Conflict Management for Terminated Financial Advisors

There is plenty of room for conflict when a financial advisor is leaving his or her broker-dealer. Although the departure may start off in an amicable fashion, tensions often flare once promissory notes and client retention issues arise. Moreover, an involuntary or “for-cause” termination may implicate defamation and regulatory issues. In other words, your broker-dealer may defame you on your U-5/U-4[1] providing you with an arbitration claim but also subjecting you to months of regulatory scrutiny from FINRA and state regulators. So here is my lecture: it is wise to retain independent counsel as soon as you are even contemplating leaving your current broker-dealer. Your legal counsel can help you achieve a smooth transition or at least advocate for you during the termination process. Our firm has represented countless departing brokers on a nearly endless array of issues. We have also recouped millions of dollars in defamations awards and settlements. Food for thought.

Please follow us on Twitter @CosLawGroup, on LinkedIn at Cosgrove Law Group, LLC, and on Facebook at Cosgrove Law Group, LLC.  

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[1] In 2020, U5 defamation cases were the fourth most common intra-industry claim filed with FINRA, behind breach of contract, promissory notes, and compensation claims. (https://www.littler.com/publication-press/publication/form-u5-defamation-claims-rise-finra-be-prepared)

U-5 Filings and the Compelled Self-published Defamation Doctrine

 

Last year, the California Court of Appeals issued a highly instructive opinion in the area of U-5 defamation. Some excerpts from that opinion will help us get started on a variety of blogs. The case is Tilkey v Allstate Insurance Company.

INTRODUCTION

While Michael Tilkey and his girlfriend Jacqueline Mann were visiting at her home, the two got into an argument. Tilkey decided to leave the apartment. When he stepped out onto the enclosed patio to collect his cooler, Mann locked the door behind him. Tilkey banged on the door to regain entry, and Mann called police. Tilkey was arrested and pled guilty to a disorderly conduct charge only, and other charges were dropped. After Tilkey completed a domestic nonviolence diversion program, the disorderly conduct charge was dismissed as well.

Before the disorderly conduct charge was dismissed, Tilkey's company of 30 years, Allstate Insurance Company (Allstate), terminated his employment based on his arrest for a domestic violence offense and his participation in the diversion program. Allstate informed Tilkey it was discharging him for threatening behavior and/or acts of physical harm or violence to another person. Following the termination, Allstate reported its reason for the termination on a Form U5, filed with Financial Industry Regulatory Authority (FINRA) and accessible to any firm that hires licensed broker-dealers like Tilkey. Tilkey sued Allstate for wrongful termination and compelled self-published defamation.

The jury returned a verdict in Tilkey's favor on all causes of action and awarded him $2,663,137 in compensatory damages and $15,978,822 in punitive damages. The Court of Appeals concluded that compelled self-published defamation is a viable theory, and substantial evidence supported the verdict that the statement was not substantially true. The court did, however, remand the matter for recalculation of the punitive damages award.

FACTS

On August 31, 2014, Mann sent an e-mail to Tilkey at work mentioning the charges that had been filed against him. A field compliance employee later discovered this e-mail while conducting a routine compliance review and forwarded it to Human Resources (HR). HR professional Tera Alferos conducted the initial investigation, and she interviewed Tilkey. She noted Tilkey had been asked to accept a plea deal to have two of the three charges dropped, then the last one dismissed. She never spoke with Mann or interviewed the arresting officers. She also did not investigate Mann's background or review her social media accounts.

A couple weeks later, Alferos sent her supervisor a summary of her investigation, which stated that the police report had been reviewed and noted Tilkey had been charged with but not convicted of a crime. The summary also explained there was no FINRA reporting obligation because there were no felony charges, and it concluded there had been no violation of company policy.

A supervisor then changed the conclusion to state Tilkey's behavior may have been at a level that caused the company to lose confidence in him. At the supervisor’s request, Alferos next added references to the domestic violence charge because it suggested Tilkey had engaged in behavior that could be construed as acts of physical harm or violence toward another person, in violation of company policy. In an e-mail referencing the decision to terminate Tilkey's employment, a Ms. Metzger wrote that they were amending the reason for terminating Tilkey to be "violence against another person whether employed by Allstate or not. "It identified the policy violation as "[t]hreats or acts of physical harm or violence to the property or assets of the Company, or to any person, regardless of whether he/she is employed by Allstate." When the company terminated his employment, it informed Tilkey, "Your employment is being terminated as a result of engaging in behaviors that are in violation of Company Policy. Specifically, engaging in threatening behavior and/or acts of physical harm or violence to any person, regardless of whether he/she is employed by Allstate."

The company then filed a Form U5 with FINRA reporting its reason for terminating him as follows: "Termination of employment by parent property and casualty insurance company after allegations of engaging in behaviors that are in violation of company policy, specifically, engaging in threatening behavior and/or acts of physical harm or violence to any person, regardless of whether he/she is employed by Allstate. Not securities related."

