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With the increased scrutiny brought on by various high-level prosecutions in the securities industry — the case against Martha Stewart being but the latest example — employers in that industry find themselves in something of a conundrum. Industry regulations require, and the investing public demands, that employers in the securities industry truthfully report the reasons for the discharge of their brokers on a form known as a Uniform Termination Notice for Securities Industry Registration — and also known as form U-5. California courts, however, have not ruled definitively on what protection the law will provide a securities employer against a defamation action based on the contents of a form U-5 filed by that employer. In other words, can an employer truthfully report the reason for an employee’s discharge without the risk of being tied up for years in litigation that attempts to prove the truthfulness of its report? This article will explore some of the legal developments in this area of the law and, more importantly, will provide some steps for securities industry employers to reduce the risk of, or better defend against, defamation actions in connection with the filing of a U-5 form. Whenever a broker is discharged, rules issued by the New York Stock Exchange and National Association of Securities Dealers require the broker’s employer to file a form U-5 with one of those groups that details the reasons for the discharge. Depending on the contents of the form, the NYSE, NASD or Securities and Exchange Commission may investigate the discharge for purposes of determining whether any securities laws were violated or whether the broker should be further disciplined. This investigative process is adversarial in nature and affords the subject various due process protections, including the right to appeal. As such, the investigation has been held by previous court rulings to be a quasijudicial administrative proceeding. The contents of specific of U-5 forms are also accessible to the investing public. So once the employer submits a form U-5 to the relevant organization, can the employer be sued for defamation by the discharged employee? California has two statutes that may provide some immunity against such suits. First, Civil Code �47(c) provides a qualified privilege for all communications between interested parties — that is, the communication is privileged only if there is an absence of malice. An employee, however, may easily maintain a defamation action against a former employer by simply alleging that the contents of form U-5 are false and were made with malice. Such an allegation may result in years of litigation over the truth of the reasons for the discharge or the employer’s lack of malice. Still, two federal circuit courts, based on the laws of Tennessee and Illinois, have held the contents of form U-5 only to be qualifiedly privileged. ( Glennon v. Dean Witter Reynolds, 83 F.3d 132, (6th Cir. 1996); Baravati v. Josephthal, Lyon & Ross, 28 F.3d 704 (7th Cir. 1994)). California Civil Code �47(b), on the other hand, provides for an absolute privilege for communications in judicial, legislative and “any other official proceeding authorized by law.” California courts have interpreted this section, also known as the “litigation privilege,” very broadly and have held, for instance, that it provides absolute immunity to reports of crimes “to the police, the local prosecutor or an appropriate regulatory agency, even if the report is made in bad faith.” Cabesuela v. Browning-Ferris Industries of California, 68 Cal.App.4th 101 (1998). Likewise, in Kashian v. Harriman, 98 Cal.App.4th 892, (2002), the court of appeal held that the litigation privilege was not limited to the courtroom but also encompassed administrative bodies and quasi�judicial proceedings “whose function it is to investigate and remedy wrongdoing.” The California Supreme Court, in Hagberg v. California Federal Bank FSB, 32 Cal.4th 350 (2004), recently reaffirmed that the absolute privilege also extends to communications to non-governmental investigative bodies, such as a letter to a hospital’s board of directors, a complaint to the State Bar and a parent’s letter to a school board. Because the filing of a form U-5 could be the first step in an investigation under a statutory scheme that allows the SEC to police and investigate broker misconduct, there is a good argument that the form squarely falls within the litigation privilege of �47(b). Clearly, this statute would offer employers more significant protection than the qualified privilege of �47(c). Nevertheless, no published California case has addressed this issue, although one published New York case, Herzfeld & Stern v. Beck, 572 N.Y.S.2d 683 (1991), has affirmatively held that the contents of form U-5 are absolutely privileged. Employers in the securities industry thus find themselves between the proverbial rock and hard place. On the one hand, industry regulations require disclosure in order to protect the investing public against broker misconduct. Yet because no California court has ruled definitively on whether the absolute privilege applies to a form U-5 filing, an employer risks being sued for defamation whenever such a filing implicates irregular or improper investment-related conduct. Nevertheless, an employer may avoid litigation or increase its likelihood of success in such a lawsuit by following some well-established principles in California employment law. � Conduct an “appropriate investigation.” There should be no dispute that, at the very least, the contents of form U-5 are protected by a qualified privilege. As mentioned above, this essentially means that, even if the employer were mistaken about a broker’s misconduct, the employer would still be protected provided that the contents of form U-5 were not made with malice. Malice has been held to mean that the publisher of the alleged defamation did not believe the publication to be true. Thus, one way to defeat a charge of malice is by documenting the investigation of misconduct that led to the termination. The California Supreme Court, in Cotran v. Rollins Hudig Hall International, 17 Cal.4th 93 (1998), has provided a similar safe harbor in connection with an employee discharge for misconduct. In Cotran, the court held that an employer, who discharged an employee for misconduct, could be mistaken about that misconduct but still be immune from liability if the discharge was (1) made in good faith, (2) based on an “appropriate investigation under the circumstances” and (3) based on reasonable grounds for believing the employee had engaged in the misconduct. While much has been written about precisely what constitutes an “appropriate investigation under the circumstances,” the Supreme Court held in Cotran that it “includes notice of the claimed misconduct and a chance for the employee to respond.” Suffice to say, the better the investigation and the better an employer can document that investigation, the easier it will be to discourage an employee from filing suit for defamation based on the filing of form U-5. � File an anti-SLAPP motion. The California anti-SLAPP statute provides, in Code of Civil Procedure � 425.16(b)(1), that a “cause of action against a person arising from any act of that person in furtherance of the person’s right of petition or free speech � in connection with a public issue shall be subject to a special motion to strike. �” A defamation suit based on the filing of form U-5 arguably falls within the anti-SLAPP statute either as a “statement made in, or in connection with, an issue under consideration or review by an official proceeding or body” or as an act in furtherance of “the constitutional right of free speech in connection with a public issue or an issue of public interest.” Indeed, the court of appeal has held, in Wilcox v. Superior Court, 27 Cal.App.4th 809 (1994), that the “favored causes of action in SLAPP suits” include suits for defamation. If an employee sues for defamation based on the contents of form U-5, an employer may have the option at the outset of the case to bring an anti-SLAPP special motion to dismiss. Unless the employee can provide evidence of probable cause of success on the merits, the court must dismiss the defamation action. Pursuant to the anti-SLAPP motion, an employer is allowed to introduce evidence that it dismissed the employee based on a good faith belief that an “appropriate investigation” supported the employer’s belief that the employee engaged in misconduct. As such, an employer may bring an anti-SLAPP motion to dismiss a defamation action by showing that, even if form U-5 is only qualifiedly privileged, the results of an appropriate Cotran investigation will defeat any allegation of malice, thereby entitling the employer to a dismissal of the defamation action. Until California courts definitively rule that the contents of a form U-5 are absolutely privileged, employers in the securities industry must rely on the qualifiedly privileged protection of Civil Code �47(c). However, existing law provides employers with some guidance as to how to proceed in this area. By following the Cotran standards of investigation, an employer may prevent the employee from filing a defamation action or, if a defamation action is pursued, seek to have it dismissed through the use of an anti-SLAPP motion. Richard H. Rahm is of counsel in the San Francisco office of Allen Matkins Leck Gamble & Mallory, where he practices in the firm’s labor and employment group.

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