Finra's U-5 directive could put firms in a tough spot

Hiked disclosure about broker termination could trigger defamation suits; regulatory ‘overkill'?

Sep 17, 2010 @ 3:35 pm

By Dan Jamieson

Disputes over U-5 termination forms could increase as a result of directives issued last week by Finra.

In Regulatory Notice 10-39, Financial Industry Regulatory Authority Inc. warned member firms about using vague disclosures on the U-5 form in dismissing a problem broker.

The regulator told member firms that the commonly used explanation for a termination — that a broker violated firm policy — is insufficient.

"The firm must identify the policy [and] provide sufficient facts and circumstances to enable the reader to understand what conduct was involved," Finra said in the notice.

The U-5 is used to report the circumstances surrounding a registered representative's termination. Some of the U-5 information is reported on Finra's public BrokerCheck disclosure system, and brokers usually provide new employers with a copy of their U-5.

But attorneys said there's risk to both firms and brokers when more-detailed information is reported on the forms.

"There's always this tension between a firm meeting those [U-5 disclosure] requirements, while at the same time avoiding lawsuits from pissed-off brokers who claim they were defamed," said Alan Wolper, an industry defense attorney at Locke Lord Bissell & Liddell LLP.

The more firms put on a U-5, the more likely it "can be construed in more than one way," Mr. Wolper said, which can lead to litigation.

Brokers, too, could be harmed with the push to put more on U-5 forms, said Jeff Liddle, managing partner at Liddle & Robinson LLP, who defends individual brokers.

The Finra notice could "gut the ability" of brokers to sue for malicious use of U-5s, he said.

Firms may be able to argue to an arbitration panel that Finra requires them to mark up a U-5 with lots of unproven allegations, Mr. Liddle said.

A problem with U-5 disclosures is that some of the alleged reasons for termination may have nothing to do with industry regulations, he added.

A broker or branch manager fired for, say, fraternizing with subordinates "doesn't fall into a category of a rule [or] industry standard of conduct," Mr. Liddle said, yet the charge would now be written up in detail on the U-5.

The Finra notice is "overkill," Mr. Liddle said.

But the notice simply reiterates firms' disclosure obligations, said Derek Linden, Finra executive vice president of CRD/public disclosure. "Firms have an obligation to compeletly and accurately complete the form," he said. "If there's a termination, the explanation has to be sufficient so regulators can see if there's something to be concerned about."

Finra also told firms to be sure to provide more-detailed answers on a number of U-5 disclosure questions, and it wants firms to use an expansive definition of "investment-related" offenses that must be reported. As a result, alleged violations could involve investment advisory work, commodities, banking, insurance or real estate.

Legal observers said the real issue with inadequate U-5 reporting is that Finra has done little or nothing to police it.

The regulator has brought some cases against firms for failing to file U-5s on a timely basis, but not for inadequate or malicious filings, attorneys said.

"Historically, I haven't seen any cases," said Mr. Wolper, a former Finra district director. "I'm not sure it's something they do."

"What they need to do to get accurate reporting is to do some serious enforcement actions," said Jonathan Kord Lagemann, a veteran securities attorney in Chatham, N.Y.

"This is not the first [Finra] notice on this subject," he said, "and no one will take them seriously until they do [take action]."

But Mr. Linden said "we have brought disciplinary actions in these circumstances," pointing to a case against Citigroup Global Markets Inc. announced last month, in which the firm was censured and fined $150,000 for not accurately disclosing that some representatives had been terminated or resigned following allegations of wrongdoing.

Finra reviews all terminations for cause, Mr. Linden added, and requires corrective action by firms when disclosures appear to be incomplete or inaccurate.


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