Recently, a formerly-registered advisor who now practices as an IAR sought expungement of an occurrence filed by two customers in 2014. The investment in question was a real estate tenancy in common investment (TIC) that the customers purchased in 2008.
One of the two customers had just sold a real estate property and was seeking a Section 1031 exchange to avoid taxes on the sale. His investment in the TIC comprised about 10% of his portfolio. The other had also recently sold real estate property and was seeking to avoid taxes on the sale. His investment in the TIC comprised about 17% of his portfolio. Both customers’ investor profiles met suitability requirements, in that each had experience investing in real estate, an annual income of at least $150,000, a net worth of $1 - $5 million, a moderately aggressive to aggressive risk tolerance, and low to no liquidity needs. Both customers were seeking income and capital appreciation from the investment.
The Investors Complained After Holding the Investment for Six Years
Shortly after the customers’ 2008 real estate purchase, the world experienced one of the worst financial crises in history. Despite that the TIC actually performed as expected for some time, and it never lost principal value.
The customers voiced no concern over the investment for the next three years. In 2011, the advisor switched firms and did not bring the customers with him. Then, in 2014, the customers filed for FINRA arbitration against the advisor’s previous firm. The customers alleged over $600,000 in damages, some of which were punitive. The firm responded, denying all allegations against them and against the advisor, even though the advisor had not been named as a respondent. Eventually, the firm made a business decision to settle for a little over $97,000. It did not ask the advisor to contribute.
Luckily, the Advisor Was Able to Share Proof of Investment Suitability
At the advisor’s hearing for expungement of this dispute, he provided a copy of the PPM given to the customers, highlighting that each customer was accredited and met the suitability requirements of the TIC and illustrating that the PPM disclosed all risks associated with the investment. To corroborate his testimony regarding the customers’ investor profiles, the advisor supplied copies of the customers’ account applications.
The advisor testified to the extensive conversations he had had with each customer regarding the investment and to the volatile market conditions that followed shortly thereafter. He presented a copy of his previous firm’s response to the customers’ complaint, stating their position that the investment was, in fact, suitable for each customer. The advisor highlighted that he had been registered with FINRA for 14 years and had only received this one complaint. Neither customer submitted a response to the request for expungement, nor did they attend the hearing. The advisor’s firm did not oppose the request for expungement.
The Arbitrator Confirmed the Economic Downturn, Not the Advisor, Was the Source of All Financial Loss
It is absolutely ludicrous that two accredited investors, each with real estate investment experience and moderately aggressive to aggressive risk tolerances, each seeking to avoid taxable gains from the sale of real estate, could even fathom making a claim that this investment was unsuitable for them. It is even more ludicrous that FINRA not only allowed, but required, such a far-fetched claim to be published on BrokerCheck. Luckily, the arbitrator hearing the case agreed, highlighting the customers’ experience with real estate investing, their desire for Section 1031 exchanges, and the fact that the subsequent financial crisis was truly to blame for any alleged losses. The advisor’s CRD record and BrokerCheck are now squeaky clean.
Are erroneous complaints holding you back? Learn more about our FINRA Customer Dispute Expungement offerings.
Over the years, AdvisorLaw has been asked the same question hundreds of times:
How does a disclosure on my CRD impact a move to a new firm?"
The answer to this question is a bit complicated, as every disclosure is somewhat unique. Depending upon their caliber, firms vary in their responses to applicants with disclosures.
High-End Firms Automatically Disqualify Any Application with a Disclosure
When considering a potential transition to a high-end firm, you will be judged on many different variables, and the disclosures on your record are just one of them. Many of these firms pride themselves on having a disclosure-free team. So, in general, a disclosure on your BrokerCheck will immediately disqualify you with many high-end, boutique, or family office firms. Simply having a disclosure on your CRD can render you a non-starter—these firms are not interested in the circumstances or the story behind it.