Tilkey sued Allstate asserting three causes of action: (1) violation of California section 432.7; (2) wrongful termination based on noncompliance with section 432.7; and (3) compelled self-published defamation to prospective employers. Following trial, the jury returned a verdict for Tilkey and awarded $2,663,137 in compensatory damages, with $960,222 for wrongful termination and $1,702,915 for defamation, and $15,978,822 in punitive damages. Allstate moved for a new trial, which the trial court denied. Allstate appealed.

I: WRONGFUL TERMINATION

Allstate argued it did not violate the California wrongful termination statue (432.7) when it used as a factor in its termination decision Tilkey's arrest and subsequent conditional plea and entry into a diversion program. Tilkey countered that the company's reliance on his arrest records violated section 432.7; thus, he was wrongfully terminated. The parties' disagreement hinged on the interpretation of section 432.7, subdivision (a)(1), which prohibits employers from utilizing as a factor in employment decisions any record of arrest or detention that did not result in conviction or any record regarding referral to or participation in any pretrial or post trial diversion program.

Allstate argued a conditional plea agreement qualifies as a conviction. Tilkey contended he never entered a guilty plea; thus, there was no conviction. The court concluded we conclude the term "conviction" as defined in section 432.7 does not require entry of judgment: “The plain language here makes clear that a judgment is not required because the conviction can exist without respect to sentencing. (See ibid.) The statute's legislative history supports this interpretation.” A conviction under section 432.7 does not require an entry of judgment; it simply requires entry of a guilty plea. Thus, Allstate did not violate section 432.7 by using Tilkey's arrest as a factor in its decision to terminate his employment.

II: DEFAMATION

Allstate next challenged the defamation verdict, contending that self-compelled defamation should not provide a basis for a defamation per se cause of action. It further contended there was no evidence that Tilkey's self-publication was compelled by its publication of the reason for his employment termination on the Form U5 because that publication contained a privileged statement. Finally, Allstate maintained that its statement was substantially true, justifying reversal of the verdict.

For a valid defamation claim, the general rule is that "the publication must be done by the defendant." (Live Oak Publishing Co. v. Cohagan (1991) 234 Cal.App.3d 1277, 1284 (Live Oak Publishing).) But there is an exception "when it [is] foreseeable that the defendant's act would result in [a plaintiff's] publication to a third person." For the exception to apply, the defamed party must operate under a strong compulsion to republish the defamatory statement, and the circumstances creating the compulsion must be known to the originator of the statement at the time he or she makes it to the defamed individual.

Compelled Self-Published Defamation Per Se

In an action for defamation per se, the meaning is so clear from the face of the statement that the damages can be presumed. The originator of the statement is liable for the foreseeable repetition because of the causal link between the originator and the presumed damage to the plaintiff's reputation but the publication must be foreseeable.  The presumed injury is no less damaging because the plaintiff was compelled to make the statement instead of the employer making it directly to the third party. Allstate offered several other arguments for why the Court should not accept a theory of compelled self-published defamation.

Form U5 Privilege

Allstate provided a written explanation for Tilkey's termination of employment on the Form U5 to FINRA, which was available to every prospective employer of similarly licensed employees. Thus, disclosure was not absolutely privileged. Thus, Tilkey was compelled to explain the reason for his discharge, and this repetition was reasonably foreseeable.

Additionally, the qualified privilege that attaches to communications about an employee's job performance when made without malice or abuse to a third party likewise protects an employer against compelled self-published defamation. This conditional privilege helps protect the free flow of reference information.

Firms are required to file a Form U5 with FINRA whenever a registered representative leaves the firm. If the registered representative's employment has been terminated, the form asks the firm to provide a reason for termination. When the Form U5 identifies allegations of improper conduct by a broker-dealer, an issue that FINRA may need to investigate, it can on those occasions be considered "a communication made 'in anticipation of an action or other official proceeding.' (Briggs v. Eden Council for Hope & Opportunity (1999) 19 Cal.4th [1106,] 1115.)" (Fontani v. Wells Fargo Investments, LLC (2005) 129 Cal.App.4th 719, 732, disapproved of on other grounds in Kibler v. Northern Inyo County Local Hospital District (2006) 39 Cal.4th 192.) In those instances, the information reported on the Form U5 would be protected by the absolute privilege outlined in Civil Code section 47, subdivision (b), at least in California.

Section 7 of the Form U5, however,  includes a list of disclosure questions for full terminations that asks if the terminated employee was the subject of a governmental investigation; was under internal review for fraud, wrongful taking of property, or violated investment related laws, regulations, or industry standards relating to compliance; was convicted of or pled guilty to a felony; or was convicted of or pled guilty to a misdemeanor that related to investments, fraud, false statements, bribery, perjury, forgery, counterfeiting, extortion, or wrongful taking of property. These questions make clear that FINRA seeks termination information that allows it to assess whether the employee's conduct lacked compliance with regulatory requirements in the securities arena. FINRA does not ask for information about non-securities-related activities because that information falls outside its scope of regulation.

