News & Resources
On September 28, 2017, the Securities and Exchange Commission charged three New York-based brokers with making unsuitable recommendations that resulted in substantial losses to customers and hefty commissions for the brokers. One of the brokers agreed to pay more than $400,000 to settle the charges.
Brokers must make recommendations that are compatible with their customers’ financial needs, investment objectives, and risk tolerances. An SEC examination of the firm Alexander Capital L.P. detected potential misconduct among certain brokers, and the ensuing investigation has led to the filing of an SEC complaint against William C. Gennity and Rocco Roveccio. The SEC also issued an order against Laurence M. Torres.
The SEC’s complaint alleged that Gennity and Roveccio recommended investments that involved frequent buying and selling of securities without any reasonable basis to believe their customers would profit. According to the complaint, since customers incur costs with every transaction, the price of the security must increase significantly during the brief period it is held in an account for even a minimal profit to be realized.
The SEC further claimed that Gennity and Roveccio churned customer accounts, engaged in unauthorized trading, and concealed material information from their customers – namely that the transaction costs associated with their recommendations (commissions, markups, markdowns, postage, fees, and margin interest) would almost certainly outstrip any potential monetary gains in the accounts. According to the SEC’s complaint, customer losses totaled $683,038 while Gennity and Roveccio received approximately $280,000 and $206,000, respectively, in commissions and fees.
The SEC’s order against Torres found that he had no reasonable basis to believe it was suitable to recommend a high-cost pattern of frequent trading that gave his customers virtually no chance of making even a minimal profit. Torres also engaged in churning and made unauthorized trades. Without admitting or denying the findings, Torres agreed to be barred from the securities industry and penny stock trading, and he must pay $225,359.36 in disgorgement plus $25,748.02 in interest, and a $160,000 penalty.
Morgan Stanley Sanctioned $13 Million in Fines and Restitution for Failing to Supervise Sales of Unit Investment Trusts
On September 25, 2017, FINRA announced that it had fined Morgan Stanley Smith Barney LLC $3.25 million and required the firm to pay approximately $9.78 million in restitution to more than 3,000 affected customers for failing to supervise its representatives’ short-term trades of unit investment trusts (UITs).
A UIT is an investment company that offers units in a portfolio of securities that terminates on a specific maturity date, often after 15 or 24 months. UITs impose a variety of charges, including a deferred sales charge and a creation and development fee, that can total approximately 3.95 percent for a typical 24-month UIT. A registered representative who repeatedly recommends that a customer sell his or her UIT position before the maturity date and then “rolls over” those funds into a new UIT causes the customer to incur increased sale charges over time, raising suitability concerns.
FINRA found that from January 2012 through June 2015, hundreds of Morgan Stanley representatives executed short-term UIT rollovers, including UITs rolled over more than 100 days before maturity, in thousands of customer accounts. FINRA further found that Morgan Stanley failed to adequately supervise representatives’ sales of UITs by providing insufficient guidance to supervisors regarding how they should review UIT transactions to detect unsuitable short-term trading, failing to implement an adequate system to detect short-term UIT rollovers, and failing to provide for supervisory review of rollovers prior to execution within the firm’s order entry system. Morgan Stanley also failed to conduct training for registered representatives specific to UITs.
In settling this matter, Morgan Stanley nether admitted or denied the charges, but consented to the entry of FINRA’s findings.
On September 14, 2017, the Securities and Exchange Commission announced that it had charged the investment services subsidiary of SunTrust Banks with collecting more than $1.1 million in avoidable fees from clients by improperly recommending more expensive share classes of various mutual funds when cheaper shares of the same funds were available.
SunTrust Investment Services agreed to pay a penalty of more than $1.1 million to settle the charges. SunTrust separately began refunding the overcharged fees plus interest to affected clients after the SEC started its investigation. SEC examiners cited the practice during a compliance review of the firm in mid-2015. More than 4,500 accounts were affected.
According to the SEC’s order, the Atlanta-based firm breached its fiduciary duty to act in its clients’ best interests by recommending and purchasing costlier mutual fund share classes that charge a type of marketing and distribution fee known as 12b-1 fees. Investors were not informed that they were eligible for less costly share class options that did not charge 12b-1 fees. The avoidable fees flowed back to SunTrust in the form of higher commissions from the funds.
The SEC’s order found that SunTrust violated Sections 206(2), 206(4) and 207 of the Investment Advisers Act of 1940 and Rule 206(4)-7. Without admitting or denying the findings, SunTrust agreed to pay the penalty totaling $1,148,071.77 as well as disgorgement plus interest on any leftover amount of the avoidable 12b-1 fees that are being refunded to clients. The firm also agreed to be censured.
