Reading The Fine Print
A client of mine is suing me for negligence. I have a clause in my customer agreement, however, that says the client agrees to hold me harmless except for intentional acts or gross negligence. I've been told that this clause may not be valid. What can you tell me about this?
— K.G., Texas
A typical "hedge clause" in an investment advisory contract is an attempt to relieve the advisor of liability unless the advisor has been grossly negligent or has engaged in reckless or willful misconduct, illegal acts or acts outside the scope of its authority. Often, hedge clauses are followed by a "non-waiver disclosure" that explains that the client may have certain legal rights, under federal and state securities laws, notwithstanding the hedge clause, that are not waived. The staff of the U.S. Securities and Exchange Commission had previously taken the position that so-called hedge clauses "are likely to mislead a client who is unsophisticated in the law into believing that he or she has waived non-waivable rights, even if the hedge clause explicitly provides that rights under federal or state law cannot be relinquished."
On Feb. 12, 2007, however, the SEC staff issued a no-action letter concerning the use of hedge clauses in advisory agreements that confirmed that such provisions must be examined on a case-by-case basis to determine whether the actual language might be considered false or misleading. Nevertheless, both the SEC and the U.S. Supreme Court have held that the common law standards embodied in the antifraud statutes hold advisors to an affirmative duty of utmost good faith and full and fair disclosure when dealing with clients. As a result, even a negligent misrepresentation or failure to disclose material facts places the advisor in violation of the antifraud provision, whether or not there is specific intent or gross negligence or malfeasance.
I currently work for a Registered Investment Adviser. I want to leave and take my clients with me. My employment agreement has a non-compete/non-solicitation clause in it and my attorney has told me there's a good chance the firm can enforce it. What do you think?
— N.F., Illinois
Without knowing the specifics of your agreement I can only speak generally about non-compete/non-solicitation agreements. In general, these agreements are enforceable and the first step in enforcing such an agreement is for the employer to seek a preliminary injunction against you. But, to convince a court to grant an injunction requires the employer to prove that there's a "likelihood of success" on the merits of the case when it's brought to trial and that "irreparable harm" will result to the employer if an injunction isn't granted.
A non-compete agreement must be reasonable both in terms of the geographic area you'd be prohibited from working in, as well as the length of time you'd be prevented from working. If either of those provisions is seen to be unreasonable, then the employer might not be able to prove a "likelihood of success". As it pertains to irreparable harm, it is interesting to note that some courts have recently ruled that firms that signed off on the so-called "Protocol for Broker Recruitment" have essentially conceded that they won't suffer irreparable harm by allowing you to solicit your clients. The reasoning is that, by agreeing to a procedure allowing a former employee to take certain customer information and solicit those clients, the employer has effectively acknowledged that they won't be harmed.
The Protocol, created in 2004, provides that, if a departing rep and his new firm follow the Protocol, neither the rep, nor the firm that he or she joins, would have any liability to the prior firm by taking the specified information or soliciting the clients. Your argument would be stronger if your firm was a signatory to the Protocol. As of Oct. 13, 2010 there were approximately 565 signatories to the Protocol. A copy of the Protocol can be obtained from SIFMA at (202) 962-7300.
I settled a civil settlement for market timing with the SEC in 2006. I paid a civil fine and accepted a two-year ban, which has since expired. Recently, I was approached by an investment bank to work for them as a wholesaler selling to the RIA community. In looking at the FINRA reinstatement requirements, it looks like I should be allowed back in, subject to retesting. Is that your understanding?
— M.G., New York
Assuming that you paid the fine and served the suspension, I don't see any reason why FINRA wouldn't relicense you (subject to retesting, as you point out). There is the possibility that FINRA might want some heightened supervision on you for a period of time but, other than that, I don't foresee any major obstacles.
One caveat I'd add is that it might be possible, depending on your role with the investment bank and the activities you would be performing, that you might have to register as an Investment Advisor Representative with the state in which the RIA is based. In that case, the state may want to see all the documentation regarding the disciplinary action and could, possibly, reject your application despite FINRA's approval. Some states are more likely to defer to FINRA's decision, while other states take a more hard line approach.
How does the writer of an investment newsletter avoid the need to register as an investment advisor? Is there some specific exemption for this kind of investment advice? What if the newsletter is in the form of a weblog?
— P.O., via e-mail
Section 202(a)(11) of the 1940 Investment Adviser's Act defines and "Investment adviser" as "any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities; but does not include... the publisher of any bona fide newspaper, news magazine or business or financial publication of general and regular circulation."
The question of what constitutes a "bona fide newspaper, news magazine or business or financial publication of general and regular circulation" was addressed in a 1985 U.S. Supreme Court case entitled Lowe V. SEC. In that case, the court said that the legislative history of the 1940 Act demonstrates that Congress was "primarily interested in regulating the business of rendering personalized investment advice, including normal publishing activities that go along with providing such advice."
But, the Court went on to say that the exemption shows that Congress was sensitive to First Amendment concerns and wanted to make clear that it did not seek to regulate the press "through the licensing of non-personalized publishing activities." The focus of the Court's decision appeared to be the fact that content of the newsletters was completely disinterested and that they were offered to the general public on a regular schedule. The Court said: "The mere fact that a publication contains advice and comment about specific securities does not give it the personalized character that identifies a professional investment adviser."
As it relates to weblogs or blogs, I don't think the mere fact that the publication is electronic, as opposed to paper, would take it out of the exemption. The SEC and courts have treated other electronic communications similarly to the way they treat paper documents in various circumstances. Thanks to John Baker, Esq. of the law firm Stradley Ronon Stevens & Young in Washington, D.C. for providing me with the case citation.
Alan J. Foxman, ESQ, is an attorney with Fred Chikovsky & Assoc. in Boca Raton, Fla.
His comments are not intended to be legal advice. He can be reached at this address.