ELITE ADVISOR BEST PRACTICES
FINRA's BrokerCheck Part One
Disclosure and Expungement: Should the System Be Changed?
By Steven J. Insel
- BrokerCheck already discloses more than even Form U4 does, and significant expansion of BrokerCheck is pending and proposed.
- It is important to periodically check your own disclosure on BrokerCheck for errors.
- It is possible to expunge or change disclosure items in BrokerCheck.
- You have the right to add comments to disclosure items in BrokerCheck.
- Equity, justice and public policy should call for consideration of changes in the rules to consider whether some disclosures are appropriate, or even misleading to the public in certain cases, and whether FINRA should have more discretion to consider expungement in such situations.
Lately I've been receiving more and more calls from advisers who want to know if they can seek expungement of items in FINRA's BrokerCheck public disclosure database that they perceive as being incorrect, unfair or simply ridiculous and arbitrary. Expungement is a difficult process—although not impossible. The importance of the ability to expunge items is magnified by pending and proposed changes in the BrokerCheck database.
Disclosure has always been a foundation of securities laws and regulation in the U.S. BrokerCheck, a public database run by FINRA, was created to provide the public with data about broker-dealers and their representatives. But the breadth of the disclosure and the fairness of the system are being questioned more and more by advisers. For representatives, BrokerCheck provides summary employment and registration history; securities examinations a broker has passed; outside business activities; criminal, regulatory and civil actions; and customer complaint histories.
BrokerCheck Has Increased the Items Disclosed over Time
In 2009, the information required on Form U4, and thus also on BrokerCheck, was expanded to include cases in which an adviser was involved in an alleged sales practice violation but was not named as a defendant in an arbitration or civil case. In 2010, the disclosure on BrokerCheck was expanded to include “historic customer complaints“ that went beyond the disclosure on Form U4. Previously, such historic complaints were disclosed only if significant preconditions were met. Historic customer complaints include: (1) written customer complaints that are more than two years old, that involve more than $5,000 or forgery or theft conversion, or that have not been settled or adjudicated; or (2) customer complaints, arbitrations or civil litigation settled for various small dollar amounts—$5,000 to $15,000, depending on the time period.
So a customer complaint that was never adjudicated, never subject to findings by a court, arbitrator or regulator, on which payment was never made, and filed with whatever motive or misunderstanding by a customer will remain on an adviser's public record. And expungement—getting an item removed from the record—is generally a difficult and costly process.
In the case of a direct dispute submitted to FINRA, there is no real discretion on the part of FINRA to investigate or act, as only clearly erroneous entries are removed. And if there is a question of fact, FINRA defers to the reporting entity, which may be the broker-dealer that the adviser has left. The only other avenue for expungement requires a court action or arbitration. While possible, it is obviously difficult and can be costly. (Expungement will be covered in more detail later in this series.)
Pending and Proposed Changes to BrokerCheck
Before July 2012, FINRA will unify BrokerCheck searches with the SEC's Investment Advisor Public Disclosure database, add the ability to search by ZIP code and include more education for people using the system.
FINRA is also seeking comment on proposals for further expansion of BrokerCheck, including adding disclosure of reasons for a broker's termination, adviser examination scores and pass/fail information, and some “formerly reportable“ information. FINRA is also seeking comment on whether or not it should open the system up to commercial information aggregators that can publish their own aggregated data and expand automated data-collection tools for users of BrokerCheck. FINRA is also considering public outreach to further publicize the availability of BrokerCheck and encourage its use, making the accuracy and fairness of the disclosure even more important.
Changing Firms and Disclosed Complaints
There are some additional reasons why the BrokerCheck database might not be a truly fair basis for comparing advisers.
In my experience, when advisers change firms, that is often the catalyst for complaints that end up on BrokerCheck. When an adviser leaves, other advisers are immediately assigned to try to retain the customers. All too often, I see the advisers who are trying to retain the accounts make all sorts of allegations about the departing adviser—for instance, allegations that he or she overcharged, cheated the client or did other inappropriate things. This is often compounded by the manager. When an adviser leaves, it will often generate ill will from his or her former firm. If a former adviser's customer calls the branch, it is understandable that the conversation will more likely turn into a reportable complaint than if a customer calls while the adviser is still at the branch. I have even seen complaints generated as a result of personal grudges unrelated to business. This can add to questions about the system and the use of BrokerCheck to compare advisers being considered by the public.
Disclosure of Mass Product Failure Cases
Another development that has caused consternation over BrokerCheck disclosure is the increase in mass product failures of recent years. For instance, thousands of advisers were involved in sales of auction rate securities (ARS). In many cases, regulators investigated and specifically found that firms had misled their advisers and had given them bad information and marketing materials. The authorities entered settlements in which the firms were required to repurchase most of the ARS from their customers. But if the customer complained in any way, it ended up on the adviser's record as a settled complaint. And to compound the situation, the amount of the settlement was generally stated as the repurchase price of the ARS, not the net damages.
But the regulators made specific findings that many advisers engaged in the same sales practice violation, passing on (or using) the bad information provided by their firms. The regulators knew the names but took no action to put it in any adviser's record, in spite of the findings. This is probably fair since advisers must know their products and are allowed to rely upon the information provided by their broker-dealers. Those actions were carried out by hundreds, maybe thousands, of advisers. But only the advisers whose clients complained before the settlement (possibly by calling a branch manager of an adviser who left the firm that misled him or her) have a complaint involving a large settlement payment on their records, and there is no proceeding in which to challenge the allegation against the advisers or ask arbitrators for expungement. Does this provide a database that fairly allows the public to compare advisers?
In the upcoming parts of this series, I will cover the expungement process and call for consideration of changes in the rules.