Putative financial advisors seeking to enter the securities industry are required to register with the Financial Industry Regulatory Authority, otherwise known as FINRA. The required registration application is called the Form U4. Question 14A(1)(b) asks whether the applicant has “ever been charged with a felony.”[i] Question 14I asks a series of questions about whether the applicant has “ever” been the subject of certain customer complaints or arbitrations. While these questions are unambiguous, the answers may not be when the applicant has previously had a felony or a customer complaint “expunged” from his or her past. If an applicant has been charged with a felony, or has been the subject of a customer complaint, can the applicant lawfully deny either occurrence when completing the U4?
Prior Felony Charges
Being charged with a felony is problematic enough when it occurs. It can remain problematic for years to come, whether in the context of loan applications, housing applications or employment applications. In the context of the financial services, or securities industry, it is especially serious at multiple levels. First, the Form U4 is essentially a job application. In many cases, the Form U4 represents the first step in the application process, with several more steps before an employment offer is extended. If in step 1, an applicant discloses a felony charge from earlier in life, will that applicant ever see step 2 in the employment application process? Will the second interview even occur? Will a hiring manager accept an explanation such as, “It was mistaken identity. Once the prosecutor realized that I was the wrong guy, the larceny charges were dropped.” The answer is not likely. In the securities industry, unlike any other industry or profession, the disclosure of a prior felony charge, regardless of whether it led to a conviction or was voluntarily dismissed by a prosecutor, will be part of one’s permanent public record. That public record appears on the “BrokerCheck®” portion of FINRA’s website. It is available to anyone with an Internet connection. In this illustration, the applicant’s CRD report will permanently reflect that he was charged with larceny.[ii] The CRD report will also reflect that the charges were dropped. Indeed, FINRA aggressively promotes to the general public that investors should investigate their broker. In one advertisement, FINRA writes, “You Check Everything. So Why Not Check Your Broker? Start Searching.” So, from the perspective of a hiring manager, under what circumstances would it be reasonable to hire a person who will forever be forced to wear the “felony badge,” especially when compared with hiring the similarly situated person without it? The answer is that the otherwise innocent (but perhaps higher risk) applicant will rarely receive the job offer. That applicant’s “felony badge,” or label, will essentially be a target on his or her back, even if wrongfully charged or even acquitted.[iii]
A dilemma faced by any job applicant is whether to disclose the earlier felony charge. In the securities industry, the applicant completing a U4 application is required to answer whether he or she has ever been charged with a felony. It is easy to rationalize that the employer will never discover the 10-year-old felony charge that was dropped two days after being brought. In most industries, including the securities industry, that would be a mistake. Every U4 applicant is fingerprinted. The fingerprint cards are then sent to law enforcement. The felony charges will thus be discovered by either state or federal authorities. The intentional misrepresentation of a fact on a U4 will lead to a statutory disqualification from the securities industry. In other words, don’t let the door hit you on the way out.
The more difficult dilemma is faced by the “innocent felon”—the one whose criminal record has been expunged by a court of law. Does a judicially granted expungement, or expunction, in the context of an employment application, give one the right to dishonestly answer “no” when the truthful answer is “yes”? The answer is not always apparent. Rather, it is a function of (1) the specific language used in the application question, (2) state law, (3) FINRA policy, or (4) a combination of these factors.
In general, if a Walmart job application asks whether an applicant has ever been charged with a felony, under what circumstances could an applicant respond in the negative, when in fact the applicant had been charged with a felony? The only circumstance in which the applicant could deny the prior felony charge is if the applicant received a judicial expungement, or by some other operation of law. In order to understand the specific rights conferred by an expungement, one must look at state law.
An example of a licensing application that provides for no wiggle room is the Nebraska State Bar Application. Questions 21 and 22 of the application, like question 14 of the U4, ask whether an applicant has ever been charged with violations of any law in a criminal context. Unlike the U4, however, the Nebraska State Bar Application contains the following language: “NOTE: Include matters that have been dismissed, expunged, subject to a diversion or deferred prosecution program, or otherwise set aside.” Accordingly, given the very specific language on the Bar Application, an applicant would presumably be required to disclose a prior felony charge.[iv]
The U4, unlike the Nebraska Bar Application, does not contain any similar note or instruction. It is silent. One must therefore look to applicable law to determine what rights an applicant acquired upon obtaining a lawful, court ordered expungement. Nebraska’s expungement statute, R.R.S. Neb. § 29-3523, provides a mechanism for obtaining an expungement of a criminal history. The statute does not, however, describe the rights one acquires upon receiving a criminal history record expungement, or expunction. Those rights are not always clear. Accordingly, the Nebraska resident completing a Form U4 may be left with nothing more than FINRA’s guidance on the issue.[v] Residents of other states must look to their home states’ statutes in order to understand their expungement rights, as well as its limitations.
In New York, when an expungement is judicially granted, “the arrest and prosecution shall be deemed a nullity and the accused shall be restored, in contemplation of law, to the status he occupied before the arrest and prosecution. The arrest or prosecution shall not operate as a disqualification of any person so accused to pursue or engage in any lawful activity, occupation, profession, or calling. Except where specifically required or permitted by statute or upon specific authorization of a superior court, no such person shall be required to divulge information pertaining to the arrest or prosecution.” NY CLS CPL § 160.60. In other words, if a person is entitled to the statutory sealing of a criminal history in New York, or expungement, it would be reasonable to deny the existence of a prior felony charge when completing a U4.