Thus, according to the California Court, the absolute privilege extends to communications required by FINRA, i.e., fraud- and securities-related information. However, the communication of Tilkey's termination here did not regard improper securities-related conduct, and Allstate did not limit its responses to fraud- and securities-related information. Instead, Allstate explained Tilkey's departure was the result of a "termination of employment by parent property and casualty insurance company after allegations of engaging in behavior that are in violation of company policy, specifically, engaging in threatening behavior and/or acts of physical harm or violence to any person, regardless of whether he/she is employed by Allstate. Not securities related." This statement did not contain allegations of improper securities conduct, theft, or allegations or charges of fraud or dishonesty. It was not offered in anticipation of or to initiate an investigation; nor was it offered in the course of any other official 29 proceeding. (See Civ. Code, § 47, subd. (b).) Thus, the absolute privilege does not apply[1].

Substantial Evidence Supported the Jury Findings That Tilkey Was Compelled to Self-Publish a Statement That Was Not Substantially True

The jury concluded that Tilkey was under strong pressure to communicate Allstate's defamatory statement to another person. There was ample evidence to support this conclusion. A “vocational evaluator” testified Tilkey would have a difficult time ever getting another job because he had been terminated, and the reason for termination reported on the Form U5 was negative. He also noted that because Tilkey sold life insurance, he was required to hold securities licenses, and agencies and employers hiring those with securities licenses would have access to U5 forms. Tilkey's supervisor at Allstate, testified that Allstate routinely reviewed the securities public information from the Form U5 of any person they were hiring, and he could not recall ever hiring anyone at Allstate whose Form U5 stated he was terminated for cause. Tilkey testified that when he recruited agents, he would have someone check the Form U5, and he never hired anyone whose Form U5 showed the termination was for cause. He also never received an interview from any company that had access to a Form U5, even though he had 30 years of experience and performed well, receiving the third largest bonus in the state just a few weeks before his termination. Even if the company never offered any specific information about the reason for Tilkey's discharge from employment to prospective employers, its statement at the time of discharge and its reporting of the information on the publicly available Form U5 necessitated Tilkey's self-publication in other settings. In sum, the Court of Appeals upheld the defamation verdict but concluded that the punitive damage award was excessive. More on that later.

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[1] Had Allstate instead eliminated the specifics in its statement, privilege may have attached because Allstate was required to report the termination. For example, it could have supplied the following statement: "Termination of employment by parent property and casualty insurance company after allegations of engaging behavior that are in violation of company policy. Not securities related."

Presidential Candidate Requests Information on Proposed Amendments to FINRA’s Expungement Rules

The Central Registration Depository (“CRD”) and the publicly available online portal, BrokerCheck, comprise FINRA’s registration and licensing system.  Via BrokerCheck, customers, employers, and regulators can access information regarding customer complaints levied against an individual broker.  BrokerCheck plays a key role in allowing customers to evaluate their broker’s track record before making investment decisions.  By the same token, adverse claims can have a devastating effect on a broker’s ability to retain their clients.   

As such, FINRA has established rules for the expungement of certain adverse claims from CRD.  Currently, FINRA Rules 12805 and 2080 control customer complaint expungement proceedings.  Rule 12805 requires that a broker file a Statement of Claim requesting expungement of the customer disclosure.  The panel must:

·    hold a recorded session regarding the appropriateness of the expungement;

·   when applicable, review settlement documents and consider the amount of payments made to any party;

·    provide a written explanation which indicates which of the grounds for expungement under Rule 2080 is the basis for the order; and

·    assess all fees for the hearing against the party requesting expungement.[1] 

Under Rule 2080, grounds for expungement include:

·    the claim, allegation or information is factually impossible or clearly erroneous;

·  the registered person was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation or conversion of funds; or

·    the claim, allegation or information is false.[2] 

Following an arbitration award recommending an expungement, the broker must then file a petition in a court of competent jurisdiction to obtain an order confirming the award and directing such expungement.

In December 2017, FINRA published Regulatory Notice 17-42, a proposed amendment relating to requests to expunge customer dispute information.  Regulatory Notice 17-42 would create a roster of arbitrators with specific training and experience to handle all expungement requests.  It would also require:

·       the broker to appear at his or her expungement hearing;

·       unanimous agreement of the three person arbitration panel;

·      expungement requests to be brought within one year of the dispute; and

·       minimum fees for filing expungement requests.[3] 

Since publishing Regulatory Notice 17-42 for public comment, FINRA has not submitted it to the SEC.  As such, the proposed expungement rules are not currently in effect.  In a March 2019 letter to FINRA President and CEO Robert Cook, Senator Elizabeth Warren requested an update on FINRA’s proposed rule changes to its customer dispute information expungement process.[4]  If eventually submitted and finalized, the new process for removing customer dispute information from a broker’s CRD will be more onerous on the broker and likely decrease the frequency with which expungement requests are granted.  Senator Warren’s letter requests, among other things, a timeline for when FINRA will submit Regulatory Notice 17-42 to the SEC for approval.

