No Good Deed Goes Unpunished:
 The Case of the Volunteered Consultant's Report and How a Claim of Attorney-Client Privilege Was Rejected.

by Bill Singer

A public customer files an arbitration complaint with NASD Dispute Resolution (NASDDR) against a broker-dealer and then demands the production of a 1996 report of the BD’s supervisory procedures, prepared by an independent consultant, who was retained pursuant to an NASD Regulation (NASDR) order.  The BD did not have an NASDR-ordered report.  However, instead of denying its possession and control of an apparently non-existent 1996 NASDR report --- and leaving it at that --- the BD “voluntarily disclosed the existence of another document, not previously requested by claimants, that had been prepared in connection with a 1996 New York Stock Exchange (“NYSE”) proceeding.”¹

In all fairness to the respondent and its counsel, I simply don’t have enough facts to understand exactly what happened here. There may have been appropriate tactical reasons to disclose something that wasn’t asked for by claimant. Nonetheless --- big surprise --- the claimant demanded production of the NYSE report.  

At some point, the BD’s attorney advised his client that the NYSE report may be considered attorney-client privileged. The attorney-client privilege protects from disclosure or discovery any confidential communications between an attorney and a client made for the purpose of obtaining legal advice. This privilege is generally codified in federal and state procedural and evidentiary rules. However, NASD Code of Arbitration Procedure Rule 10323: Evidence states 

The arbitrators shall determine the materiality and relevance of any evidence proffered and shall not be bound by rules governing the admissibility of evidence.

So that leaves us with a bit of a conundrum. Most courts respect the attorney-client privilege, but NASDDR's arbitration rules do not specifically recognize any privileges and, to the contrary, specifically note that arbitrators are not bound by any such evidentiary rules. 

The Consultant's Report

Let’s consider a fairly common set of facts. A BD has some concerns about its operations and practices.  It decides to conduct a review. Wanting to get a really unbiased, frank opinion, the BD hires an outside consultant (who's not a lawyer) to do the inquiry and draft a report.  The consultant finds many problems, prepares a report, submits the report to the BD, makes some suggestions as to corrective action, and is retained by the BD to perform follow-up reviews. 

Is the outside consultant's report entitled to attorney-client privilege?  

Probably not.  Why?  

First off, an attorney didn’t prepare it. Second, the report doesn't appear to have been prepared for the purpose of obtaining legal advice.  When a non-attorney prepares a report, the resulting document may be subject to attorney-client privilege if it was prepared solely for an outside law firm (in-house counsel presents somewhat more problematic issues). However, there should be an embargo beyond the law firm on the distribution of the original report and any copies. Separately, if the report was prepared pursuant to the BD’s compliancefunction, then it may not be considered a “legal” document subject to attorney-client privilege.  

Practice Pointers
Upon becoming aware of a threatened customer lawsuit, it might be better to have outside counsel investigate and retain any drafted report. Similarly, if it is deemed advisable to have an outside non-attorney consultant perform a particular investigation, it may be preferable to have that individual directly retained by outside counsel.  Although neither foolproof nor a legal certainty, the above measures may provide additional protections against discovery of the reports by civil litigants and regulatory authorities. 
HOWEVER!!!  Nothing above is meant to replace your regulatory obligation to conduct appropriate compliance reviews and supervision.  Further, if any report is prepared pursuant to an obligated compliance function, the regulators will argue that there is no attorney-client privilege.

And now, back to our case . . .

After due consideration, the arbitration Panel grants claimant’s discovery request and orders production of the NYSE report. At this juncture, the BD retains outside legal counsel for the specific purpose of seeking reconsideration of the order of production.  This is an unusual move - - - one would guess it arose from the existence of some conflict on behalf of the attorney handling the arbitration case.  

The Panel Orders Production of the Report

In support of the motion for reconsideration, the BD submits an affidavit from its General Counsel attesting to the nature of the report, and describing the underlying facts that led the firm to consider the document protected by the attorney-client privilege. At some point the panel raises the possibility that it might seek to resolve the privilege issue by reviewing the matter in camera --- basically an off-the-record review for purposes of considering an issue in dispute.  The BD declines the in camera inspection and explains that such consent may be argued or held to be a waiver of the attorney-client privilege. Notwithstanding, the panel orders the BD to produce the report for in camera inspection.  

Now faced with an order to produce the sensitive report, the BD counter-offers to the panel that it would permit an NASD attorney to review the document under a “non-waiver agreement” to confirm that it was privileged.  Rejecting the proposal, the panel insists upon compliance with its order for in camerainspection. The BD declines to produce the report; respectfully noting that its decision was based upon the issue of attorney-client privilege.  The Panel did not interpret the firm’s refusal to produce as disrespectful and apparently took cognizance of the principle at issue.   However, the panel advised the BD that it would refer the matter of the firm’s failure to produce the document for in camera inspection to the NASDR for whatever action the regulator deemed appropriate. 