Florida’s expunction statute, § 943.0585, provides that an expungement recipient “may lawfully deny or fail to acknowledge the arrests covered by the expungement record,” except under certain explicitly defined circumstances. Those circumstances include candidates for admission to The Florida Bar, those seeking to be employed by the Florida Department of Children and Families, and other categories. The Florida legislature did not create an exception for applications for securities licenses (the U4) that are filed with FINRA and the Florida Office of Financial Services. Accordingly, a Florida resident who obtains a lawful, court ordered expungement may reasonably believe they have the right to “lawfully deny” ever having been charged with a felony. In responding to the question of whether the Florida applicant has ever been charged with a felony, it would not be surprising that Florida applicants would check the “no” box. Moreover, it would be reasonable for the Florida applicant to believe that he or she does not need to ask for FINRA’s permission, through its Registration and Disclosure Department, to answer “no.” After all, the entire point of conferring the expungement is to provide individuals with a fresh start, or clean slate. Being forced to ask FINRA for permission to lawfully answer “no” is tantamount to letting the cat out of the bag—both FINRA and the prospective employer will have information to which they are not entitled. That is manifestly unfair to the individual who obtained a lawful expungement. Furthermore, there exists the risk that FINRA will not uniformly apply its unpublished criteria for determining whether one can deny the existence of a felony charge.
In Connecticut, an individual who receives a judicially granted erasure of criminal records “shall be deemed to have never been arrested within the meaning of the general statutes with respect to the proceedings so erased and may so swear under oath.” Conn. Gen. Stat. § 54-142a. The Connecticut Supreme Court noted that one entitled to an erasure shall be “placed in the same position he would have occupied had he not been arrested.” New Haven v. AFSCME, Council 15, Local 530, 208 Conn. 411, 544 A.2d 186 (Conn. 1988).
Galligan v. Edward D. Jones & Co., 2000 Conn. Super. LEXIS 3041, 2000 WL 1785041 (Conn. Super. Ct. Nov. 13, 2000) involved a financial advisor who was terminated by Edward D. Jones & Company, a Missouri based broker-dealer. Mr. Galligan claimed that he was terminated after denying on his U4 that he had previously been convicted or pled guilty or no contest to certain drug related charges. Pursuant to Conn. Gen. Stat. § 54-142a, Mr. Galligan claimed that his criminal record had been erased, and that as a matter of law, he was entitled to deny that the arrest ever occurred. In the context of denying Edward D. Jones’s Motion for Summary Judgment on the claim for wrongful termination, the court applied Missouri law in holding that two exceptions to Missouri’s employment-at-will policy existed under these facts. First, the court held that a jury could find that Mr. Galligan was terminated for his refusal to perform an illegal act. Under these facts, the “illegal act” was the employer’s effort to compel Mr. Galligan to check the “yes” box when he believed he was entitled to check the “no” box on the U4. Second, the court held that a jury could reasonably find that the “discharge [was] because the employee participated in acts that public policy would encourage….”[vi] This case clearly illustrates how quickly one can lose their career by what is perceived to be an inaccurate or misleading answer to a U4 question. These scenarios will only continue, given the lack of uniformity among the various state statutes, and the difficulty of interpreting those statutes in the context of U4 applications that can conceivably be submitted to more than 50 states and territories.[vii]
As another example of the disparity, West Virginia’s expungement statute provides that upon expungement, “the proceedings in the matter shall be deemed never to have occurred. The court and other agencies shall reply to any inquiry that no record exists on the matter. The person whose record is expunged shall not have to disclose the fact of the record or any matter relating thereto on an application for employment, credit or other type of application.” W. Va. Code § 61-11-25.
Maryland Criminal Procedure Code Ann. § 10-109 defines one’s post-expungement rights in connection with employment applications. Pursuant to Maryland law, a “person need not refer to or give information concerning an expunged charge when answering a question concerning: (i) a criminal charge that did not result in a conviction….” Maryland’s statute, like Nebraska’s statute, is not as clear as the statutes in Florida, New York, Connecticut and West Virginia. The expungement statutes in those states transform criminal records into nullities, thereby giving one the right to deny that the event ever occurred. Notwithstanding the Maryland statute’s ambiguity, a Maryland expungement recipient would be reasonable in concluding that he or she may deny the existence of a prior felony charge on a U4 application. However, simply because this position might be reasonable, adopting it may be akin to “cutting off your nose to spite your face.” In the financial services industry, the employer is likely to learn of the expunged charge through the fingerprint search process. The U4 applicant therefore has a dilemma—whether to stand on principle and deny the existence of an expunged event, or simply disclose the event, knowing that it will ultimately be revealed in the fingerprint search.[viii]
It should be noted that some states do not have statutory expungement mechanisms for the expungement of non-conviction records.[ix] Other states have expungement mechanisms that confer limited rights. As previously noted, Florida’s expungement statute carves out specific circumstances under which one may not deny the existence of an expunged record. Missouri’s expungement statute, § 610.140 R.S.Mo., precludes one from denying the existence of an expunged offense “when the disclosure of such information is necessary to complete any application for: (1) A license, certificate, or permit issued by this state to practice such individual’s profession….” Because the U4 serves as an application for a securities license within the state of Missouri, one could not deny the existence of a prior criminal record. Each state’s statute is unique.
