The soon-to-be-implemented general instructions for Form ADV Part 3 dictate that it must include “disclosures for any of your financial professionals in Items 14 A–M on Form U4.” So, while these investor disputes are no longer reportable on an advisor’s ADV Part 1A and Part 2A, because advisors must still report the events on their Form U4, these items will have to be reported to ADV Part 3.
Form U4, specifically in question 14I(1)(b), requires disclosure when an advisor was named as a respondent in the customer dispute with allegations of sales-practice violations in cases where a FINRA arbitration panel awarded a judgment against the financial advisor.
Question 14I(2)(a) of Form U4 requires disclosure for advisors who have ever been the subject of an investment-related, consumer-initiated complaint, which alleged that they were involved in one or more sales-practice violations and was settled for $10,000 or more prior to May 18, 2009 or $15,000 or more after May 18, 2009.
For the purposes of illustration, let’s consider an advisor whose BrokerCheck and IAPD profile includes two separate customer dispute disclosures: one from 1991 and one from 1997.
Settled Customer Dispute from 1991
The customer complaint disclosure from 1991 is an investor dispute claiming damages of $140,000 that went to arbitration. The advisor’s client alleged several sales-practice violations, and it ultimately concluded in a full award judgment of $33,000 against our financial advisor and two others. Our advisor was liable for $3,000 of that amount, and the other two respondents were liable for the remaining $30,000. No findings were entered regarding any causes of action on our advisor’s part.
Settled Customer Dispute from 1997
This same advisor’s 1997 initial complaint alleged damages over $250,000 with investor allegations of excessive margin trading and breach of fiduciary duty. The broker-dealer settled on behalf of the financial advisor in the amount of $200,000, with our advisor contributing $10,000.
Form U4 vs. ADV
The 1991 customer dispute that went through FINRA arbitration is not reportable on the advisor’s ADV Parts 1 or 2, because it’s over ten years old, and there were no findings of conduct violations on the part of the financial advisor. However, the FINRA arbitration case must be reported to Form U4, as Form U4 14I(1)(b) only requires an advisor to be named as a respondent with allegations of sales-practice violations in which a FINRA arbitration panel awarded a judgment against the advisor. Thus, because our financial advisor was named as a respondent, because the underlying arbitration alleged multiple sales-practice violations, and because the arbitration panel awarded a judgement against the advisor, the customer dispute disclosure must be reported on Form U4.
The 1997 customer dispute is not reportable on Form ADV Parts 1 or 2 for multiple reasons, primarily, because it was merely an investor complaint and did not involve a judgment, as well as the fact that ten years have passed. However, Form U4 still requires disclosure, because the complaint alleged a sales-practice violation and was settled for an amount in excess of the $10,000 threshold for reporting client disputes from that time.
Despite the fact that neither investor complaint is reportable to existing ADV Parts 1 and 2, both customer disputes in our hypothetical example will now be reportable to the new ADV Part 3, due to its requirement to report such events from financial advisors’ Forms U4.
If the application of these new rules in determining what should and should not be disclosed seems tricky to navigate—don’t worry—relief is available. AdvisorLaw can do all of the compliance heavy lifting for you and make sure that your ADV Part 3 or Form CRS will stand up to an audit.
Give us a call at (303) 952-4025 for a free consultation
Be sure you’re following the written policy and any written guidance provided by your supervisor or home office compliance.
Ensure your communications are properly monitored.
Once you’re sure that you’re in line with the written BCP, consider whether or not your firm has an internet phone service, and, if so, use it to its fullest potential.
Can you call out on a work line through your mobile phone? If so, use that feature when working from home. If you have an app that allows your firm to capture your texts, use that.
If you are not set up for text surveillance, don’t text or respond to texts from your personal phone. Clients may know you are working remotely and may reach out through methods, such as personal email or texts to your personal mobile phone. Always be sure to respond from the appropriate account and device.
As we previously warned, on February 7, 2020, FINRA issued a Rule Filing Status Report (SR-FINRA-2020-005). The 219-page status report provides some insight into the regulator’s advancement of several changes to the customer dispute and the U5 termination expungement process through the FINRA Dispute Resolution arbitration forum.
Timeline Of FINRA Expungement Forum Modifications
FINRA initially proposed extensive changes to the customer dispute expungement process. (Regulatory Notice 17-42)
December 2018 – Approved Amendment
“The [FINRA] Board [of Governors] approved proposed amendments to the Codes of Arbitration Procedure for Customer and Industry Disputes to codify the Notice to Arbitrators and Parties on Expanded Expungement Guidance and modify the fees for small claim expungement.”
March 2019 – Congressional Pressure
Senator Elizabeth Warren (D–MA) published an open letter to FINRA President and CEO, Robert W. Cook, pressuring Cook to submit the proposed Rule changes to the SEC for approval.
