FINRA has prolonged its review of who should be allowed to act as public arbitrators in its cases, with no decision possible at least until the fall. As the regulator holds off on this definition, its current arbitration process continues to yield a number of disputes over language between opposing brokers and firms.
The SEC, which must approve the rule proposal by FINRA, now has until October 1 to consider prohibiting anyone who has worked in the securities industry from serving as a public arbitrator. The rule would also bar any professional who has spent 20% or more of their time serving either industry or customer clients from acting as a public arbitrator.
As the SEC studies and comments on the proposed changes to FINRAs arbitration process, broker advocates claim that in a dispute between an individual and a firm, FINRAs rules and oversight are largely tilted in favor of the member firms that fund the regulator, and that it gives firms too much power to affect an individuals career.
They cite concerns over the information that goes into an individual brokers U4 securities industry registration form and his U5 termination form, and how easily a firm can cast a negative perception on a former employee.
Last year there were over 3,700 arbitration cases filed with FINRA, and it has seen a year-on-year increase of 8% in filings from last June. The regulator does not break down the number of intra industry cases it hears concerning disputes over notations on U5s, FINRA officials say.
Leaving negative comments on U4s and U5s are a "cynical tactic," on the part of brokerage firms, says Michael Smith, an employment litigation attorney for Maryland-based law firm Bowie & Jensen.
Smith currently is representing a client who he says had a long, complaint-free and successful career with a major financial services firm. But after his client resigned, the firm alleged his client misused expense accounts in their report to FINRA. They are now attempting to get the record expunged from the U5.
"They were very nuanced in what they did," Smith says. "They were trying to avoid a claim of defamation. So they put up a top line, resignation, and then below that, refer to pending allegations expense account misuse. Which was true, there was an allegation, but when you put two and two together, it looks like they offered him to resign rather than be fired for misusing his account."
Smith adds, "The whole area is rife for abuse. You could have a stellar record, and then a heck of a time finding a job. Any other firms that are seeing this U5 will say this guys radioactive."
Smith characterizes 'marking up' employee U4s and U5s as an effort by firms to shift disputes to FINRA arbitrators rather than courts, and the burden of costs to employees to file initial complaints. "Its a poor mans way for an employer to interfere with a former employees ability to conduct future business, and costs them nothing."
Smith and other attorneys say that power of a firm to make such an impact on an individuals career is an issue for FINRA to address. "What are the sanctions for abusing it?" Smith asked.
FINRA officials note there are rules to guard against firms making defamatory statements in an ex-employees U5, and the regulator can bring action against an offending firm as a result. Additionally, the regulator has a central review group that examines U5 filings for such abuses.
When it comes to arbitration matters involving customer disputes and the financial industry, decisions have been evenly split between the two parties, officials say. The majority of intra-industry dispute it arbitrates, however, are disputes over the promissory notes signed between firm and broker at the start of an employment contract. In those cases, the majority of the rulings are in favor of firms.
The regulator has a roster of nearly 6,400 public and non-public arbitrators to select from to hear disputes. It breaks down arbitration cases into three categories -- one for disputes between customers and a firm, another for disputes between investment firms, and the third for disputes between brokers and firms. Either one arbitrator or a panel of three arbitrators is selected for a hearing, depending on the value of the claim. Before hearings, both parties in the dispute are allowed to strike a certain number of arbitrators from the roster.
But even the FINRA arbitration process has come under scrutiny after a long-time arbitrator was found to be lying about his credentials. FINRA now conducts reviews of the arbitrators assigned to cases, and excuses those who do not disclose if they have been flagged for potential conflicts.
"When you have a case before arbitrators, you hope they are impartial and come to a good conclusion, and if there is a conflict, they excuse themselves," says Constantine Katsoris, a Fordham University law professor and veteran arbitrator at the New York Stock Exchange.
Katsoris says that the issue of language is one that will continue to feed disputes. "As an arbitrator you have to keep an open mind," he adds. "Sometimes the complaints are completely fair and sometimes they are totally unfounded and vindictive."