The Uniform Collateral Consequences of Conviction Act
At present, those state statutes providing mechanisms for the expungement of non-conviction records are a hodgepodge. The same is true for mechanisms for the expungement of conviction records. With respect to the expungement of conviction records, which is also relevant for purposes of the U4 application, the state of the law may be changing. In 2010, the National Conference of Commissioners on Uniform State Laws approved and recommended for enactment the Uniform Collateral Consequences of Conviction Act.[x] Because of the growth of the convicted population in the United States, millions of people are released from incarceration, probation and parole supervision every year. A Department of Justice study estimates that if the 2001 imprisonment rate remains unchanged, 6.6% of Americans born in 2001 will serve prison time during their lives.[xi] An even greater percentage of Americans will be convicted of crimes but not imprisoned. And an even greater percentage will be charged with felonies. This entire population, a high percentage of which is comprised of minorities, is subject to question 14A(1)(b) of the Form U4. An April 2013 report by the U.S. Government Accountability Office noted that from 2007 to 2011, there have been no substantial changes in the number of minorities and women in management in the financial services industry. The representation of minorities in senior management level positions is only 11 percent at financial firms.[xii] According to Maxine Waters, U.S. Representative of California and author of Section 342 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act), although the lack of inclusion of women and minorities is not limited to the financial services industry, that sector is the worst offender. One must wonder whether one cause of this is the inclusion of question 14A(1)(b) on the Form U4. How many minorities never seek employment in the financial services industry because they will be compelled to disclose felony charges, even though they may have been dropped or expunged?
The reality for any U4 applicant is that a state and/or federal fingerprint search is likely to uncover any prior criminal charges. The day of reckoning will come when the applicant will be required to explain why the “no” box was checked when the perceived correct response was “yes.” Before checking the “no” box in reliance upon a court ordered expungement, any applicant should consult with legal counsel in order to understand what rights were acquired from the expungement, and the practical consequences of exercising those rights.
Prior Customer Complaints
Question 14I of the U4 contains a series of queries regarding prior customer complaints and how they were resolved. FINRA Rule 2080 provides a mechanism for the expungement of customer complaints. Rule 2080’s predecessor, Rule 2130, is discussed in NASD[xiii] Notice to Members 04-16. Unfortunately, neither Rule 2080 nor NASD Notice 04-16 contains a definition of “expungement.” The recipient of an expungement, therefore, will simply have information removed, or expunged, from the CRD system. The individual is without guidance as to any additional rights that may have been acquired from the expungement. For instance, if the individual changes jobs within the securities industry and is required to complete a new U4, may the individual deny the existence of the expunged customer complaint? What if the individual applies for employment outside the securities industry? Can the individual deny having been the subject of the expunged matter? Again, availing oneself of the apparent right to say “no” when the answer is actually “yes,” carries risk.
Question 14A(1)(b) on the Form U4 is antiquated. It serves no legitimate business purpose, especially in view of the fact that an affirmative answer, regardless of the underlying circumstances, will forever appear on an applicant’s public CRD (assuming the applicant ever gets through the hiring process), or BrokerCheck® record. The public disclosure of a felony charge that was dropped serves only to embarrass. If indeed such public disclosure served any legitimate business purpose, it would be adopted by the legal community, the public accounting community and the medical community. Finally, because expungements are neither universally available nor uniformly defined, there will always be confusion in trying to answer questions 14A(1)(b) and 14I of the U4. Although it makes sense for question 14A(1)(b) to be removed in its entirety from the U4, a reasonable compromise would be for the otherwise useless responsive information to be removed from one’s BrokerCheck® report, and be relegated to the non-public section of Web CRD®.
[i] Questions 14A(2)(b), 14B(1)(b), and 14B(2)(b) also ask about prior charges, but in other contexts.
[ii] All of the information contained within a U4 application is submitted to the Central Registration Depository system, operated by FINRA. According to FINRA, Web CRD® “contains the registration records of more than 4,015 registered broker-dealers, and the qualification, employment and disclosure histories of more than 642,980 active registered individuals.” The publicly available BrokerCheck® report is essentially a watered down, or redacted version of the Web CRD® report. The Web CRD® report is a publicly available document, but is only available from state regulators, such as the Florida Division of Securities.
