April 17, 2009
This is to comment on FINRAs proposed changes to Form U-4 and U-5 reporting requirements. I have been representing both securities industry participants and customers in securities arbitrations since 1991. While for many years I mostly represented industry parties, I currently represent primarily customers. I have lectured and spoken often on the subject of securities claims by investors and the FINRA arbitration process, and have been an NASD/FINRA arbitrator for many years.
I see from the SECs web site that registered representatives and investment advisers (financial advisers, below) have launched a letter writing campaign opposing one change in particular-—requiring financial advisers to report if they have been a participant in an alleged violation which is the subject of a customer legal/arbitration claim, but in which the customer names only their firm as a Respondent.
The objectors complain that the proposed change will make them guilty before charged. That does not address the issue: who should have to report alleged sales practice violations.
Everyone who is named a Respondent or is even the subject of a simple written customer complaint must report the claim, becoming (in the eyes of objectors) guilty before charged. Obviously any reported claim against an innocent financial adviser can hurt his or her reputation. That problem is addressed by trying to make it clear that a mere reported claim is not a determination of guilt. Simply allowing alleged violators to not report some claims in no way affects the guilty before charge issue inherent in the regulatory system it just frees them, individually, from review by that system.
The objectors complaint that the proposed change will require public disclosure of claims that they have no opportunity to disprove, because they are not a party, is more real. I have seen situations in which a firm has settled a claim when the financial adviser professed innocence and wanted to defend against it. Perhaps some rule should be considered to protect financial advisers in those situations. But simply excusing them from having to disclose a claim is a bad answer.
Whether or not a Claimant names the involved individual(s) as a party has nothing to do with the individuals conduct or the need for regulatory review. Ordinarily it is a strategic decision unrelated to the individuals culpability. Those strategic decisions have a random effect on who does and does not have to report the claim. There is no rational basis for a reporting requirement that turns on whether an alleged participant is, or is not, separately named as a party to an action.
Things have changed. In the past, it was pretty standard for Claimants lawyers to name everyone involved in a claim—the reps, their managers, the firm—as a party. Over time experienced Claimants attorneys have learned that it is often, or even most often, better to just not name the the individuals as parties. (In my case its usually because I dont want to have to deal with two opposing attorneys, two sets of arbitrator strikes by the defense, two opposing opening arguments, two defense cross examinations of every witness, etc.) So nowadays, if non-party individual participants in an alleged violation are excused from any reporting requirement, a very large percentage of alleged violations will be concealed from the public and from the regulators.
While it is not a perfect solution, the proposed changes to the U-4 and U-5 reporting requirements are huge improvements over the current system. They serve the SECs charge to protect American investors, and should be adopted.