FINRA’s Discovery Guide for Customer Disputes is not perfect. I think that FINRA would be the first one to admit that – which is why the Discovery Guide adopted under the Code of Arbitration Procedure for Customer Disputes has been revised three times in the past five years, and a task force has been set up to continue making revisions. This is the first of what will likely be many posts that highlight some of the Guide’s serious “misguidance.”
The Discovery Guide for Customer Arbitration List 1 Item 10 requires respondents, i.e., broker-dealers and registered representatives, to produce:
All Forms RE-3, U-4, and U-5 and Disclosure Reporting Pages, including all amendments, for the associated persons assigned to the customer parties’ accounts at issue during the timer period at issue, redacted to delete associated persons’ Social Security numbers, all customer complaints identified in such forms, and all customer complaints filed against the associated persons that were generated not earlier than three years prior to the first transactions at issue through the filing of the Statement of Claim, redacted to prevent the disclosure of non-public personal information of the complaining customers.
Phew! After you catch your breath from that ridiculously long sentence, with a ridiculously large number of commas – and no subparts – go ahead and read it again. If you are like me, at first glance you may have interpreted Item 10 as requiring the production of one item (Forms RE-3/U-4/U-5) with various information redacted.
But, when you get to the end of Item 10, you realize that’s not correct. The request actually calls for production of three items: (a) Forms RE-3/U-4/U-5, redacted to delete the associated person’s Social Security numbers; (b) all customer complaints identified in such forms, redacted to prevent disclosure of non-public personal information about the complaining customers; and (c) all customer complaints filed against the associated person that were generated not earlier than three years prior to the first transactions at issue through the filing of the Statement of Claim, redacted to prevent disclosure of non-public personal information of the complaining customers.
Why the drafters choose to use commas instead of subparts like they do for other Items, such as Items 1 and 7, is a mystery. But the lack of subparts makes the request confusing at best, and misguiding at worst. Even more troubling, however, than the structure of Item 10 is its substance. Item 10 requires production of all complaints listed on the rep’s Form U-4/U-5, and all complaints filed within the three years prior to the first transaction at issue – not just complaints that are “of a similar nature” to the claims at issue.
Seasoned practitioners may remember a time – prior to May 16, 2011 – when a rep was only required to produce complaints if they involved claims or conduct “of a similar nature” to those at issue in this case. From April 16, 2007 to May 16, 2011, Item 8 (predecessor to current Item 10) required production of “All Forms RE-3, U-4, and U-5, including all amendments, all customer complaints identified in such forms, and all customer complaints of a similar nature against the Associated Person(s) handling the account(s) at issue.” FINRA rather quietly eliminated the language “of a similar nature” from that Item. Both the original list of FINRA’s presumptively discoverable items, first published in Notice to Members 99-90, as well as the first version of the modern iteration of the discovery guide in place from 2007 to 2011 required only Complaints “of a similar nature” to be produced.
So why did FINRA remove this condition? Are complaints about insider trading really relevant to claims involving churning? Of course not. Will a panel allow a claimant to present evidence of a rep’s disciplinary history, no matter how old or unrelated to the claims at issue? Probably. Apparently, FINRA now believes that if a rep is even merely accused of being a bad guy once, he must surely be bad guy now, even if the two incidents are “apples and oranges.”
Even more curious – or troubling, depending on your point of view – is the fact that throughout the revisions to the Discovery Guide, FINRA actually left intact the condition that other categories of documents only need to be produced if they involve conduct “similar to the conduct alleged in the Statement of Claim.” These categories of documents include any internal audit reports (Item 14), records of disciplinary action (Item 15), regulatory investigations (Item 16), and examination reports (Item 17). In a case involving churning, is an internal audit report related to insider trading any less relevant than a customer complaint related to insider trading? The answer is obvious to everyone except FINRA, which decided to eliminate the “similar conduct” language from the request for customer complaints, but kept it as a restriction in these requests.
So, to recap – if you have ever been accused of any wrongdoing by a disgruntled customer who lost money in a down market and found an attorney in the newspaper willing to take his case, that is relevant regardless of the subject matter. But, if you have been the subject of a disciplinary action or a regulatory investigation, this isn’t so bad that you need to produce it, unless it is “similar” to the conduct at issue. Is a disgruntled customer’s complaint more indicative of a rep’s character than a report by a regulator whose job is to detect improper behavior? Not likely. Someone please tell this to the Discovery Guide task force. And while you are at it, teach them about commas.