[iii] Lawyers, certified public accountants and physicians do not wear this very public target. As an example, The Florida Bar’s website only discloses an attorney’s ten year disciplinary record. There are numerous attorneys admitted to The Florida Bar with felony records. They have been admitted (or allowed re-admission) because their backgrounds have been thoroughly vetted by The Florida Bar. That aspect of their background, unlike in the securities industry, is not placed on public display on the Bar’s website, or anywhere else. The Florida Bar does not have a BrokerCheck® equivalent.
[iv] Query whether a Nebraska Bar applicant, who has obtained a lawful expungement in a state whose statutes explicitly provide that the receipt of an expungement is absolute, can argue that disclosure to the Nebraska Bar is not required? Can the Nebraska Bar applicant rightfully treat the expunged charge as a nullity? Or has the applicant just added a year or two to the licensing process?
[v] On March 5, 2015, FINRA released Form U4 and U5 Interpretive Questions and Answers. FINRA was asked whether one is required to report a conviction which was ultimately pardoned. From FINRA’s perspective, FINRA is the sole arbiter of whether an item is reportable. Any court order granting a pardon is required to be sent to FINRA’s Registration and Disclosure Department for review. FINRA employees within that department then determine whether the item must be disclosed on the Form U4. Because this interpretation requires one to disclose a prior felony conviction or charge to both FINRA and a prospective employer, it is inconsistent with the legislative intent of those states that have enacted laws recognizing the right to both privacy, and a fresh start, where a judge has explicitly ruled that the prior charge or conviction may forever be considered a nullity—as if it had never occurred. See, e.g., NY CLS CPL § 160.60 and Fla. Stat. § 943.0585.
[vi] It should separately be noted that regardless of the statutory “erasure,” Mr. Galligan answered the U4, question 22, correctly. He was only charged with a misdemeanor, and the charge did not involve the investment related business, fraud, false statements or omissions, wrongful taking of property, or bribery, forgery, counterfeiting or extortion.
[vii] Typically, an individual would sign a single U4 application. That application is then sent to each state in which the applicant wishes to be registered.
[viii] In the event the employee is later terminated after refusing to disclose information about the criminal charges, the employer may be subjected to criminal charges. Md. Criminal Procedure Code Ann. § 10-109(b)(1).
[ix] Idaho, Montana, North Dakota and Wisconsin do not have statutory provisions for expungements of non-convictions.
[x] The Uniform Collateral Consequences of Conviction Act was first put into law in Vermont. The Act was signed into law on June 10, 2014. Uniform Collateral Consequences of Conviction Act (Added 2013, No. 181 (Adj. Sess.), § 1, eff. Jan. 1, 2016). With respect to expungements of non-convictions, §§ 7603 and 7606 apply. Section 7606, signed into law in 2012, provides, “In any application for employment, license, or civil right or privilege or in an appearance as a witness in any proceeding or hearing, a person may be required to answer questions about a previous criminal history record only with respect to arrests or convictions that have not been expunged.”
[xi] Thomas P. Bonczar, Prevalence of Imprisonment in the U.S. Population, 1974 – 2001, at 1, Bureau of Justice Statistics Special Report (Aug. 2003, NCJ 197976), as cited in Prefatory Note to Uniform Collateral Consequences of Conviction Act.
[xii] Doreen Lilienfeld and Amy Gitilitz Bennett, Will Dodd-Frank’s Diversity Mandates Go Far Enough? Law 360, cited in U.S. Magistrate Karen Wells Roby, Diversity and Inclusion: The Financial Services Sector and Dodd Frank, ABA Section of Litigation, 2015, http://www.americanbar.org/groups/litigation/committees/diversity-inclusion/news_analysis/articles_2015/financial-services-sector-dodd-frank-diversity.html.
[xiii] National Association of Securities Dealers, now known as FINRA, or Financial Industry Regulatory Authority.
What on earth is a ten hour expungement? It is the approximate number of hours it should take a competent attorney to expunge an auction rate complaint from a registered representative’s CRD. Contrary to popular belief, the CRD is not engraved in stone. Rather, the CRD is intended to be a document that accurately reflects a registered representative’s relevant personal history. It is not intended to be a wall upon which all mud sticks.
So why focus on auction rate complaints? Beginning in March 2008, the CRD system was flooded with U-4 and U-5 amendments reflecting customer complaints related to frozen auction rate positions. While the reporting of many of these customer complaints was appropriate, often it was not. In those instances where reporting may have been inappropriate, the complaining customer was generally happy with his or her registered representative(or “associated person”, as referred to in FINRA lingo), but unhappy with the registered representative’s firm, or the auction rate market in particular. Indeed, the customer whose complaint lead to a reportable event may still be doing business with the registered representative whose CRD reflects the same customer’s complaint. In those cases, it is more likely than not that the customer would agree that his or her complaint based on events from years ago was not about the registered representative, but rather, about the registered representative’s firm, the product, or some other event.