Smiths client eventually found employment. "It took him six months to find a job, he was dipping into savings to live," Smith says. "For any former employee sitting there, dealing with notation on a U5, out of work, or starting their own firm and potential customers finding this in the database, it can be devastating."
Placing such recruits is always a challenge, says Bill Willis, president of recruiting firm Willis Consulting of Palos Verde Estates, Calif. "Some firms have a policy that they won't hire anyone who's been terminated," he says. "Other firms have a policy that they'll look at the individual advisor and their story."
That isnt an option, though, for those among the most vocal about alleged abuse of FINRA rules by firms against individuals -- the segment of brokers who decide to breakaway and start their own firms.
A broker that makes preparations to start his own investment firm while still employed, such as registering a new business name, can leave him open to violating FINRAs Outside Business Activity (OBA) rule, which carries fines and penalties of suspension. The OBA requires brokers to inform their firm first and obtain approval before taking action.
However, attorneys note, any broker who follows the letter of the law and informs his company about his intention to start his own new company can expect to be terminated immediately.
If the broker did not disclose that he was planning on starting his own firm, theres agreement it was a violation of the OBA, says Bill Singer, veteran securities attorney with New York firm Herskovits Law. But in either situation, he adds, a firm can sully the employees reputation by marking up his record with claims and unflattering language. "Its a chilling message to colleagues about leaving," he said.
Singer says that in these Catch-22 instances, the regulator is weighed against an employee. "There still is a perception in the industry that FINRA is a tool of its member firms," he says. "Member firms hire FINRA staff. Its one of the terrible flaws of self-regulation."
Sharron Ash, chief litigation counsel at the Hamburger Law Firm, says in her experience she has not seen ex-employee records marked up for purely vindictive reasons, since U5s in practice must be truthful and accurate. However, she says, notations can become an issue about language. "There are a number of different ways to say the truth," she adds.
Ash and the Hamburger Law Firm are one of several firms offering an alternative for wirehouse managers and brokers seeking to become independent without running afoul of FINRA rules. Instead of having the departing employee actively involved, the firm sets up the company for them to take over, thereby avoiding legal entanglements.
The turnkey solution offered by her firm doesnt mean that the employee can disclose what is happening while he is still working, Ash explains -- to be safe, they have to stay quiet about their new company, and then wait out the 30-day period after they leave for their old firm to file the U5.
Ash prepares a strict set of guidelines for her clients to ensure they do not get caught up in a dispute over a damaging U5, fired and subject to a FINRA investigation. Part of that means making them understand that sentimentality and collegial feelings can be exploited.
"Relationships dont matter," Ash says. "Everyone is out for themselves."
BREAKING RULES, WITH NO COMPLAINTS
The nuance of negative U5 notations is demonstrated in one example where a customer complaint wasnt even recorded against a broker. No allegations of abuse were made, and both parties declined to comment on the case.
Gregory Barr, a 25-year industry veteran, left Deutsche Bank in May after he allegedly exercised discretion in a non-discretionary account, according to FINRA BrokerCheck records.
Barr was "discharged" from Deutsche, the records show, and Deutsche said in its report to FINRA that the firm was not aware of any customer complaints at the time it notified the regulator.
Barr vouched for his actions in a statement filed in BrokerCheck. "My clients consented to and approved the trades in question, and did not complain or suffer a loss. I acted in their best interest and with their tacit approval and consent," he said in the FINRA record.
Regarding Barrs example, experts said the burden fell on the broker. "There are very serious regulatory implications in terms of fairness and what kind of records you need to take. The responsibilities are much higher," says David Ruder, professor emeritus of law at Northwestern University School of Law. "If you're doing that, you're putting the brokerage firm at risk because it's the firm's account."
Attorney Thomas Lewis, based in the Princeton office of Stevens & Lee, says penalties vary from firm to firm. "Some firms might put you under tighter scrutiny, but Deutsche Bank chose to terminate [Barr]," he says. He adds that alleged misconduct can affect an advisor for years, especially when potential clients can learn of the circumstances via BrokerCheck.
Now with Raymond James in Boca Raton, Fla., Barr declined to comment, and did not return calls seeking additional comment. Both Raymond James and Deutsche Bank also declined to comment.
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