It is unclear if or when the new CRD expungement rules will be submitted to the SEC and put into effect.  FINRA spokespersons have declined to comment on the substance of Senator Warren’s letter, stating, “We have received the senator’s letter and are working to respond accordingly.”[5] 

Given the uncertainty of the status of FINRA’s expungement rules, it is important that brokers seeking CRD expungement select an attorney capable of guiding them through expungement proceedings under the current and any potential future FINRA rules.  Cosgrove Law Group, LLC has represented numerous individuals in CRD expungement proceedings under the current rules and stands ready to represent brokers in proceedings governed by the proposed amended rules.  If you are seeking expungement of customer complaints from your CRD/BrokerCheck, you may wish to consult with experienced counsel at Cosgrove Law Group.

BY: Max Simpson

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[1] FINRA Rule 12805, http://finra.complinet.com/en/display/display_main.html?rbid=2403&element_id=7229

[2] FINRA Rule 2080, http://finra.complinet.com/en/display/display_main.html?rbid=2403&element_id=8468

[3] Regulatory Notice 17-42, http://www.finra.org/industry/notices/17-42

[4]Letter, Sen. Warren to Cook, March 21, 2019, https://www.warren.senate.gov/imo/media/doc/2019.03.21%20Letter%20to%20FINRA%20re%20Broker%20Expungement%20Data.pdf

[5] Financial-Planning.com, Warren presses FINRA for answers on expungement reform, https://www.financial-planning.com/news/elizabeth-warren-presses-finra-for-answers-on-expungement-reform

FINRA’S NEW DISCLOSURE REVIEWS MAY HELP LIFT BURDEN FOR FIRMS AND REPRESENTATIVES

Beginning July 9, 2018, FINRA will conduct an individual public records search on every applicant when a broker-dealer files a form U-4 application for registration.  FINRA currently performs this search for all registered persons—but only annually.  This additional records search—

which will satisfy the requirement to perform a search of records for judgments, bankruptcies, and liens only—will provide added benefit to member firms and registered persons, according to FINRA.  In FINRA’s May 18, 2018 Information Notice, FINRA claims this additional search is “likely to: (1) reduce the costs to firms associated with conducting these public records checks, which often involve finding and hiring a vendor; (2) result in more timely reporting of disclosure information to the benefit of regulators, investors and firms; and (3) result in a significant reduction of late disclosure fees related to judgments and liens[1].”

Numbers (1) and (2) seem like probable benefits to both the member firms and the registered persons.  Saying the same for number (3), however, appears to be a stretch.  Regardless, the burden of these public records searches is real, especially to smaller broker-dealers.  FINRA taking over this requirement is a welcome change and one that makes sense given that it is already performing the annual searches.  Firms and agents will still need to respond to and file any items that are found in these searches, but the searches themselves will no longer have to be performed in-house or by a third-party vender for each registered hire. 

Finally, firms and registered persons are still required to report unsatisfied liens and judgments within 30 calendar days of learning of the event as long as the agent is registered and to report other activity, such as certain criminal matters per FINRA Rules.

Cosgrove Law Group, LLC regularly assists registered persons with disclosure matters, regulatory inquiries, registration matters, and other matters related to industry registration compliance.  We also have experience assisting broker-dealers with regulatory inquiries related to their registration filings.

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[1] Firms and registered persons are required to report unsatisfied liens and judgments within 30 calendar days of learning of the event. FINRA determines whether a filing is late based on the date the registered person learned of the judgment or lien and, if it is late, will assess the late disclosure fee based on that date. See Information Notice 8/17/12 (Late Disclosure Fee Related to Reporting of Judgment/Lien Events). Occasionally, an individual is unaware of the existence of a judgment or lien. The public records search facilitates the identification and timely reporting of these events

Financial Advisors Expunging Baseless Customer Complaints in State Court

The Internet is awash with articles about “bad brokers” with clean U-4s, and “rouge brokers” obtaining expungements of valid customer complaints.  Indeed, studies have been published ostensibly demonstrating that state regulators poses more valuable information on their system than what appears on FINRA’s public Broker-Check data base.  In sum, there is a consensus that too many complaints are being expunged.  But whether that consensus is based on fact is subject to debate.

Regardless, FINRA has repeatedly responded to the hue and cry by making it increasingly difficult for a financial adviser to obtain an expungement of a customer complaint published on his or her professional record.  But amidst all of this anguish and gnashing of teeth, a politically incorrect truth has been left in the shadows.  I feel compelled to share it with you.  Here it is:  some customer complaints are baseless.  There; I said it.

Another often-overlooked fact is that FA’s are able to go straight to a court of law, rather than a FINRA arbitration, to obtain an expungement.  Almost exactly one year ago, FINRA issued new guidance to its arbitrators raising ever higher the procedural bars for a panel to recommend expungement[1].  Should a FA surmount the procedural hurdles and slim avenues to success, the FA still has to go to court to get the Award confirmed.  And, in that state court action, he or she still needs to name FINRA as a party so that they can show up and oppose the FINRA arbitrator’s recommendation.

