On May 16, 2022, FINRA published an Acceptance, Waiver and Consent (“AWC”) in which FA, Robert Bennett Zamani, accepted a 14-month suspension and a $27,500 fine for violations of FINRA Rule 3270 (Outside Business Activities), Rule 2210 (Communications with the Public), Rule 4511 (Books and Records) and, as always, Rule 2010 (Standards of Commercial Honor). The investigation of Zamani was triggered by a Form U5 filed by his former firm, Morgan Stanley.

The Rule 4511 violation was based on Zamani’s alleged use of business-related text messages that were not retained by Morgan Stanley, effectively causing Morgan Stanley to violate its obligation to maintain such communications under Rule 4511. This is an easily avoidable rule violation that many FAs fall prey to.

More interesting, however, are Zamani’s alleged violations of 3270 and 2210. Zamani formed a company in 2015 before becoming associated with Morgan Stanley. Without ever disclosing the company to Morgan Stanley, between January 2017 and April 2020, Zamani, through this company, offered subscription-based investment content. On its website, which was established and operated by Zamani, the company touted itself as a subscription-based platform providing investment content for aspiring day traders to “learn from professionally licensed stock traders the skills needed to become a profitable trader.” The company maintained a blog on its website, containing investment-related content, and maintained a publicly-available YouTube channel, with investment-related videos and distributed periodic newsletters to subscribers. Remarkably, during that 3-year stretch, Zamani earned $360,000 from his subscriber-based investment advice company.

FINRA Rule 2210 requires “an appropriately qualified registered principal of the member to approve each retail communication . . . .” Retail communication is defined broadly as “any written (including electronic) communication that is distributed or made available to more than 25 retail investors within any 30 calendar-day period.” A retail investor is anyone other than an institutional investor “regardless of whether the person as an account with a member.”

An important exception to this review process is that it does not apply to a communication “that does not make a financial or investment recommendation or otherwise promote a product or service of the member.” Interestingly, the AWC accuses Zamani of “disseminating investment-related communications” which is significantly different from the language in the rule, which requires the recommendation of an investment or promotion of a product.

FINRA Rule 2210 not only calls for a review of communications with the public but also sets forth Content Standards and Zamani was accused of violating several of these standards. The AWC accused Zamani of disseminating communications that (a) were not fair and balanced because, among other things, he failed to explain any risk associated with investing, (b) made “promissory statements” regarding returns, (c) made projections of investment performance, (d) contained testimonials without the required disclosures, (e) contained securities recommendations without the required disclosures, (f) contained performance data without the required disclosures, and (g) failed to disclose Zamani’s association with Morgan Stanley. Each of these Content Standards are specifically addressed under Rule 2210.

As you might imagine, Zamani apparently never disclosed this activity to Morgan Stanley or asked Morgan Stanley to review and approve any of the communications he released through YouTube, his website or his newsletters. Undoubtedly, Morgan Stanley would not have permitted any of it and a profit of $360,000 over three years is likely more money than Zamani was making at Morgan Stanley.

Zamani’s alleged conduct violated FINRA Rules 3270 and 2210. This was not a close case but FA’s should be knowledgeable about the constraints of Rule 2210. It is one of FINRA’s more complicated and detailed rules and FA’s would be well advised to seek legal or compliance advice before sending any investment-related communication to more than 25 people.

Herskovits PLLC has a nationwide practice defending investigations by FINRA, the SEC and state securities regulators. Call us for a consultation at (212) 897-5410.

On May 6, 2022, FINRA released a “Discussion Paper – Expungement of Customer Dispute Information” (the “Discussion Paper”) to address what FINRA clearly sees as problems with the current system for expunging customer complains. Let’s be clear from the outset, FINRA is openly hostile to the expungement of customer complaint information. FINRA is particularly hostile to what they describe as “straight-in” expungement arbitrations where the financial advisor seeks expungement by naming their firm as the respondent (typically after a customer arbitration has settled).

As many practitioners know, FINRA passed an amendment, effective September 14, 2020, establishing a minimum filing fee for expungement arbitrations. The Discussion Paper touts the success of this amendment in reducing the number of straight-in expungement actions by 37% between 2019 and 2020. Thus, FINRA makes it clear that its goal is reduction of expungement claims rather than making sure the claims have merit.