Where the complaining customer is still doing business with the selling registered representative, the likelihood of obtaining an expungement is significantly increased. Moreover, the value of a clean CRD cannot be overstated. Pursuant to FINRA Rule 2080, FINRA will expunge a CRD if:
(A) the claim, allegation or information is factually impossible or clearly erroneous;
(B) the registered person was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation or conversion of funds; or
(C) the claim, allegation or information is false.
Demonstrating one of these factors is not especially challenging with the customer’s cooperation. If a customer is willing to sign an affidavit stating that the reportable event is “clearly erroneous”, or that the registered representative “was not involved in the alleged investment related sales practice violation”, obtaining a court order to this effect is realistic. All one needs to do is (1) obtain a customer affidavit; (2) file a complaint in court, naming FINRA as a party; and (3) schedule a hearing to have an Order directing an expungement entered into the public record. If the registered representative’s position regarding expungement is reasonable, and the customer’s affidavit is not contrived, there is a strong likelihood that FINRA will not contest the expungement. Once the Order directing the expungement is entered, the Order is forwarded to FINRA in order to effectuate the expungement. While this is not the only route leading to an expungement, it is the opinion of this lawyer that it is an efficient route.
FINRA’s website contains examples of expungement orders that FINRA finds acceptable for each of the three criteria provided above. Those orders can be found at:
Assuming that the court Order contains the “magical” language that FINRA requires, expungements are clearly within reach.
So Why Bother to Spend Time and Money on Expungements?
There are several reasons one would want to clean up a CRD. First, not only is the CRD a matter of public record through FINRA’s broker check system, a more complete version of the CRD is a matter of public record through various state regulators. The more complete version of the CRD contains the names of complaining customers, whereas the broker check version does not. There are other differences as well. However, because the CRD is a matter of public record, the presence of a complaint on a CRD is information that is available to both current and prospective clients. That information may prove embarrassing, or even threaten an existing or prospective client relationship.
Second, the presence of customer complaints on a CRD may threaten a registered representative’s relationships with referral sources. Those referral sources, such as lawyers and CPA’s, may be reluctant to refer to registered representatives with complaints on their CRD.
Third, the presence of customer complaints on a CRD may impact a registered representative’s ability to find new employment. Prospective employers may have policies limiting new hires to those with clean CRD’s. Prospective employers may also be less inclined to offer transitional compensation (forgivable loans) to registered representatives with complaints. Alternatively, the loan amount may be less generous.
Finally, customer complaints may impact one’s ability to transfer state licenses. Various states routinely ask for additional information before approving the transfer of licenses from one firm to another. It is the registered representative’s responsibility to do everything within their power to maintain their ability to change firms, and in turn, transfer registrations.
Any registered representative interested in an expungement should not delay pursuing it. It is conceivable that FINRA’s rules could change at any time, thereby limiting the availability of expungements. Additionally, if a customer’s cooperation is needed for the expungement, it is better to seek that cooperation while the relationship with that customer is healthy.
The Form U4 is the basic application for any person seeking to become registered with a FINRA member firm. Although updated in 2009, the U4 is an antiquated document in need of overhaul. In order to consider revisions to the U4, it is important to understand its role in today’s financial services world. Historically, the U4 was an administrative document used by self-regulatory agencies and state agencies for determining whether to grant requests for securities licenses. While the U4 retains this original purpose, that purpose has evolved. All of the information contained within a U4 application is submitted to the Central Registration Depository system, operated by FINRA. According to FINRA, Web CRD® “contains the registration records of more than 4,015 registered broker-dealers, and the qualification, employment and disclosure histories of more than 642,980 active registered individuals.” All of the information contained on the U4 becomes public, but only some of that information is available through FINRA’s BrokerCheck® website (which obtains its information from Web CRD®). Prior to the advent of BrokerCheck®, it was very difficult for a consumer to review a broker’s background. BrokerCheck® changed that. BrokerCheck® serves as “a free tool which is part of FINRA’s ongoing efforts to help investors make informed choices about brokers and brokerage firms.”
Because the U4 serves as BrokerCheck’s template, the U4 must be evaluated in the context of one of its purposes, helping investors make informed choices about brokers. With this purpose in mind, the U4, as well as BrokerCheck®, are ripe for change.
So what information is missing from the U4 that investors would find helpful in making informed choices about brokers? The first glaring absence from the U4 is any question about the applicant’s education. The only context in which education is mentioned is in the instructions to question 12, in which an applicant is asked to provide his employment history for the past ten years. According to the instructions, if an applicant was engaged in “full time education” within the past 10 years, that information should be provided in the employment history section. The applicant is not asked whether he or she finished the sixth grade, graduated from high school or college, or has a graduate school degree. The reason this information is not requested is because the securities industry has no minimum education criteria for the various licenses that permit individuals to manage client assets. To the extent FINRA wants BrokerCheck® to help investors make informed choices, an Education History section needs to be added to the U4. How many people would knowingly trust the management of their life’s savings to a person who did not graduate from high school? Or only finished one year of college? The answer is few, if any. So why hide this information? In order for the U4, as the template for BrokerCheck®, to be relevant in the 21st century, it should be revised in order to require the disclosure of an applicant’s entire education history. Stay tuned for Part II!
