When Silence Isn't Golden

Jul 1, 2004 12:00 PM, By Bill Singer

The current suit-happy environment has left more than one registered rep yearning for the Cone of Silence, that whimsical invention from the 1960s spy sitcom Get Smart.

But like the fictional secret agent Maxwell Smart, reps are likely to find that interpersonal privacy is not so easily ensured — particularly when government agencies are involved.

Here's a typical scenario in which a rep might want to use the fabled cone: The rep makes a mistake — writing an order ticket with the wrong symbol or the incorrect number of shares, for instance — and the customer catches the error. After assessing the situation, the rep quickly decides to forego retaining a lawyer and fighting the case in arbitration, opting instead for a direct settlement with the client.

So far, so good. It's often cheaper and certainly more expeditious to settle such a straightforward matter by paying the client. After all, lawyer fees can quickly outstrip the settlement costs, and there's no guarantee that an attorney's presence at an arbitration will keep a financial advisor from paying damages in addition to the legal bills.

All's Quiet

The registered rep understandably wants the settlement to put the matter to rest once and for all, so he builds a caveat into the agreement that bars the client from cooperating with regulators after the fact.

As logical as this sounds, though, it's not permissible. A registered rep may not prohibit or discourage customers or other persons from disclosing settlement terms (and the underlying facts of the dispute) to any securities regulator. More specifically, reps may not inhibit customers or other parties from providing information, documents or testimony or from cooperating otherwise with a regulator in an investigation of alleged violations.

Unfair? Well, you can argue that one, but you can't get around it. Even if a rep settles, the customer can still spill the beans to the regulators.

Of course, this fact will not keep everyone from trying to convince customers to clam up. Some reps can be terribly clever in finding ways to circumvent rules.

For example, some brokers who know they can't “prevent” a client's cooperation with regulators instead try to “delay” cooperation. Typically, the settling rep concocts a confidentiality clause to require the settling customer to first call the broker or broker/dealer before responding to a regulator's request for information. Another ingenious effort is the one that requires a customer or third party to first be served with a court order, subpoena or similar condition before permitting disclosure to a securities regulator.

But both these approaches are against the rules.

Held in Confidence

This is not to say a registered rep shouldn't include confidentiality clauses in settlement agreements with customers. The limitations outlined above only relate to communications with regulators. As to the rest of the world, there are frequently legitimate reasons to impose confidentiality, and, where appropriate, a broker should do so.

However, it's important that any confidentiality clause states expressly that it does not extend to regulatory matters. Indeed, the NASD requires such a clause to expressly authorize the customer or other person to respond, without restriction or condition, to any inquiry about the settlement or its underlying facts and circumstances by any regulator.

Here is a sample wording: “Any nondisclosure provision in this agreement does not prohibit or restrict you (or your attorney) from responding to any inquiry about this settlement or its underlying facts and circumstances by the Securities and Exchange Commission (SEC), the National Association of Securities Dealers, Inc. (NASD) or any other self-regulatory organization.”

Finally, registered reps must make certain to disclose all settlements and changes to their U4s to their firms.

Placing the details of settlements under the Cone of Silence might seem like a good idea, but simply put, it's begging for trouble. Indeed, trying to muzzle a customer is an almost certain way to get barred from the industry — and even Maxwell Smart knows that's not a good thing.

Writer's BIO:
Bill Singer is a partner with the law firm of Gusrae, Kaplan & Bruno.
rrbdlaw.com