The tone of the Discussion Paper starts off somewhat defensive as FINRA makes sure to let the public know how few expungements are actually awarded every year. Between January 2016 and December 2021, approximately 8 percent of financial advisors registered with FINRA had a customer dispute disclosure on their record and only 1 in 10 had customer dispute information expunged during that time period. If expungement of customer dispute information is so rare, it is hard to understand why FINRA has as they put it, “engaged in longstanding efforts with NASAA and state securities regulators to explore a redesign of the current expungement process.” I recently blogged about the Alabama Securities Commission’s (“ASC”) intervention into an expungement award confirmation proceeding and the ASC’s very dim view of the “straight-in” expungement process. In light of the intervention and then the subsequent release of this Discussion Paper, it seems likely that more state regulators than just Alabama are unhappy with the current expungement system.

The Discussion Paper notes that FINRA filed a new rule proposal with the SEC in September 2020 known as the “Special Roster Proposal.” The Special Roster Proposal entailed a number of measures that would make expungement of customer dispute information more difficult. For example, the Special Roster Proposal would:

• as its name implies, create a roster of arbitrators with specialized training,

• require a three member panel, and permit no strikes or stipulations to remove an arbitrator,

• set time limits to prevent expungement after more than six years from the complaint or two years from the close of a customer arbitration,

• provide notice to state regulators upon the filing of an expungement request, and

• require financial advisors, when an arbitration has been filed, to seek expungement from the same panel that hears the arbitration.

On May 18, 2021, FINRA withdrew the Special Roster Proposal from the SEC’s consideration “in response to concerns raised by the SEC staff . . . .” The Discussion Paper provides no insight as to what those concerns are but states FINRA’s intention to continue pursuing the Special Roster Proposal, and to “continuing discussion with NASAA . . . regarding a more fundamental redesign of the current expungement process . . . .”

To that end, the Discussion Paper raises a number of possible changes to the existing expungement process, including measures such as raising the standards for awarding expungement set forth in FINRA Rule 2080. FINRA is also considering altering what firms’ and financial advisors’ have to disclose in the first instance, presumably expanding the current universe of required disclosures. FINRA makes clear, however, that it plans on moving forward on a dual track approach. In the near term, FINRA wants to implement the Special Roster Proposal, presumably after addressing whatever concerns the SEC had. In the long term, FINRA wants to completely redesign the expungement process by doing away with arbitration of expungement of customer dispute information entirely and to rely instead on FINRA and state securities regulators to determine what disclosures can be expunged. The Discussion Paper raises many questions about how this “Administrative Process” would work and what it would look like. FINRA also acknowledges that implementing such a process is going to require SEC approval and possibly Congressional action. Putting the details aside, however, the Discussion Paper makes it clear that administrative control over expungement is what FINRA wants for the future.

Herskovits PLLC has a nationwide practice representing registered representatives with Form U4 and Form U5 expungement claim. Feel free to contact us at 212-8907-5410.

Maybe you were caught using a fake ID when you were in college or maybe you got into a heated exchange after a fender bender. Each of these could lead to a variety of criminal charges that vary by state and by prosecutorial discretion. Criminal charges have obvious negative consequences. Many people however – even criminal defense attorneys – ignore the more subtle issue of whether or not a registered representative will have to disclose these indiscretions on FINRA’s Form U4 and publicly display them on BrokerCheck.

What Needs to be Disclosed on Form U4?

The Form U4 requires registered representatives to disclose if they have ever been “convicted of or pled guilty or nolo contendere (“no contest”) in a domestic, foreign, or military court to any felony” or if they have been “charged with any felony.” The Form U4 also requires the disclosure of any conviction, guilty plea or nolo contendere plea for any “misdemeanor involving: investments or an investment-related business or any fraud, false statements or omissions, wrongful taking of property, bribery, perjury, forgery, counterfeiting, extortion, or a conspiracy to commit any of these offenses” or if the registered representative has ever been charged with such a misdemeanor.

What at first blush seems straightforward is actually quite complicated. What if the state, such as New Jersey, does not have felonies or misdemeanors? FINRA defines these terms to help with these questions. For example FINRA explains that, “[f]or jurisdictions that do not differentiate between a felony or misdemeanor, is an offense punishable by a sentence of at least one year imprisonment and/or a fine of at least $1,000.” FINRA’s other definitions and guidance, however, can be less helpful.