But FINRA Rule 2080 actually reads as follows:

2080. Obtaining an Order of Expungement of Customer Dispute Information from the Central Registration Depository (CRD) System

(a) Members or associated persons seeking to expunge information from the CRD system arising from disputes with customers must obtain an order from a court of competent jurisdiction directing such expungement or confirming an arbitration award containing expungement relief.

(b) Members or associated persons petitioning a court for expungement relief or seeking judicial confirmation of an arbitration award containing expungement relief must name FINRA as an additional party and serve FINRA with all appropriate documents unless this requirement is waived pursuant to subparagraph (1) or (2) below.

(1) Upon request, FINRA may waive the obligation to name FINRA as a party if FINRA determines that the expungement relief is based on affirmative judicial or arbitral findings that:

(A) the claim, allegation or information is factually impossible or clearly erroneous;

(B) the registered person was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation or conversion of funds; or

(C) the claim, allegation or information is false.

(2) If the expungement relief is based on judicial or arbitral findings other than those described above, FINRA, in its sole discretion and under extraordinary circumstances, also may waive the obligation to name FINRA as a party if it determines that:

(A) the expungement relief and accompanying findings on which it is based are meritorious; and

(B) the expungement would have no material adverse effect on investor protection, the integrity of the CRD system or regulatory requirements.

(c) For purposes of this Rule, the terms "sales practice violation," "investment-related," and "involved" shall have the meanings set forth in the Uniform Application for Securities Industry Registration or Transfer ("Form U4") in effect at the time of issuance of the subject expungement order.

It seems as if very few have read the actual rule.  I recently read an attorney blog that makes no mention of the direct-to-court avenue whatsoever!  Well, our attorneys are very familiar with both the state court and arbitration options and procedures. 

   

There is actually some case law out there on a financial adviser’s right to go to court to seek an expungement.  In Lickiss v. FINRA, 208 Cal.App. 4^th 1125 (2012), the California Court of Appeals reversed a lower court’s dismissal of the FA’s petition.  In fact, it held that the trial court abused its discretion by limiting itself to the criteria set forth in Rule 2080(b), rather than employing the court’s broad equitable power and discretion.  The Court of Appeals stated in part:

            FINRA has established BrokerCheck, an online application through which the public may obtain information on the background, business practices and conduct of FINRA member firms and their representatives.   Through BrokerCheck, FINRA releases to the public certain information maintained on the CRD, thereby enabling investors to make informed decisions about individuals and firms with which they may wish to conduct business.   This data includes historic customer complaints and information about investment-related, consumer-initiated litigation or arbitration….

            The issues surrounding Lickiss's sale of CET stock occurred more than 20 years ago, and the one regulatory matter against him resolved 15 years ago in 1997.   Since then, his record has been clear, yet Lickiss attested that he suffers professional and financial hardship relating to the prior sale of CET stock because current and potential clients increasingly use the Internet to obtain his BrokerCheck history.

Lickiss petitioned for expungement of his CRD records, asserting that the superior court had jurisdiction “pursuant to (1) FINRA Rule 2080(a);  [and] (2) the Court's equitable and inherent powers to effectuate expungements.”…

FINRA removed the action to federal court.   Upon Lickiss's motion, the federal district court remanded the matter back to the state superior court, ruling that it did not have subject matter jurisdiction over the case because there is no statute, rule or regulation imposing a duty on FINRA to expunge….

Had Lickiss merely petitioned the court for expungement relief under rule 2080, without also invoking the court's equitable powers, that might be the end of the matter.   However, Lickiss explicitly invoked those powers….

Equity aims to do right and accomplish justice.  (Hirshfield v. Schwartz (2001) 91 Cal.App.4th 749, 770.)… 

The equitable powers of a court are not curbed by rigid rules of law, and thus wide play is reserved to the court's conscience in formulating its decrees… 

This basic principle of equity jurisprudence means that in any given context in which the court is prevailed upon to exercise its equitable powers, it should weigh the competing equities bearing on the issue at hand and then grant or deny relief based on the overall balance of these equities…

The choice of a very narrow, rigid legal rule to assess the legal sufficiency of Lickiss's petition—a choice that closed off all avenues to the court's conscience in formulating a decree and disregarded basic principles of equity—was nothing short of an end run around equity…

This is not, as FINRA contends, merely a request for a remedy.   Rule 2080(a) essentially recognizes the right of members and associated persons to seek expungement of information from the CRD system by obtaining an order from a court of competent jurisdiction directing such expungement. 

See also Lickiss v. FINRA, Fed.Sec. L. Rep. P.96, 345 (2011). Compare Updegrove v. Betancourt, 2016 WL 3442762 (2016).

  

If you are a FA who has a U-4 scarred by one or more clearly erroneous customer complaints, we would be happy to evaluate your prospects for success in seeking an expungement in state court or arbitration.  Your chances of erasing an unfair or unfounded complaint in a court of law at a reasonable cost might be better than you think.