Over the past several months, FINRA has received an influx of arbitration case filings related to Puerto Rico bonds. Most cases are filed by Puerto Rico residents. FINRA held various conversations and meetings concerning administration of these cases. After careful consideration, FINRA determined to issue the following guidance:
FINRA will determine venue in the Puerto Rico bond cases in accordance with Rule 12213 of the Customer Code of Arbitration Procedure (the “Code”) which states in relevant part that “the Director will select the hearing location closest to the customer’s residence at the time of the events giving rise to the dispute . . . .” FINRA cases generally are venued where the customer resides, the transactions took place, and the witnesses are located. These criteria all point to Puerto Rico as the appropriate venue.
Accordingly, FINRA will not modify its existing venue rule and procedures absent the agreement of the parties.
FINRA will follow Rule 12213 in assigning venue for the following reasons:
• FINRA’s longstanding rule and policies, which were codified in 2007, were designed for the convenience and protection of customers;
• The solicitations and transactions in these cases took place in Puerto Rico;
• Many Claimants in these cases are elderly and travel to the continental United States would be difficult, burdensome and expensive;
• Many Claimants’ attorneys are located in Puerto Rico and requested venue in Puerto Rico;
• Many named individual associated person Respondents are located in Puerto Rico;
• Almost all potential witnesses are located in Puerto Rico, including non-party witnesses;
• Compelling non-party witnesses located in Puerto Rico to testify at arbitrations in the continental United States may be difficult;
• The total expenses, including Claimant and witness travel, of requiring individuals from Puerto Rico to travel to the United States would be substantial.
FINRA will continue to allow customers with more than one residence to choose venue based on the location of any of their residences. Further, if all parties in an arbitration case agree in writing to a hearing location other than one based on the customer’s residence, FINRA will select that hearing venue.
FINRA will initially provide arbitrators for the cases venued in Puerto Rico from Puerto Rico and from other hearing locations within the Southeast Region and Texas. Counsel for Claimants and Respondents were in agreement that this was the area from which to seek arbitrators to expand the available roster in Puerto Rico.
FINRA has expanded the available pool of arbitrators to serve in Puerto Rico from these states and FINRA will pay their travel expenses. To date, approximately 700 currently eligible arbitrators on the FINRA roster have agreed to serve in Puerto Rico. FINRA continues to expand the available pool of Puerto Rico arbitrators willing to serve. Additionally, FINRA is actively recruiting and training arbitrators who reside in Puerto Rico. As a reminder, parties retain the option to agree to modify the provisions of Rule 12401 to have a sole public arbitrator decide their case, as opposed to a three arbitrator panel, even in cases in which the amount in controversy exceeds $100,000.00.
FINRA arbitration hearings generally are conducted in English. However, FINRA recognizes that Spanish is the primary language in Puerto Rico and that many Claimants are not conversant in English. Therefore, at FINRA’s request, the following firms have agreed to bear the costs of consecutive translation services in the Puerto Rico bond fund cases venued in Puerto Rico in which these firms are a named Respondent and Claimant or Claimant’s witnesses are not fluent in English and translation is necessary: UBS, Merrill Lynch, Santander Securities and Popular Securities. In addition, Oriental Financial Services has agreed to consider bearing such costs on a case-by-case basis upon request. Customer-Claimants should make arrangements directly with counsel for these firms regarding translation services. Please note that the agreement is to bear costs of translation when it is necessary, and any disagreements between the parties regarding interpreter services shall be addressed by the arbitration panels.
The Customer Code of Arbitration, Code of Mediation, Uniform Forms Guide, Resources for Parties Representing Themselves and Filing a Claim–Frequently Asked Questions are available in Spanish on FINRA’s website.
FINRA is providing this information and the translation of the above-mentioned documents in Spanish as a service to the customers who use or would like to use its forum. If you have questions concerning the meaning or application of a particular rule or law, please consult with an attorney who specializes in securities law. The English versions of the FINRA Dispute Resolution Codes serve as the official versions of our rules.
Service of Arbitrators:
Counsel for Claimants and Respondents have agreed that FINRA should not limit the service of arbitrators who have previously served on a case involving Puerto Rico bonds through Award. Parties, of course, have available to them the FINRA rules on causal challenges and the Director’s authority to remove an arbitrator as set forth in Rule 12407.
Costs of Witnesses:
Witness costs will be minimized by setting venue in Puerto Rico, where almost all of the likely witnesses are located. Therefore, FINRA will follow its existing rules concerning witness costs.
The arbitrators will be asked to answer an agreed upon set of disclosure questions submitted by the parties as part of the list selection process in order to alert the parties to possible conflicts.