What does it mean to be charged?

Here again FINRA provides a definition for the word “charged”. According to FINRA: “Charged: Means being accused of a crime in a formal complaint, information, or indictment (or equivalent formal charge).” The problem with this definition is that many states and municipalities use the term “charged” very differently. For example, a police officer may fill out an arrest report that may ask him or her to designate what crime you have been “charged” with. On more than one occasion, we have seen instances where the arresting police officer indicated that the registered representative was being “charged” with a felony only to have the prosecutor immediately change that “charge” to a misdemeanor. FINRA’s staff agrees that the police officer’s “charge” is not a “formal complaint, information or indictment.” Only a prosecutor can bring formal charges. However, the court paperwork will rarely, if ever, make a clear distinction between the police report charges and the prosecutors’ formal charges. In most cases, it will appear in the records as if the prosecutor decided to merely reducing the initial charge, which would make the initial felony charge still reportable. This can only be resolved (to FINRA’s satisfaction) by obtaining a letter from the court or the prosecutor’s office attesting that the prosecutor never formerly charged the registered representative with a felony. Obviously, this is not an easy task to accomplish.

Which Misdemeanors Involve “False Statement or Omissions” or “Forgery”?

What about the fake ID we mentioned before? This is a particularly tricky issue because different states have various criminal statutes that might apply to the possession of a fake ID. In New York, for example, the prosecutor might charge a person with misdemeanor level, “Criminal Possession of Forged Instrument.” So that would seem to clearly fall under a disclosable forgery. A “forged instrument” however, is defined under New York’s Penal Code as a “written instrument which has been falsely made, completed or altered.” So what if your fake ID was not an altered instrument but just someone else’s license who looked like you? You may still be guilty of violating New York Vehicle and Traffic Law § 509(6) which prohibits “any person at any time possess or use any forged, fictitious or illegally obtained license, or use any license belonging to another person.” Is the charge now not disclosable because you did not alter the ID? In addition, is a New York Vehicle and Traffic law a misdemeanor? What if you lied to arresting officer about your age when you were found with the fake ID.? In some states, that is a separate crime. Are you now back in the world of a disclosable “false statement” misdemeanor? The answer, of course, is that every arrest and criminal charge has its own peculiarities that require an in-depth and individualized analysis.

FINRA provides little guidance on this issue but in one example, a registered representative was accused by FINRA’s Enforcement Department of violating FINRA Rule 2110 by failing to report that he had been charged with a misdemeanor for possessing a “false and fraudulent written, printed and phototoxic evidence of age and identity.” The registered rep reported the misdemeanor at a prior firm, but when he joined a new firm, the compliance officer advised him it was not reportable. Enforcement did not contest this. A FINRA Hearing Panel found that “the applicability of those terms [false statements and omissions] to a fake ID charge is not so clear that it was unreasonable for Smith to rely on the compliance officer’s advice that he was not required to disclose the charge.” See Department of Enforcement vs. Smith. What About Criminal Records That are Sealed or Expunged?

FINRA’s guidance provides that if, “the purpose of an order to set aside a conviction is to restore the individual to the position he would have been in if the conviction had never been entered; in such case, the conviction is not reportable.” Each state has a different statute for sealing, expunging or setting aside criminal records. FINRA states that any such order should be submitted to the Registrations and Disclosures Department (“RAD”) for review to determine if a conviction is disclosable.

In theory, the guidance above would imply that if a matter has been sealed but not fully expunged then it is still needs to be disclosed. In practice however, RAD staff have verbally advised that fully sealed criminal records, i.e. ones that do not appear on any fingerprint background check, do not need to be disclosed. As such, if a rep has a criminal record that has been sealed it is important to confirm that the court personnel notified all of the necessary agencies to ensure that the records are not reflected in the FBI’s database.

Ultimately, whether a criminal charge requires disclosure is often a complicated analysis. Many criminal defense attorneys are completely unaware of FINRA’s reporting rules and might bargain for a particular charge or adjudication that looks great from the criminal law perspective but could potentially cost their client their career.