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[1] http://www.fa-mag.com/news/finra-continues-to-tighten-lid-on-expungements-with-newly-enhanced-arbitrator-guidance-23443.html

http://finra.complinet.com/en/display/display.html?rbid=2403&record_id=15841&element_id=11616&highlight=2081#r15841

FINRA's BrokerCheck Posting Terminations More Quickly, but Firms Still have 30 days to Report

FINRA's RegulatoryNotice 15-39 is getting a little blog time, but sadly some law firms writing about it seem to misunderstand not only the Notice itself, but also the implications of the changes that have been implemented.  

FINRA Rule 8313 governs the body’s public disclosure of the professional history, business practices, and conduct of their security industry member firms, associates, and those affiliated with the Central Registration Depository (CRD). The Notice, issued December 12, 2015, advises of the approved change to this rule that effects the timeframe in which FINRA releases information to the public through its online BrokerCheck report system.

FINRA currently requires firms to report the termination of a representative’s registration/employment with them within 30 days of the termination through the CRD system[1]. In other words, once a representative leaves or is fired from his or her job with XYZ Financial Services, XYZ has 30 days to file a Form U5 regarding that termination. Once the U5 has been processed, it becomes available for FINRA to post on BrokerCheck, and the states to provide in the CRD Snapshot. 

The Notice states that the time FINRA must wait (after processing the filing) before making the U5 available for public access has decreased by 80 percent, from 15 days to three (3).  While this is a big change, and worthy of plenty of blog time, it in no way effects the 30-day window employment firms have to make the U5 filings.  

Now to the real heart of the matter:  Fairness.  

According to FINRA, “a three-business-day waiting period is more reasonable than a 15-day period because it allows investors to more quickly access disclosure information reported on Form U5 while at the same time still providing brokers with the opportunity to comment on the reported disclosure event.” FINRA claims this was necessary for it to fulfill its mandate to, “prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, and, in general, to protect investors and the public interest[2].”  

While FINRA's argument is for prompt disclosure to the public, they miss a key element in this process—the accuracy of the firm's Form U5 filing.  The problem is that firms sometimes have reasons to file improper or down-right false U5s[3]. (See a previous blog titled “How to Terminate,Discredit, and Interfere with a Financial Adviser: the U-5.”) 

Until FINRA member firms are held accountable for improper U5 termination language, the shorter window does little to ensure that fair and accurate information is being provided to the public, much less in a prompter fashion.  The initial 15-day window was selected to provide the representative with at least some amount of time to respond to the filed termination language before it became public.  Changing that window to three days eliminates that opportunity.  While FINRA seems to be trying to make strides to be more transparent and customer-friendly, they once again ignore that their own members are, at least initially, able to wantonly disparage brokers and reap the benefits that an improper, overly harsh, inaccurate, or unfair U5 can bring to them.  

David Cosgrove and Cosgrove Law Group, LLC have handled many U-5 defamation cases over the past several years. If you believe you are a victim of U5 defamation, please contact our firm and speak with one of our qualified attorneys.

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[1] The CRD is an online registration and licensing database that allows for the filing of required forms related to the securities industry that must be submitted for a multitude of reasons, such as “Form U5 – Uniform Termination Notice for Securities Industry Registration.” Regardless of the circumstances surrounding a representative leaving the firm to which they are registered, a U5 must be filed by the firm with the CRD within 30 days of the date of termination, as well as be provided to the representative. FINRA determines what portions of the CRD filings become publicly available on BrockCheck.

[2] Securities and Exchange Commission (2015 September 25). Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Notice of Filing of a Proposed Change to Amend FINRA Rule 8312 (FINRA BrokerCheck Disclosure) to Reduce the Waiting Period for the Release of Information Reported on Form U5 (Release No. 34-75988; File No. SR-FINRA-2015-032) [electronic format]. Retrieved from https://www.sec.gov/rules/sro/finra/2015/34-75988.pdf

[3] Most U-5 disclosures, however, are free of defamatory content or tortious intent. In other words, most broker-dealers satisfy their obligation to ensure a full, fair, and accurate reporting. There are, however, far too many times where this is not the case.

How to Terminate, Discredit, and Interfere with a Financial Adviser: the U-5

I did not design the method I am about to share with you. Nor do I condone it. But I have observed its employment repeatedly during my legal representation of financial advisers. And although some of the players on the field participate unwittingly, there is always a motivating participant. So, this is how it often works:

