NASD EMPLOYMENT DISCRIMINATION CLAIMS: SOMETHING OLD, SOMETHING NEW...

Once upon a time, securities industry attorneys came to a cross in the road whenever the filing of a public customer lawsuit occurred.  As with so many things in life, such complaints were rarely simple and straightforward; often, they included violations of federal law and also of state law.  But pleading both federal claims and state common law claims caused a tactical problem.    If the claimant's lawyer filed the customer's complaint pursuant to state common law fraud, then the case had to be arbitrated in accordance with the arbitration agreement included in the new account documentation.   But the law at the time was that federal securities fraud claims could not be arbitrated but had to be in federal court.  To make things even more complicated, a claimant could get punitive damages under state law claims but not under federal law claims.  

How courts dealt with this mess makes interesting reading.  A number of federal courts had ruled that the law of the land included something called the "intertwining doctrine."  The intertwining doctrine said that it was inefficient, uneconomical, and legally dubious to attempt to parse out the competing federal and state claims typically involved in customer lawsuits.   Those courts decided that whenever a customer complaint contained any federal securities fraud count—as virtually all of them did—that the entire case must proceed in federal court.  In essence, the Court concluded that the state claims had become "intertwined" with the federal ones, and that the entire matter fell within the ambit of the federal courts. This ruling effectively rendered many arbitration clauses useless.

In the ensuing battle over the intertwining doctrine, public customers always attempted to plead both federal and state claims ---they intertwined the two claims --- in an effort to avoid arbitration and get before a federal jury.  Of course, with equal vigor, broker-dealers and registered personnel routinely challenged the validity of the federal claims (frequently on the basis of an expired statute of limitations) in an effort to reduce the case to a state matter subject to arbitration. The intertwining doctrine was a problem for the industry, because federal court meant juries, who were more likely than arbitrators to give high damage awards and punitive damages on the state law claims.

Eventually the Supreme Court issued a couple of decisions that changed the federal courts' mandate from trying to find a way to bring customer cases into the federal court system, to ensuring that they stay off of the federal docket.  This transformation, which amounted to a 180^o turn, basically took all the legal logic behind the promulgation of the intertwining doctrine, substituted federal for state, reversed always for never, and, by an amazing act of legerdemain, concluded that federal claims didn’t really need to be in federal court after all and that whenever state and federal claims were intertwined, all claims had to be arbitrated.  When that happened, the modern era of mandatory arbitration of customer complaints began.

I told you the intertwining story in order to set the stage for what follows.  History, legal and otherwise, has a way of repeating itself, as I was recently reminded  when I read the NASD’s new arbitration rules relating to employment discrimination cases. As the law now stands, employment discrimination cases arising under the constellation of federal and state statutes outlawing discrimination and harassment based on race, sex, age, disability, creed and national origin are arbitrable. Because the Form U-4 signed by all registered employees of the broker-dealer contained an agreement to arbitrate all disputes, all claims by a registered employee against the employer, including discrimination and harassment claims, had to be arbitrated before an all-industry panel.

However, a few years back, victims of discrimination and their advocates began to argue that it wasn’t fair to have their constitutionally and statutorily protected civil rights ruled on by arbitration panels composed of members of the very industry which they were accusing of having violated those rights. Against the backdrop of such celebrated sexual harassment cases as the Pamela Martens class action and the "Boom-Boom Room" case, their arguments were gaining momentum, to the point that many in the business became concerned that the SEC or, even worse, Congress, might take some step (like, maybe, pass a law) to require all discrimination and harassment cases to be tried by a federal court regardless of arbitration clauses, just like customer cases claiming federal securities fraud used to be. That would again mean—juries for all!

Taking the lead in an effort to forestall that possibility, in 1998 Merrill Lynch unilaterally declared that it would no longer require the arbitration of discrimination and harassment cases brought against it by its registered employees. Other firms followed suit, and the practice was codified on January 1, 1999, when the NASD itself amended its Code of Arbitration to exclude such cases from mandatory arbitration. But effective January 18, 2000, the SEC has approved a set of NASD rules that are expressly concerned with the arbitration of employment discrimination and harassment cases. So what gives?

What gives is this: Although no registered person can be forced to arbitrate an employment discrimination or harassment case by the mere act of being registered and by signing a Form U-4, he or she can still be forced to arbitrate if he or she signs an express agreement to do so with the employer.

Ordinarily, a registered employee of a broker-dealer must, because of an agreement contained in the Form U-4 that he or she signed when he or she became an employee, arbitrate all disputes against the employer. Under January 1, 1999 amendments, the NASD gave up jurisdiction to hear employment discrimination and harassment claims, effectively excluding those claims from the Form U-4 arbitration clause. The new amendments go a step further. They provide certain disclosures to the employee to make sure he or she is aware of that fact when he or she signs the Form U-4 and agrees to be employed. Here is the text of the relevant part of the new disclosure now given to anyone signing a Form U-4:

The remaining amendments then go into great detail about the composition of arbitration panels hearing discrimination cases, and provide specific rules governing the arbitration of discrimination cases, governing such things as the availability of depositions, awarding attorneys fees, and coordinating arbitrations with court cases. In succeeding articles, I will discuss the new rules in depth.

