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95-87 Confidentiality Clauses In Settlement Agreements

SUGGESTED ROUTING

Senior Management
Internal Audit
Legal & Compliance
Training

Executive Summary

Members must review and correct promptly, as needed, their settlement agreements with customers or other persons that contain confidentiality clauses that prohibit or discourage the customer or other person from disclosing the settlement terms (and the underlying facts of the dispute) to the NASD® or any other securities regulator upon inquiry. Such confidentiality clauses violate NASD Rules of Fair Practice.

Background

Recent NASD examinations and a special survey have revealed that a number of member firms continue to use broad confidentiality clauses in settlement agreements with customers and other parties that impede NASD investigations. Such settlement agreements violate Article III, Section 1 of the NASD Rules of Fair Practice as conduct inconsistent with just and equitable principles of trade.

Of the member firms surveyed during June to August 1995, 61 percent were using settlement agreements with customers that contained confidentiality or nondisclosure provisions that prohibited the customer from disclosing the settlement terms (and the underlying facts of the dispute) to the NASD or any other securities regulator upon inquiry. Some clauses required a court order, subpoena, or similar condition before permitting disclosure to a securities regulator.

These prohibitively broad nondisclosure clauses continue to be used by certain members despite past NASD notices warning members to stop using them. Notice to Members 86–36 (May 1986) and the NASD Regulatory & Compliance Alert (June 1994 and July 1995) were among the warning notices provided. For example, Notice to Members 86–36 cautioned members "against executing agreements that may prevent any customer or other party from providing information, documents, or testimony, or otherwise cooperating with the NASD in its investigations of alleged violations."

Other than these broad confidentiality clauses, settlement agreements used by firms in settling disputes with their customers or other persons are not usually a regulatory concern. Indeed, settlement agreements may require confidentiality as to persons other than securities regulators. However, a violative confidentiality clause is one that prohibits or inhibits the customer or other person from disclosing the settlement terms (and the underlying facts of the dispute), upon inquiry, to a securities regulator, such as the NASD, or imposes conditions on such disclosure.

Acceptable Confidentiality Clauses

Whenever the settlement agreement references confidentiality, the confidentiality clause should be written 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 securities regulator, including the NASD. In a recent case, a District Business Conduct Committee found violative settlement agreements that required the customers to notify the firm, reasonably in advance, before disclosing any information to the NASD concerning their complaints against the firm.

We are suggesting appropriate language below that members may use to correct past confidentiality clauses and to ensure that new or future agreements comply with NASD rules.

Suggested Notice To Customers To Correct Past Settlement Agreements

"You are hereby notified that the Settlement Agreement you previously executed with this firm should not be construed to prohibit or restrict you (or your attorney) from responding to any inquiry about the 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."

Suggested Language For Future Settlement Agreements

"Any non-disclosure 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."

Conclusion

An attempt to impede an NASD investigation is a serious violation of just and equitable principles of trade [see William Edward Daniel, Sec. Exch. Act Rel. No. 28408 (September 6, 1990)]. Use of such violative confidentiality clauses will likely result in NASD disciplinary proceedings, especially in view of past warnings to NASD members about noncompliance in this important area. The New York Stock Exchange recently fined a member $25,000 for executing improper settlement agreements that required "prior notification, consent or formal process before customers could disclose information relating to their complaints, which thus restricted or limited the customers' ability to cooperate with an Exchange investigation."

Member firms should immediately review their settlement agreements and make such changes in the confidentiality clauses as may be necessary to ensure that they comply with Article III, Section 1 of the NASD Rules of Fair Practice as discussed above.

If you have questions about appropriate language for the confidentiality clause, please contact your local NASD District Office.


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