Feel free to contact Herskovits PLLC for securities industry regulatory and litigation advice. We can be reached at 212-897-5410, www.herskovitslaw.com

The arbitration was conducted under FINRA’s simplified rules before a single public arbitrator and the Claimant represented herself without an attorney. Merrill Lynch was represented by the law firm Seyfarth Shaw LLP.

In her findings, the single arbitrator seemed particularly concerned that Merrill Lynch failed to even speak with the customer about the allegations in dispute. Merrill Lynch also failed to have the customer sign an affidavit supporting the allegations. The client in question was known to be suffering from memory problems so significant that Merrill Lynch terminated her as a brokerage client despite an account balance in excess of $500,000. The client had previously complained about unauthorized trading in her account by her primary advisor.

Reminiscent of the Wells Fargo account fraud scandal, several former Merrill Lynch employees testified that they were encouraged to open new accounts for customers even if the client had existing accounts. Those same former employees testified that the policy for opening up new accounts was “ambiguous and not uniformlty enforced.” Interestingly, the arbitrator noted that the Claimant “only earned $700” from opening up the account in question and concluded that, “[n]o reasonable person would have done so had he or she been aware of the severe consequences that would issue.”

Herskovits PLLC has a nationwide practice representing financial advisors with Form U5 and Form U4 expungement claims. Herskovits PLLC was recently featured in AdvisorHub for successfully obtaining expungement of an FAs Form U5 and even recouping attorneys’ fees. Feel free to contact us for a consultation at (212) 897-5410.

On November 19, 2020, FINRA published a noteworthy arbitration award for a Herskovits PLLC client in FINRA Arbitration No. 20-01054. This case has garnered significant attention in the press due to the fact that Wells Fargo was ordered to pay our client’s attorneys’ fees. Stories about the case have been reported in AdvisorHub, InvestmentNews and ThinkAdvisor.

On February 18, 2020, Wells Fargo terminated the FA and inserted the following allegation on the Form U5:

“WF Bank, N.A., registered banker was discharged by the bank after a bank investigation reviewed complaints received by AMIG from two bank customers alleging the customers were enrolled in renter’s insurance policies for which the banker received referral sales credit without the customers’ authorization. The registered banker denied the customers’ allegations. The activity was not related to the securities business of WFCS.”

The arbitrator deemed Wells Fargo’s disclosure to be defamatory in nature and ordered that (a) the reason for termination be changed from “discharged” to “other”; and (b) the termination explanation be changed to “Not for cause termination.” In addition, Wells Fargo was ordered to pay attorneys’ fees in the amount of $30,000.

Herskovits PLLC has a nationwide practice representing individuals and entities in FINRA investigations and FINRA arbitrations. Additionally, we routinely represent financial professionals in compensation and termination-related disputes, including Form U4/Form U5 expungement claims. We can contacted at 212-897-5410.

On September 22, 2020, FINRA submitted a proposed rule change to the SEC. The proposed rule furthers FINRAs assault on the expungement process by imposing stringent requirements on expungement requests filed during a customer arbitration by or on behalf of the associated person (“on-behalf-of request”) or filed by a registered representative separate from a customer arbitration (“straight-in request”). The proposed rule also (a) establishes a roster of arbitrators with enhanced training and experience, from which a panel of 3 arbitrators would decide straight-in requests; and (b) codifies and updates the Notice to Arbitrators and Parties on Expanded Expungement Guidance.

Here are some of the key takeaways from the proposed rule change:

Denial of FINRA Forum

FINRA proposes to change Rule 12203 (Customer Code) and Rule 13303 (Industry Code) to require the Director of Arbitration “to decline the use of the FINRA arbitration forum if the Director determines the expungement request is ineligible for arbitration under Rule 12805.”

Proposed Rule 12805 will provide substantial limitations on expungement requests as noted below:

Requesting Expungement When FA is Named as a Respondent in an Arbitration

• The associated person must seek expungement in the arbitration or shall be prohibited from seeking expungement at a later date. The associated person must include the expungement request in the answer or other pleading. The expungement request must include the applicable fee, CRD number of the party requesting expungement, CRD occurrence number that is the subject of the request, the case name and docket number that gave rise to the customer dispute information if applicable, and an explanation of whether expungement was previously sought and, if so, how it was decided.
• The associated person shall be prohibited from seeking expungement if (a) an arbitrator previously considered a request for expungement of the same customer dispute information; or (b) a court previously denied a request to expunge the same customer dispute information.
• If the arbitration settles, the panel cannot consider the expungement request and the associated must initiate a new arbitration against the member firm to obtain expungement.