1. A FINRA broker-dealer needs a sacrificial lamb (or two) to satisfy a regulator, or a manager or large producer has an ax to grind, or a large producer is seeking to leave with a substantial piece of the broker-dealer's overall assets, or Compliance is too lazy to ferret out a false accusation against a financial adviser.
2. The motivating participant employs Compliance to (unwittingly?) establish an alternative pre-textual basis for termination. Sometimes it is a sales or management practice that has been accepted or overlooked for years.
3. The motivating participant and Compliance employ Legal and Registration, under cover of the attorney-client privilege, to approve and issue a sufficiently disabling Form U-5 disclosure¹. Extra damage can be done by simply checking any of the “yes” boxes under U-5 question 7. This can be too-easily justified by expanding the scope of the term “industry standards” in question 7E. 7E will trigger a public disclosure and regulatory investigation.
4. Delay #1: The broker-dealer has 30 days after the termination to file the Form U-5. It can also update it at any time should updates be necessary.
5. Delay #2: State regulators will refuse to register the financial adviser until they can investigate the basis for the U-5 disclosure. They may take weeks or months to inquire of the financial adviser and broker-dealer, giving the unmotivated broker-dealer 30-60 days to respond to their request for information. Often times this lengthy response time is used by the broker-dealer to craft a letter that is misleading and refers to the financial adviser in the worst possible light. A copy is not sent to the financial adviser.
6. Delay #3: FINRA will likely demand documents and explanations as well from all of the parties.
7. During the pendancy of #'s 3, 4, and 5, the broker-dealer may aggressively enforce non-solicitation or non-compete provisions. The successor financial adviser will call the departing financial adviser's book and, among several tactics, claim that he/she does not have contact information for the departed financial adviser. He or she may also encourage the client to view any disclosures on BrokerCheck and to stay with the current broker-dealer².
8. Finally, a promissory note balance may be used to exert extra financial pressure or silence from the financial adviser.

This is the basic anatomy of a tortious scheme to interfere with a financial adviser's business relationships. If you are currently or about to be a part of this game, either as a victim or hesitant participant, I urge you to contact me³ immediately.

1Most U-5 disclosures, however, are free of defamatory content or tortious intent. In other words, most broker-dealers satisfy their obligation to ensure a full, fair, and accurate reporting.

2This is a critical footnote. One or more of the players may simply be mean-spirited or incompetent. While this person may be the motivating player, he or she is usually manipulated and used by the motivator. The ultimate financial adviser victim—typically our client—frequently has a character defect (like all of us) that is exaggerated and exploited.

3David Cosgrove has handled U-5 matters involving MetLife Securities, US Bancorp Investments, Questar, US Allianz, Edward Jones, Raymond James, Morgan Stanley, ING Financial partners, and others.    

New FINRA Rule Limits usage of Expungement Requests in Arbitration

The SEC has approved FINRA Rule 2081 that would disallow brokers from conditioning settlement of a customer dispute on a customer’s consent to the broker’s request for expungment from the Central Registration Depository (“CRD”). The CRD is the licensing and registration system used by all registered securities professionals. The system enables public access to information regarding the administrative and disciplinary history of registered personnel, including customer complaints, arbitration claims, court filings, criminal matters and any related judgments or awards. Because of the open nature of information available to its investors, registered professionals would like sensitive matters, such as customer complaints, expunged from the record. 

The purpose of Rule 2081 is to make sure that full and reliable customer dispute data remains available to the public, brokerage firms, and regulators to prevent concealment by prohibiting the use of expungement as a bargaining chip to settle disputes with a customer. Furthermore, it allows regulators to make informed licensing decisions about brokers and dealers and improve FINRA’s transparency on broker-dealer complaint histories. This prohibition applies to both written and oral agreements and to agreements entered into during the course of settlement negotiations, as well as to any agreements entered into separate from such negotiations. The rule also precludes such agreements even if the customer offers not to oppose expungement as part of negotiating a settlement agreement and applies to any settlements involving customer disputes, not only to those related to arbitration claims.

On one hand, Rule 2018 will make it more difficult for brokers to sanitize their CRD report from a past claim, ensuring that future investors can more accurately assess the quality and integrity of a registered securities professional, ensuring protection from potential fraud and abuse.  On the other hand, settlements are a significant part of resolving FINRA claims in a timely manner.  If more FINRA claims reached arbitration, then the average FINRA claim would take substantially longer to adjudicate.  Ultimately, Rule 2081 could dissuade broker-dealers from settlement prior to arbitration because they may want to take their chances in arbitration, making an already potentially slow moving process, slower.

When investigating historical use of expungement in arbitration, pursuant to SEC Release No. 34-72649, the SEC found “despite the very narrow permissible grounds and procedural protections designed to assure expungement is an extraordinary remedy…, arbitrators appear to grant expungement relief in a very high percentage of settled cases.” In order to even seek expungement, FINRA Rule 2080 requires a showing that (1) the claim, allegation or information is factually impossible or clearly erroneous; (2) the registered person was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation or conversion of funds; or (3) the claim, allegation or information is false. 

In approving Rule 2081, however, the SEC cautioned FINRA that the new rule should not be the last word on the subject of expungement and that FINRA should continue to consider making improvements to the expungement process. In this regard, even though “the proposed rule change is a constructive step to help assure that the expungement of customer dispute information is an extraordinary remedy that is permitted only in the appropriate narrow circumstances contemplated by FINRA rules,” the SEC nonetheless remains concerned about “the high number of cases where arbitrators grant brokers’ expungement requests.” SEC Release No. 34-72649

Official rule language:

2081. Prohibited Conditions Relating to Expungement of Customer Dispute Information.

"No member or associated person shall condition or seek to condition settlement of a dispute with a customer on, or to otherwise compensate the customer for, the customer’s agreement to consent to, or not to oppose, the member’s or associated person’s request to expunge such customer dispute information from the CRD system. See Regulatory Notice 14-31."