The arbitration proceeds without the report and an award is rendered in claimant’s favor but for an amount less than sought in the claim.  The BD paid the award on a timely basis.  As you may have guessed, the arbitration panel forwarded the BD’s non-compliance with the discovery order to NASDR.  Subsequently, NASDR filed a Complaint charging the BD with a violation of NASD Conduct Rule 2110 by failing to comply with an order issued by an NASDDR arbitration panel. NASDR requested that the BD be censured, fined $30,000, and orderedto pay costs of the disciplinary proceeding. 

So let’s recap where we are procedurally. 

The BD refused to produce the NYSE report. The BD lost the arbitration; however, the award was for less than the claimant sought. Certainly, given the BD’s disobedience of the arbitrator’s production order, it's somewhat surprising that the award for less than the amount sought. Additionally, the BD timely paid the panel’s monetary award of damages.  And now, pursuant to the arbitrators’ referral, the BD is named as a respondent in an NASDR disciplinary hearing. 

NASD Code of Arbitration Procedure Rules 10322 and 10323 give arbitrators substantial powers --- like judges --- to issue subpoenas, direct the appearance of members and associated people, direct the production of any records in the possession or control of members and associated people, and to determine the materiality, relevance and admissibility of any proffered evidence.  

NASD Interpretive Material IM-10100 
Failure to Act Under Provisions of Code of Arbitration Procedure
It may be deemed conduct inconsistent with just and equitable principles of trade and a violation of Rule 2110 for a member or a person associated with a member to:
(c) fail to appear or to produce any document in his possession or control as directed pursuant to provisions of the NASD Code of Arbitration Procedure.

NASD CONDUCT RULE 2110
Standards of Commercial Honor and Principles of Trade
A member, in the conduct of his business, shall observe high standards of commercial honor and just and equitable principles of trade.

Of course now we’re at an interesting point. Typically the consequence of disobeying an arbitrator is that you are fined by the panel, negative inferences are drawn from your misconduct, and Claimants tend to get larger awards. Quite frankly, that seems a pretty effective threat. Otherwise you run the risk that public customers will perceive that member firms and registered persons may choose to disregard arbitrators with the hope of obtaining better consideration from their peers on disciplinary hearing panels.  Certainly the fines imposed by disciplinary panels do not normally go into the pockets of public customers. 

What's the Piper's Price?

In arguing for sanctions, NASDR requested that the BD be censured, fined $30,000, and ordered to pay costs of the proceeding. NASDR compared the BD’s misconduct to that of a member firm failing to pay an arbitration award.  This analogy posed problems for NASDR because according to the NASD Sanction Guidelines:

• a failure to timely honor an arbitration award calls for a fine of at least $2,500 with a possible suspension of up to five business days, or 

• an absolute failure to pay an arbitration award calls for a fine of at least $5,000 with a possible suspension until satisfaction of the award plus at least 30 additional business days (or even a bar).  

First, the lesser monetary sanctions under the failed/late-arbitration-payment provisions do not seem in accord with the Staff's requested $30,000 fine.  Second, the BD timely paid the arbitration award, so it would seem troublesome to impose an analogous fine for failure to timely/completely pay --- when in fact such occurred.

The NASDR also suggested that a comparison be drawn with situations where a member fails to comply with NASD Procedural Rule 8210, which essentially requires members to comply with staff demands for testimony and the production of documents.  Here the staff stood on firmer ground, as the higher monetary sanctions for failure to timely or fully respond ran from $2,500 through $50,000, with suspensions running up to a bar.   

The NASDR hearing panel rejected efforts to draw too close a comparison with Rule 8210.  Certainly any regulator is seriously hampered in carrying out its regulatory investigations or proceedings when a member firm fails to cooperate.  As such, the only proper means of cultivating the necessary compliance with such obligations may be the severe sanctions imposed under the Sanction Guidelines.  

But the failure to comply with an arbitration panel’s order does not necessarily require that compliance be enforced by yet another, more distant body, such as an NASDR disciplinary hearing panel.  The single most potent mechanism to enforce compliance with an arbitration panel’s orders is the panel itself--- it is the ultimate power of the arbitrators to decide the case in favor of one party over the other, and to award damages.  

Some Final Thoughts

In a well-crafted decision, the NASDR panel opted for the less severe fines suggested under the failure-to-pay-an-arbitration-award sanction guidelines. The panel viewed the misconduct here as more aptly characterized as a failure to comply with an order of the arbitrators (akin to a failure to pay an ordered award) than with a refusal to cooperate with a regulatory investigation.  Accordingly, the panel decided that the broker-dealer be censured and fined $10,000.

In recent years I have taken issue with certain NASDR Hearing Panel Decisions. Some of the decisions seem to revel in belittling arguments and what I view as inappropriately dismissive (if not downright disrespectful) references to the parties, their counsel, and their procedural/substantive arguments.  Respondents and their attorneys can be intemperate.  Frequently such passion results from the heat of battle and the vital career-threatening consequences to registered persons and their BDs.  However, Hearing Officers must stay above the fray and it is imperative that they command respect from the even-handed administration of their powers.   

As such, NASDR Hearing Officer Carleton's decision is a balanced presentation of the facts, displays well-reasoned consideration of the issues and applicable regulations, and reflects a respectful understanding of the difficult  position espoused by the respondent.  A job well done!