I have discussed in prior blogs some issues with the process of registering individuals, and ensuring that information on U-4 is complete and accurate. To some degree, the debate is a bit silly, if the question is whether there is enough information provided on BrokerCheck.
There is a real problem, however, one that is much less academic, and with potentially devastating consequences. It stems from the definition of “statutory disqualification,” or “SD,” a subject that routinely confounds both practitioners and industry members. (Sadly, I have been retained on numerous occasions to help someone who, on the advice of some other lawyer, signed a Consent Order with the SEC or a state securities Commissioner that resulted in them being deemed “SD’d,” much to the surprise of the rep and prior counsel. By that point, unfortunately, the tools available to me are extremely limited.) In short, if a registered representative does one of a long list of things that have been identified by the SEC (and adopted by FINRA), e.g., a felony conviction, a supervisory failure, the rep is forbidden from ever associating with any BD in any capacity (unless the rep can induce a BD to file an MC-400 application on his behalf, and convince FINRA and the SEC that he or she should be permitted to remain in the securities industry, subject to heightened supervision). Becoming “SD’d” is the equivalent of the death penalty for a broker.
One of the acts that triggers an SD is a finding that the broker willfully failed to make a required disclosure in an application for registration, i.e., a Form U-4. That includes a willful failure to update a Form U-4 in a timely manner to disclose something that requires disclosure. A common example of such a failure is a pending tax lien. For some reason, registered representatives cannot seem to remember that Form U-4 requires them to disclose when they become the subject of a tax lien. (It hardly matters if the lien is being contested; it still has to be disclosed.) FINRA, on the other hand, does remember. It routinely runs the equivalent of a credit check on registered persons, and, if the check turns up a pending tax lien, FINRA will then review CRD to ensure that the U-4 was properly amended to reflect it. (In fact, in its recent Examination Priorities letter for 2015, FINRA expressly acknowledges that it “is expanding its use of data mining [and] analytics” to look for issues precisely like this.) If it was not, then it presents FINRA with an easy Enforcement case (and we all know how much FINRA likes to bring the “low-hanging-fruit” cases). FINRA has brought dozens of these “U-4” cases in recent months.
Interestingly, the potential sanctions for filing a false U-4, as described in FINRA’s Sanction Guidelines, seems to indicate that this is not a serious problem in FINRA’s eyes, given that the range of appropriate fines starts at only $2,500. If you want further evidence that FINRA appears to view an untimely U-4 amendment to be a relatively modest problem, consider that it is included among the long list of Minor Rule Violations, which, by definition, call for fines of no more than $2,500.
But…these benign outcomes are only available when the failure to file the U-4 amendment, or the failure to file it timely, is not “willful.” And, unfortunately, the definition of “willful” is ridiculously easy to satisfy. It does not mean that someone intended to violate the rule. It does not mean that someone knowingly failed to file the update. It merely means, “an intent to do the act which constitutes a violation.” Thus, generally speaking, there are only two facts that FINRA needs in order to demonstrate willfulness: (1) respondent knew about the pending tax lien, and (2) respondent failed to amend his U-4 to disclose it. It has no bearing whether or not respondent knew of his obligation to disclose it.
The upshot of this is that what FINRA has expressly acknowledged to be a relatively minor rule violation can, when deemed to be willful, become a career ending catastrophe, due to the fact that it will result in a Statutory Disqualification. There is nothing cheap or easy about dealing with an SD. Assuming the SD’d rep is fortunate enough to have, or to find, a broker-dealer willing to file an MC-400, there is absolutely no guarantee that the application will be granted. It could mean an evidentiary hearing in front of a subcommittee of the National Adjudicatory Council, a hearing at which the applicant has the burden of proving his or her right to remain in the industry. As the reported SD decisions readily reveal, MC-400 applications are routinely denied.
Given the hubbub about BrokerCheck and registered reps’ failures to keep their Forms U-4 updated, coupled with FINRA’s historic reaction to “bad press,” it is easy to anticipate that FINRA will become even more aggressive in pursuing these failures as Enforcement cases, and will characterize the failures as “willful.” The result may very well be a host of brokers who, through nothing other than inadvertence or mistake, find themselves SD’d, facing the possibility of being permanently excluded from the securities industry.
The lesson here? Every rep has the duty to ensure that his or her own Form U-4 is accurate, complete and up-to-date. That cannot be left up to the broker-dealer, even though a rep cannot file his own U-4 amendments. Every rep should take the time to review Form U-4 and study the questions, to serve as a reminder the universe of information must be disclosed. Then, they should have their broker-dealer provide a copy of the CRD record itself, and confirm that everything requiring disclosure is, in fact, disclosed. (It is not enough simply to review BrokerCheck inasmuch as some things in CRD are not published via BrokerCheck, as noted at the outset of this entry.) If there are omissions, or disclosures that need updating, reps should request or, more accurately, demand that the U-4 be corrected immediately. And, of course, that that communication with the BD needs to be documented. One of the few ways that a failure to timely amend a Form U-4 charge can easily be proven not to be willful is by demonstrating that the BD was timely notified of the need for the U-4 update but somehow failed to do it. With documentation of the request/demand in hand, that is an easy demonstration to make.
P.S. Since I published this earlier this week, a good friend of mine, Gregg Breitbart, had an excellent article picked up by Investment News on the same subject, i.e., the serious problems that ensue when a failure to update a Form U-4 is deemed to be “willful.” Gregg focused on what is seemingly FINRA’s favorite case to bring, the failure to disclose an unpaid tax lien in a timely fashion. In my experience defending these cases, there are really only two ways to establish that the failure was not willful. First, have documentary evidence that establishes the registered representative advised his or her broker-dealer about the tax lien, but, for whatever reason, the BD failed to amend the Form U-4. Second, have documentary evidence that proves, somehow, the registered represenative was simply unaware that the lien was filed. While that argument will never fly when a registered representative fails to disclose a bankruptcy filing (since it would be awfully hard to convince anyone you didn’t know about something that you had filed something in court and which bears your signature), it can prevail in connection with tax liens, which are simply mailed by the IRS (or the state) to the taxpayer, and, thus, can be lost in the mail.
Here is the link to Gregg’s article.