on Burden on Competition

NASD Regulation does not believe

that the proposed rule change will result

in any burden on competition that is not

necessary or appropriate in furtherance

of the purposes of the Act, as amended.

C. Self-Regulatory Organization’s

Statement on Comments on the

Proposed Rule Change Received From

Members, Participants, or Others

The proposed rule change was

published for comment in NASD Notice

to Member 97–77 (November 1977).

Fifty-three comments were received in

response to the Notice.

III. Date of Effectiveness of the

Proposed Rule Change and Timing for

Commission Action

Within 35 days of the date of

publication of this notice in the Federal

Register or within such longer period (i)

as the Commission may designate up to

90 days of such date if it finds such

longer period to be appropriate and

publishes its reasons for so finding or

(ii) as to which the self-regulatory

organization consents, the Commission

will:

A. By order approve such proposed

rule change, or

B. Institute proceedings to determine

whether the proposed rule change

should be disapproved.

IV. Solicitation of Comments

Interested persons are invited to

submit written data, views, and

arguments concerning for foregoing,

including whether the proposed rule

change is consistent with the Act.

Persons making written submissions

should file six copies thereof with the

Secretary, Securities and Exchange

Commission, 450 Fifth Street, N.W.,

Washington, D.C. 20549. Copies of the

submission, all subsequent

amendments, all written statements

with respect to the proposed rule

change that are filed with the

Commission, and all written

communications relating to the

proposed rule change between the

Commission and any person, other than

those that may be withheld from the

public in accordance with the

provisions of 5 U.S.C. 552, will be

available for inspection and copying in

the Commission’s Public Reference

Room. Copies of such filing will also be

available for inspection and copying at

the principal office of the NASD. All

submissions should refer to file number

SR–NASD–98–18 and should be

submitted by May 19, 1998,

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.7

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 98–11211 Filed 4–27–98; 8:45 am]

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–39903; File No. SR–NYSE–

98–13]

Self-Regulatory Organizations; Notice

of Filing of Proposed Rule Change by

the New York Stock Exchange, Inc.

Relating to the Trading of Bonds

April 22, 1998.

Pursuant to Section 19(b)(1) of the

Securities Exchange Act of 1934

(‘‘Act’’),1 notice is hereby given that on

April 15, 1998, the New York Stock

Exchange, Inc. (‘‘NYSE’’ or ‘‘Exchange’’)

filed with the Securities and Exchange

Commission (‘‘Commission’’) the

proposed rule change as described in

Items, I, II, and III below, which Items

have been prepared by the NYSE. The

Commission is publishing this notice to

solicit comments on the proposed rule

change from interested persons.