Average Firms Use a More Holistic Review Process (for the Right Disclosures)
Applications with Mildly Derelict Disclosures Get Some Grace
The average firm (e.g., banks, regionals, independents, RIAs, and most wirehouses) does care about disclosures. However, these firms will not necessarily disqualify a candidate off the bat simply because a disclosure appears on the candidate’s CRD. Instead, disclosures are reviewed on a case-by-case basis.
Certain aspects of a customer dispute disclosure on a Form U4 can prompt a firm to exclude a candidate, such as allegations of unethical practices of forgery, theft, or a gross misrepresentation, for example. Some firms have thresholds, in that they will not consider an advisor with a settlement over $15,000 or more than three investor complaints.
Tax Liens, Bad Credit, and Severe Disclosures Can Be a Dealbreaker for the Average Firm
There are red-flag disclosures that the average firm will review, though it will prove to be an uphill battle for the candidate upon applying for employment. The first type is a tax lien or serious financial disclosure, which many firms across the spectrum view as grounds to eliminate a candidate. Financial professionals who have trouble managing their own tax liabilities or credit are viewed by many firms as irresponsible, and firms do not want sales production being influenced by outside financial pressure, such as a tax lien or bankruptcy disclosure that is viewable by potential clients.
U5 Disclosures Can Also Damage a Rep’s Chances for a Smooth Transition into An Average FirmClick To Add Text
The next disclosure type that can be a major speed bump is an Employment Separation After Allegations disclosure (ESAA), or a U5 termination disclosure. These bad boys can be a nightmare for a rep who is trying to transition to a new firm, in part because the previous firm will often take a heavy-handed approach to the language used in reporting a U5 disclosure. Often, firms will do so in an attempt to prevent the departing rep from competing with them at a new firm so they may sure to check the box that displays the U5 on BrokerCheck. This is an unfortunate reality in our industry, and many do not realize its gravity until they have lived for some time with the impact that these Form U5 disclosures cause.
Average Firms Won’t Touch Records with Regulatory Investigations
The next type of disclosure that can cause myriad issues for an advisor is any regulatory disclosure. These clearly pose a risk directly from FINRA for a hiring firm. However, what is not typically taken into consideration is the fact that FINRA and the state regulators tend to aggressively push for a settlement or an Acceptance, Waiver & Consent (AWC) after a regulatory investigation. The cost of fighting a FINRA enforcement action tends to prevent most parties from having their day in front of a judge or arbitrator. While many state and FINRA regulatory disclosures on BrokerCheck appear much worse than they are in reality, the firms view them as toxic.
Smaller, Lesser-Known Firms Give Everyone a Chance—But You May Lose Some Clients
The firms that will hire otherwise unhireable professionals in the industry tend to be smaller, lesser-known firms. These firms are still selective, because they have to be. While they tend to look at candidates based on merit and risk, they are more open to hiring an individual with negative disclosures. The downside for the candidate is that these firms hold all of the leverage, because they are the only remaining option. As a result, transition/compensation packages for candidates tend to be low to non-existent, and the rep’s existing clients may be wary of moving to a firm that does not have a brand name in the market.
Employers and Clients Outside the Industry Can Still Find Your Disclosures After You Leave the Industry
Some individuals with serious financial, customer complaint, U5 termination or regulatory disclosures opt to go RIA-only or leave the industry altogether. Yet they still find that their public BrokerCheck record (and Form ADV if they go RIA) haunts them for many years to come, because it still ends up being viewed by employers and potential clients conducting background checks. This is a sad truth. Be prepared to answer to that allegation, even the meritless ones, for at least the next decade when you leave the industry.
Because all will be picked up in an employment background check, our advice for transitioning with a FINRA disclosure on your CRD is to be up front about any and all current or pending allegations, whether or not you believe them to be reportable.
And if you want to remove the disclosures, contact us. We are in the business of protecting your livelihood.
Losing potential business due to customer complaints on your BrokerCheck report is bad enough, but it isn’t the only cost of having FINRA U4 disclosures on your CRD.
