District Court Retroactively Applies Dodd-Frank Ban on Pre-dispute Arbitration in SOX Whistleblower Claims

The U.S. District Court for the District of Massachusetts applied the Dodd-Frank Act (“the Act” or “Dodd-Frank”) prohibition on pre-dispute arbitration agreements under the Sarbanes-Oxley (“SOX”) whistleblower protection retroactively. In a March 1 ruling, in Pezza v. Investors Capital, et al, Judge Douglas P. Woodlock, reasoned that retroactive application was appropriate due to the lack of clear Congressional intent to restrict the temporal scope and procedural nature of Section 922.

Section 922 of the Act, among other things, confers jurisdiction on the courts, rather than to a Financial Industry Regulatory Authority (FINRA) arbitration panel, by voiding arbitration provisions in employment agreements that purport to force an employee to arbitrate, rather than litigate disputes arising under Section 806 of SOX.

The suit arose from a claim of wrongful retaliation (in violation of SOX) against the plaintiff after he raised concerns about the defendant’s misconduct in connection with securities transactions. (The plaintiff had previously filed the requisite complaints with the Department of Labor.) The defendants, Investors Capital Corp., Investors Capital Holdings, Inc., and Timothy Murphy, argued that the plaintiff was required to submit his dispute to arbitration, not the courts, pursuant to a pre-dispute arbitration provision in his employment agreement. However, while the defendant’s motion to compel arbitration was under advisement, Congress enacted Dodd-Frank, which included the prohibition on pre-dispute arbitration agreements for whistleblower claims brought under SOX.

In determining whether to apply Section 922 retroactively, the court used the framework setup by the Supreme Court in Fernandez-Vargas v. Gonzales, which essentially instructs a court to first look to whether there is any Congressional intent allowing for retroactive application. If there is no clear indication by Congress, the court then must look to whether retroactive application would result in a disfavored consequence affecting a substantive right. If the court answers in the negative, retroactive application is appropriate.

Here, Section 922 did not include any express provisions or clear statements of Congressional intent regarding retroactivity. Further, after applying the standard rules of statutory construction, the court found nothing that indicated Congress intended for the provision to apply to existing arbitration agreements. The court also found it insufficient that Congress vested the authority to limit future pre-dispute arbitration provisions with the new Bureau of Consumer Financial Protection and the CFTC. Thus the court determined that the result regarding retroactivity under Fernandez-Vargas was inconclusive.

However, under Landgraf v. USI Film Prods, the Supreme Court recognized that jurisdictional statutes may be applied retroactively absent specific legislative authorization without raising retroactivity issues. As a result, the District Court construed Section 922 to be a jurisdictional statute and relied on the holding from Landgraf instead of the retroactivity test under Fernandez-Vargas. Accordingly, the court denied the defendants’ motion to compel arbitration and concluded that Section 922 should be applied retroactively to combat bad conduct arising prior to the enactment of Dodd-Frank.

HOUSE PASSES HISTORIC FINANCIAL REGULATORY REFORM BILL

On Friday, December 11, 2009, the House of Representatives passed the Wall Street Reform and Consumer Protection Act. This is a comprehensive piece of legislation aimed at responding to the worst economic crisis since the Great Depression. This legislation seeks to address the many causes that led to the crisis, including predatory lending and unregulated derivatives.

Among the many reforms included in the Act are the creation of two new federal agencies. The Consumer Financial Protection Agency (CFPA) is an independent federal agency solely devoted to protecting Americans from unfair and abusive financial products and services. The Financial Stability Council will be made of of regulators that will identify financial firms so large, interconnected, or risky that their collapse would put the entire financial system at risk. This Council would have the power to break up these financial companies even when healthy if it is believed they pose a risk to the financial system.