Cosgrove Law Group, LLC has experience with financial industry disputes including representing investors in recouping their losses and registered representatives seeking expungement. We also provide training, information, and compliance for registered professionals through the Investment Adviser Rep Syndicate.

Authored by Mercedes Hansen

FINRA Panel Awards Expungement in Unlikely Case

 A FINRA hearing Panel in Pittsburgh, Pennsylvania recently made an uncommon move when it expunged an arbitration from a broker’s CRD records despite finding the broker jointly liable to the customer. 

In Bordas v. Wells Fargo, FINRA ID # 11-00484, the Claimants, James and Linda Bordas filed an arbitration claim against Wells Fargo Advisors, LLC and Ernest Coffindaffer for unsuitability, unauthorized trading, forgery, misrepresentation, fraud, negligence, breach of fiduciary duty, violations of the Securities and Exchange Act of 1934 and Rule 10b-5, respondeat superior, failure to supervise, and breach of contract.  The causes of action relate to the alleged recommendation and purchase of municipal bonds and variable annuities against the Claimants’ express wishes. 

The Respondents asserted counterclaims for defamation per se, tortious interference with business relationships, and tortious interference with prospective business relationships. 

At the close of hearing, Claimants’ requested a total award of $10 million: $754,765.00 in lost capital; $707,200.00 in lost gain; and the balance in non-economic and punitive damages.  Respondents’ requested $2,000,000.00 in compensatory damages, plus attorneys’ fees of $381,561.60 and $65,564.63 in disbursements. 

The Panel found Wells Fargo and Coffindaffer jointly and severally liable to the Claimants in the amount of $97,250.00.  Since arbitration awards rarely discuss findings of fact, it is unclear which claim(s) the award relates to.  James Bordas was found liable to Coffindaffer for defamation in the amount of $1,000.00.  All other claims against Claimants were dismissed with prejudice. 

Despite finding Coffindaffer jointly and severally liable with Wells Fargo, the Panel made a specific finding of fact that Coffindaffer was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation, or conversion of customer funds.  Even though it is uncertain what claim(s) the award was based on, one can assume that Coffindaffer was probably not found liable for fraud or any claims involving an element of willful intent especially since the Panel found that Coffindaffer’s conduct was “not so egregarious as to warrant a permanent stigma on his CRD.”  

The Central Registration Depository (CRD) is a database used by FINRA and NASAA to store and maintain information on registered securities and broker firms.  CRDs contain qualification, employment, and disclosure histories of registered individuals and can be used like a background check on brokers.  FINRA also pulls information from CRDs for its BrokerCheck program, which provides background information on brokers and firms to investors. 

When a broker is named as a respondent in a customer-initiated arbitration, the claim and any alleged wrongdoing are required to be reported on the borker’s Form U4, which will eventually get recorded in the CRD system and become available to the public through BrokerCheck. Therefore, some information that can be disclosed on one’s CRD could be damaging to a broker’s reputation.   

Brokers may seek to expunge any reference to the allegations or involvement in the arbitration from the CRD system.  However, FINRA provides rules that arbitrators must follow before awarding expungement to a broker. 

FINRA Rule 2080 requires that a court of competent jurisdiction confirm an arbitration award granting expungement.  FINRA must be named as an additional party to these court proceedings.  In most cases, FINRA generally opposes the confirmation of an award to expunge.  However, upon request, FINRA may waive the requirement to be named as an additional party in these proceedings if the award directing expungement contains one of the following findings: (1) the claim, allegation or information is factually impossible or clearly erroneous; (2) the registered person was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation or conversion of funds; or (3) the claim, allegation or information is false.

FINRA Rules 12805 and 13805 provide that in order to grant expungement, an arbitration panel must hold a recorded hearing session regarding the appropriateness of the expungement.  If the case involves a settlement, the panel must review the settlement documents and conditions of the settlement to determine whether concerns exist about the broker’s involvement in the alleged misconduct. The panel must also indicate which grounds exist under FINRA Rule 2080 to support expungement.  Finally, all hearing session fees must be assessed against the party requesting expungement for any hearings in which the sole topic is expungement. 

Therefore, although the panel awarded expungement, Coffindaffer will still have to obtain a confirmation of the expungement award by the courts.  While the Panel made a specific finding under FINRA Rule 2080, FINRA may still oppose the expungement since he was sheld jointly and severally liable to the customer.  The Panel’s finding that Coffindaffer’s conduct was “not so egregarious as to warrant a permanent stigma on his CRD” may not be enough.

If you are a broker named in a customer-initiated arbitration and would like to seek expungement of the allegations or involvement in the arbitration from your CRD, contact the experienced attorneys at Cosgrove Law Group, LLC.