Suffice it to say for now that under the new rules, any case that raises any claim of discrimination must be heard by a special panel. That panel is entirely a public panel—no industry arbitrators allowed.

That panel also has expanded powers to permit depositions; they have the power to award punitive damages and attorneys fees to the same extent that a court hearing a discrimination case could. Under the discrimination statutes, a court can award punitive damages and attorneys fees to a victim of discrimination even if the victim suffered only nominal or even no damages.

What does all this mean to you? Two things, at least:

First, if an employer wants to make sure that any discrimination claims against it are arbitrated, there must be an express agreement, like a separate employment contract, between the employee and the employer that provides for it. You cannot rely on the Form U-4 to mandate arbitration of discrimination and harassment claims. Conversely, an employee can’t be forced to arbitrate a discrimination claim unless he or she signed a separate employment agreement containing an arbitration clause. But if you do sign such an agreement, you will be required to arbitrate those claims.

Certainly the NASD expects so, as the rest of the amendments now provide rules for handling more, not fewer, discrimination cases. So the recent moratorium on arbitrating discrimination cases really had only one purpose: To give the industry and the NASD time to come up with a new set of arbitration rules to govern such cases, rules that would pass public and legislative scrutiny better than that old ones would have. Now that those rules have been passed, we can once again expect to see virtually all discrimination claims between NASD member firms and registered employees—indeed, unless I miss my guess, all employees—brought before NASD arbitration panels.

Second, under the new rules, any claim raising a discrimination count must be heard by a special panel composed entirely of non-industry people, with training in employment law, chaired by an experienced non-industry lawyer. These panels may end up being very employee-friendly. And, they have the power to order depositions, and award punitive damages and attorneys fees disproportionate to any economic loss suffered by a victim of discrimination. Clearly, the composition of the special panels and their powers were designed specifically to counter the argument that NASD arbitration is inherently hostile to discrimination and harassment claims and biased in favor of employers.

So far, so good. But whenever you try to engineer a way around a problem, you risk creating other problems. Consider this not-too-unlikely scenario. I’m a female employee who has just had it out with my employer. I have a big economic beef with my employer—I think he owes me a lot of money in commissions, a share of profits on a deal, underwriters warrants, a bonus, a piece of the business, you name it. I’ve also been in the rough and tumble world of securities sales or trading long enough to be able to point to a handful of boorish incidents, which I considered juvenile but harmless when I had put up with them, but which could, maybe, be viewed by some as harassing or discriminatory conduct by my employer or co-workers.

What do I do?

Under the new rules, I couple my compensation claims to a perhaps weak but still articulable discrimination and harassment claim, and I automatically end up having my more substantial economic compensation claim heard by a friendly non-industry panel, chaired by a non-industry employment lawyer. Because my case includes a discrimination claim, however speculative, the whole matter must under the new rules be heard by a special employment panel, which I will lay odds will be more likely to render me a larger compensation award than an industry panel would, with the added benefit that if I can make out any part of my discrimination claim, I might also get attorneys fees into the bargain.

Does this not sound to you like the old intertwining doctrine come alive again? I don’t know if the NASD ever intended this, or even thought about it (they probably didn’t), but the practical result of the new rules will be a schism in the way compensation cases are decided. Those groups more likely to suffer discrimination, women and minorities, will be able to use the special panels to their advantage to obtain higher awards and settlements in what otherwise would have been straightforward compensation cases. Meanwhile white males, unlikely to come up with any discrimination theory, will invariably have to bring their compensation cases under the old rules, will continue to have their cases viewed more skeptically by all-industry panels, and will continue to suffer smaller awards than their women and minority counterparts.

Now, there may be some poetic justice in this, and that I will leave to each of my readers to ponder. But as a lawyer, it irks me to see this kind of blatant procedural flaw, which can so easily lead to dissimilar results in basically similar cases. How to fix it? Easy. Decouple the discrimination counts from any other counts. As the Supreme Court did when it began to overturn the intertwining doctrine, require employees to bring their discrimination claims to the special panels, and their compensation claims to the regular industry panels. An even simpler solution, though not one the industry is likely to embrace: Make the special panels available to all employment cases, whether they involve discrimination or not, and reserve the all-industry panels for purely intra-firm disputes.

In the next article, I will take an in depth look at the arbitrability of employment discrimination and harassment claims under the new rules. In the third installment, I’ll explore the make-up and powers of the new special panels. In the meantime, if anyone would like an employment agreement drafted or reviewed, you know how to reach us!