Today, most clients search online before setting up an initial meeting with a financial advisor. I’ve heard people say, “You don’t go to lunch in a new part of town without checking Yelp--why wouldn’t you check online before discussing your million-dollar portfolio?”
When FINRA began requiring advisors to include a link to their BrokerCheck profile in 2016, they opened the door for existing clients to review an advisor’s record and potentially take their business elsewhere should they find any negative disclosures. For financial advisors with unfounded and unwarranted customer disputes in their careers, it’s impossible to avoid thinking about how many prospects they’ve lost because of the negative disclosures on their FINRA BrokerCheck report.
Bogus FINRA U4 disclosures can lead to a loss of existing customers
Lost opportunity is not the only cost involved with unexpunged customer disputes. What about the time, money, and effort an advisor and their staff lose each time they have to explain a bogus incident?
Consider this example: You are licensed in Missouri, and most of your clients are in Missouri, but then Bob and Mary decide to follow their kids to Arizona. Bob and Mary are one of your top households, and you have been their planner for 25 years. They want you to keep working for them, so you need to get licensed in Arizona.
To get that new state license, you once again need to explain bogus customer allegations and misunderstandings that occurred 15 years ago, like that one time a customer misread his annuity statement, blamed you for losing $30,000, and wrote a scathing letter to your manager about the loss. You and your manager later discovered that the so-called “financial loss” was a simple misunderstanding caused by a subaccount reallocation, but FINRA still required you to report the alleged sales practice violation on your public BrokerCheck record until the end of time. As a result, you now have to explain the situation every time you are working to retain clients you’ve successfully worked with for 25 years.
It’s likely that you have a paragraph or two on hand for these types of situations, but do you really have the time and emotional energy to explain this incident over and over again? In addition to annoyance, there is a sense of injustice, because “Ole Mr. Johnson couldn’t read a statement to save his life, rest his soul,” and now you have to justify yourself for the remainder of your career.
In many cases, advisors have registrations in more than one state, and most advisors are able to drop and add states at the end of each year based on the needs of their practice. However, those with U4 disclosures may have to keep a state they don’t need or may have to hand a client in a specific state over to a partner simply so they can avoid the hassle of explaining the BrokerCheck disclosure. If you try to measure the cost in time, inconvenience and missed opportunity in this scenario, you will undoubtedly end up frustrated.
False FINRA U4 disclosures can inhibit career growth
Similarly, each time an advisor works with a new insurance company to add new insurance products to her offerings, she has to get appointed with that company. If she has any disclosures on her record, an otherwise simple process turns into an inconvenience and/or a loss of opportunity clients. Even if the insurance company approves the appointment, what about the cost of the time and effort to complete the process that simply would not exist for someone with a “clean” BrokerCheck report?
Advisors with designations like the CFP® find themselves having to provide a complete explanation of the customer allegations to yet another entity. All of a sudden they find themselves answering questions like, “What was Mr. Johnson’s risk tolerance? What was his time horizon? What was his age? What was his investment experience? Was the annuity even suitable for him in the first place? How long did he hold it? Was it in his IRA? If so, why? Was he taking income? How were the subaccounts allocated?” While it may be easy to answer all of these questions, it has been 15 years since you made your recommendation, and no one enjoys the process of constantly being held accountable for something they did not do.
What is the cost of having to repeatedly explain the invalidity of this supposed customer complaint, just to ensure that you can continue working successfully in your profession? The answer, of course, is your very own career growth. As long as the U4 disclosure remains on an advisor’s record, the costs of negative disclosures on their BrokerCheck record reach far beyond the cost of potential lost opportunity and will recur when they acquire new clients, change firms, offer new products, seek new licensures, and beyond.
Michelle Atlas, J.D.
This blog is our ongoing effort to inform and educate FINRA licensed professionals about the evolving regulatory ecosystem in which we operate.