Please also note that any party may request additional information from an arbitrator whose name appears on the arbitrator ranking form. If a party requests additional information about an arbitrator, FINRA will request the additional information from the arbitrator, and will send any response to all of the parties at the same time.
On September 17, 2015, the Securities and Exchange Commission announced that it was charging four former Penson Financial Services officials for their roles in a series of accounting and disclosure failures related to decisions to extend credit to certain customers beyond what is allowed under the federal securities laws.
Through the SEC’s investigation, it was found that Penson Financial Services provided customers nearly $100 million in margin loans secured mostly by risky, unrated municipal bonds, including some funding a horse racetrack in Texas. The loans to the customers, including the ones used to fund the racetrack’s operations, became impaired in the wake of the financial crisis. Instead of following industry standards and liquidating the collateral, accounting properly for the loan losses and disclosing the situation to its investors, Penson officials extended more loans to the same customers in hopes that their financial condition would improve and they could pay off the loans. By doing so, Penson violated the federal margin regulations. Penson’s eventual accounting and disclosures of the loan losses that reached $60 million contributed to the firm’s demise and bankruptcy filing in 2013.
The Director of the SEC’s Division of Enforcement said in a statement “Penson took on extraordinary risks as a broker-dealer by making margin loans to certain customers backed by speculative collateral…When these loans became impaired, Penson’s leadership improperly placed more of Penson’s critical capital at risk to bail out these customers instead of timely recording the losses and disclosing the truth about the loans to investors.” The Penson officials involved in the loans agreed to settle the charges in administrative proceedings without admitting or denying the SEC’s findings.
SEC Announces Fraud Charges Against Financial Adviser for Greatly Exaggerating Assets under Management and Investment Returns
On September 9, 2015, the Securities and Exchange Commission announced that they were bringing fraud charges against a Maryland-based financial services firm and its founder/CEO. Dawn J. Bennett, personally, and as CEO of the Bennett Group Financial Services, allegedly made material misstatements and omissions between 2009–2011. In an effort to attract new clients to her fledgling investment advisory business, Bennett lured new clients with claims of industry success and impressive investment returns.
Bennett and her firm knowingly made misstatements about their managed assets to three media organizations. As a result, the media organizations ranked Bennett fifth in the category of “top 100 Women Financial Advisors” and second in its listing of the “2011 Top Advisor” in Washington DC. Bennett used these distinctions to publicize her success to existing and prospective clients. In 2010, the Bennett Group paid to appear in a weekly radio show on an AM radio station in the Washington D.C. area. Bennett hosted the radio show called Financial Myth Busting with Dawn Bennett. She also determined all of the show’s content. Bennett used this platform to falsely claim that she and the Bennett Group managed assets ranging from $1.5 billion to more than $2 billion. In reality Bennett and the Bennett Group did not provide any form of management for assets exceeding approximately $407 million. Additionally, Bennett touted the Bennett Group’s investment returns and performance during the radio show’s broadcast. However, she failed to disclose that the returns were calculated for a model portfolio, in which only a small portion of her customers participated. The same fraudulent claims were published on the radio show’s Facebook page.
During the SEC’s investigation, Bennett and her firm made additional false statements in an effort to substantiate their prior fraudulent claims about the amount of managed assets. Bennett and her firm falsely asserted that they gave advice about short term cash management to three corporate clients regarding more than $1.5 billion in corporate assets. In reality, they never provided such advice. The matter will be scheduled for a public hearing before an administrative law judge for proceedings to adjudicate the Enforcement Division’s allegations and determine what, if any, remedial actions are appropriate. The Director of the SEC’s Philadelphia Regional office said “The investing public is entitled to a level of confidence that information they receive about brokerage and advisory services is accurate, and this case shows that so-called financial experts on the radio are often merely advertisers who may not be doing so truthfully.”
According to FINRA, the Financial Industry Regulatory Authority, “Concentration risk is real. The sooner you give your portfolio a concentration checkup the better.” We are presently seeing portfolios constructed or managed by Raymond James and UBS Financial Services, concentrated in the precious metals sector or commodities sectors. Examples of the securities seen in these concentrated accounts include European Goldfields, LTD, Gold Resource Corp., Goldcorp Inc., Golden Queen Mining, Ltd., New Gold Inc., Silver Wheaton Corp., Yamana Gold Inc., Market Vectors Gold Miners ETF, Franklin Gold and Precious Metals, Van Eck International Gold Fund and Eldorado Gold. Investors, certified public accountants and estate planning attorneys should be especially concerned when seeing clients with concentrated positions in the precious metals sector or commodities sector, especially when any of these securities are part of the portfolio. Not only should your clients consider having a Certified Financial Planner review the portfolio, they should also consider having an experienced securities arbitration attorney review the portfolio.
David A. Weintraub, P.A. is interested in speaking with Raymond James and UBS clients with concentrated positions in the precious metals sector.