September 2019 – SEC Filing For Arbitrator Panel Changes
FINRA Board of Governors meeting minutes contained language indicating that “[t]he Board approved proposed amendments to the Code of Arbitration Procedure to create, among other things, a roster of arbitrators with enhanced training and experience from which a panel would be selected in certain instances to decide an associated person’s request to expunge customer dispute information. The proposed amendments will next be filed with the SEC.” (September 2019 Meeting Minutes)
October 2019 – PIABA Expungement “Study”
The PIABA Foundation published an “Expungement Study” purporting to be a neutral perspective on the customer dispute expungement process through FINRA’s Dispute Resolution arbitration forum. PIABA pressured FINRA that, “This is a situation that requires major surgery…”
Increased Minimum Filing Fees
SR 2020-005 increases the minimum filing fee against an advisor from $50 to at $1,575 — more than a 3,000% increase.
Increased Hearing Session Fees
SR 2020-005 increases each hearing session fee under the proposed changes move from $50 to $1,125 -- more than a 2,100% increase.
Rules 12401 and 13401, which are applicable to all arbitrations within FINRA’s Dispute Resolution arbitration forum, dictate that the amount of monetary relief at issue determines whether the matter will be heard by a sole arbitrator or a three-person panel of arbitrators. Regardless of the amount of monetary relief requested, the Rules authorize “the parties to agree in writing to one arbitrator.”
In a vast departure from these Rules, SR 2020-005 proposes that Rules 12401 and 13401 shall not apply to arbitrations in which expungement relief is requested. More pointedly, SR 2020-005 proposes that the right of “the parties [to] agree in writing to one arbitrator” be denied to those seeking expungement relief.
The result of this disparate treatment of parties to expungement claims conveniently increases each hearing session fee when compared to a sole arbitrator hearing a non-monetary claim.
Additional Hearing Session Fees
FINRA also makes the assumption that one initial prehearing conference and one hearing on the merits will be sufficient to account for all hearing sessions. However, in the 721 expungement cases completed by AdvisorLaw, the average number of hearing sessions for each case was 4.7. Under the proposed Rule change, the average total hearing session fee would be $5,287 -- a far cry from the $2,250 that FINRA estimates.
The Final Tally
What used to average around $768 in total fees to FINRA to seek expungement of a meritless disclosure will now be close to $10,000!
Proposed Arbitration Panel Changes That FINRA Is Adopting
This promise (threat) by FINRA is eerily familiar to us. In December of 2017, via Reg. Notice 17-42, FINRA asserted that “FINRA Board of Governors has approved filing with the [SEC] to make the best practices from the Notice to Arbitrators and Parties [ ] rules that the arbitrators must follow when considering expungement requests.”
In essence, for over two years, FINRA has been telling the public that its Board approved the codification of the five-page document and merely needed to be submitted to the SEC for approval.
Even in this latest mention, FINRA remains silent on the issue of why it has not been submitted to the SEC for approval at any point in the preceding 25-plus months.
Proposed Changes That FINRA Does Not Address
A number of the broad and sweeping changes proposed by FINRA in the December 2017 Reg. Notice 17-42 have seemingly gone by the wayside, including:
- doing away with telephonic hearings;
- formally prohibiting the ability of advisors to name the underlying investor(s), who instigated the false, erroneous, or baseless complaint;
- prohibiting advisors from seeking expungement of claims more than one year old; and
- requiring a unanimous decision (3/3) in favor of expungement, rather than a majority (2/3) in favor, as is the requirement for all other arbitrations within the forum.
The Walls Are Getting Taller, And The Costs Exponentially Higher
FINRA’s attempt to portray SR 2020-005 as a thorough analysis, discussion, and explanation of the proposed changes left us wanting.
The document lacks any meaningful explanation as to the justification for increasing the costs and obstacles for those seeking to obtain expungement relief. References to lost income through expungement become hollow when considering the sheer magnitude of meritless disclosures levied against its patrons. Further, FINRA’s cries of missed opportunities for revenue become tired when you review its nearly billion-dollar annual budget for mere administration.
Actions by FINRA and investor advocates to increase the costs and difficulty of seeking expungement relief amount to nothing more than a brazen and outward expression of its unwillingness to allow the accused the right to a determination as to their guilt or innocence.
FINRA continues to expend tremendous resources, aimed at erecting additional barriers and outrageously inflating costs associated with seeking expungement. Its efforts to dissuade those seeking the opportunity for a neutral third-party arbitrator to determine the merit, or lack thereof, associated with an investor’s complaint are entirely off point.
- Why not implement measures to ensure that investors’ complaints are vetted?
- Why not only publicly disclose those investor complaints that have been adjudicated and found to have a factual basis?
- Why are settlements that are entered into unilaterally by broker-dealers publicly reported on the on the advisor’s BrokerCheck profile, while the very same settlements are omitted from the broker-dealers’ BrokerCheck profiles?
Financial advisors are simply seeking the due process afforded to all Americans to clear their good name. For those burdened with the stigma and harm caused by meritless customer complaints or U5 termination disclosures, these new changes will prove to be a tremendous financial barrier at affording them access to the expungement process.
Contact us by phone: (303) 952-4025 for a free consultation as to the viability of your case. We win nearly 90% of our cases, and we can give you an honest assessment as to what it would take to remove disclosures from your BrokerCheck.
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This blog is our ongoing effort to inform and educate FINRA licensed professionals about the evolving regulatory ecosystem in which we operate.
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