The Act also focuses on various areas which are aimed at minimizing systematic risk. Although not a comprehensive list, the Act:

• Establishes an orderly process for shutting down large, failing financial institutions like AIG or Lehman Brothers in a way that ends bailouts and prevents adverse effects spreading to the rest of the financial system.
• Enables regulators to ban inappropriate or imprudently risky compensation practices, and requires financial firms to disclose incentive-based compensation structures.
• Strengthens the SEC's powers so that it can better protect investors and regulate the nation's securities markets.
• Regulates the $600 trillion over-the-counter (OTC) derivatives marketplace by requiring all standardized swap transactions between dealers and "major swap participants" to be cleared and traded on an exchange or electronic platform. A "major swap participant" is defined as anyone that maintains a substantial net position in swaps, exclusive of hedging for commercial risk, or whose positions create such significant exposre to others that it requires monitoring.
• Incorporates the tough mortgage reform and anti-predatory lending bill the House passed earlier this year. This legislation outlaws many of the industry practices that led to the subprime lending boom.
• Requires registration of hedge funds by forcing all advisers to private pools of capital to register with the SEC. These advisers will be subject to systematic risk regulation by the Financial Stability regulator.

Large financial companies will be greatly affected by the Act. Not only will there by additional restrictions on operations, but the firms will be charged billions of dollars in new fees as a result of the creation of a fund to pay for future failures of large financial institutions.

For more information, the House Committee on Financial Services issued a press release which can be found here. A Wall Street Journal article addressing the Act can be found here.

IS MORE ALWAYS BETTER? IS LESS ALWAYS ACCURATE?

The Financial Industry Regulatory Authority (FINRA) is a private regulatory body charged with protecting investors and keeping an eye on the financial industry. As part of its services, FINRA offers BrokerCheck, an online database where investors can obtain information about registered brokers. The information made available is known as a CRD Report and contains information about employment and registration history, qualifications, as well as reportable customer disputes, disciplinary, and regulatory events. BrokerCheck allows users to access a full report and a consolidated report. Currently, under Rule 8312, this information is available for two years after a broker’s registration expires.

A recent proposal to amend the rule would make the consolidated reports available for a longer period of time, but the full reports will still be removed after the two year time period. However, this proposed change would only apply to brokers who have had a final regulatory action against them. Full reports would still be available through state agencies as they are now.

A recent Wall Street Journal article discussed the changes being made and the author took the position that the amendment was a step in the right direction, but still insufficient. In the article, the WSJ follows an insurance agent who was a former broker, but was banned from the securities industry after misappropriating $9,000. His CRD report was no longer available, but WSJ obtained it from Kentucky state regulators. After the Journal disclosed his expulsion to his current employer, he was fired from his job even though both he and his company acknowledged he had never provided financial advice in his then-current position.

One of the concerns with the proposed amendments is that only consolidated reports will be available. Consolidated disclosure does not mean better disclosure. The consolidated reports do not disclose the details about customer disputes, disciplinary, and regulatory events. Instead, the report merely states “customer dispute” or “criminal.” Because there is no full disclosure into the details of the criminal action, the information available can be very misleading. Those looking at the CRD will likely develop a bias against that person as they will not know if the criminal action is relevant to the practice of brokering. The Wall Street Journal’s chronicle ironically demonstrates this potential bias in that the former broker was fired from his job after the WSJ author disclosed the man’s CRD report.

Advocates of this amendment claim it will help delineate the “bad” brokers from the “good” brokers and better protect investors. However, this is flawed logic as more disclosure does not mean all the “bad” brokers will turn up. For example, a quick search on BrokerCheck reveals that Joseph Cassano, a former A.I.G. executive who was recently indicted for securities fraud, had a clean CRD report until the Department of Justice filed a complaint against him recently. Until the DOJ suit, there was no evidence on his consolidated report or his full report that suggested he was a “bad” broker. Our firm has also seen where incomplete or inaccurate information in the consolidated CRD report or other “public records” can have misleading results to the detriment of a “good” broker. Because the CRD also requires the reporting of information unrelated to brokers’ ability to perform their jobs well, irrelevant information in little to no context unduly punishes registered persons and does not provide real value to consumer protection.

If consumer protection is truly the goal, this proposed change would not meet that goal and would in fact provide more confusing information to the public. A more comprehensive approach would better serve all parties involved.