Requesting Expungement on Behalf of an Unnamed Person

• A broker-dealer shall be prohibited from seeking expungement on behalf of an unnamed person if (a) an arbitrator previously considered a request for expungement of the same customer dispute information; or (b) a court previously denied a request to expunge the same customer dispute information
• The unnamed associated person must sign a form permitting the broker-dealer to seek expungement on her behalf.
• The unnamed is prohibited from intervening in the arbitration if the broker-dealer elects not to seek expungement on behalf of the unnamed person.
• If the arbitration settles, the panel cannot consider the expungement request and the associated must initiate a new arbitration against the member firm to obtain expungement.

Straight-in Expungement Requests

• An associated person is prohibited from filing an expungement claim if (a) an arbitrator or court previously denied a request to expunge the same customer dispute information; (b) the customer complaint or arbitration that gave rise to the customer dispute information is not closed; (c) more than 2 years have passed since the arbitration or litigation that gave rise to the customer dispute information has closed, or more than 6 years have passed since the customer complaint was reported to CRD.
• The customer must be notified of any expungement hearing.
• A panel of 3 public arbitrators with certain qualifications will hear the expungement request.

Expungement Hearing

• The panel must hold a recorded hearing.
• The associated person must appear at the hearing. A party requesting expungement on behalf of an unnamed person must also appear at the hearing.
• The customer has a right to appear at the hearing or otherwise state his position in writing. The customer has the right to testify at the hearing and offer opening and closing arguments.
• The panel must review any settlement agreement and consider the amount of payments and other terms of the settlement agreement. The panel must inquire whether a party conditioned a settlement on the customer’s non-opposition of the expungement request.

Herskovits PLLC has a nationwide practice prosecuting and defending FINRA arbitration claims, including expungement requests. Feel free to call us for a consultation. 212-897-5410.

On April 21, 2020, California’s Court of Appeal, Fourth Appellate District created a significant carve-out to the absolute immunity standard previously applicable to Form U5 defamation claims in California. The full opinion in Tilkey v. Allstate Insurance Co., Super. Ct. No. 37-2016-00015545-CU-OE-CTL (2020) is available here. This case significantly changes the landscape for Form U5 defamation claim unless California’s highest court intervenes. As a result of Allstate’s defamation, the trial court awarded Tilkey $2,663,137 in compensatory damages and $15,978,822 in punitive damages.

Background

Before jumping in to the facts of the case, some background on Form U5 defamation claims might be helpful. Broker-dealers are required to file a Form U5 whenever an employee’s registration is terminated. The Form U5 requires the firm to provide a narrative explanation of the termination if the employee was discharged or permitted to resign. When it comes to the narrative explanation, professionals in the financial services industry frequently complain that employers “play games” by providing extraneous and gratuitous remarks or, worse yet, offering an entirely false explanation for the termination. The consequences flowing from negative Form U5 disclosure information are severe. In addition to reputational harm, FINRA will start a costly investigation and potential employers will shy away from a prospective employee with negative information on CRD.

The Tilkey Case

Tilkey was arrested in Arizona following an argument with his girlfriend. He was charged with criminal damage deface, possession or use of drug paraphernalia, and disorderly conduct. Domestic violence charges were attached to the criminal charge and disorderly conduct charges. Tilkey pled guilty to the disorderly conduct charge only, and the other two charges were dropped. Following completion of a domestic nonviolence diversion program, the disorderly conduct charge was dismissed.

The Form U5 Language at Issue

Before the disorderly conduct charge was dismissed, Allstate terminated his employment based on the arrest for a domestic violence offense and his participation in the diversion program. Allstate thereafter filed a Form U5 reporting the termination explanation as: “Termination of employment by parent property and casualty insurance company after allegations of engaging in threatening behaviors that are in violation of company policy, specifically, engaging in threatening behavior and/or acts of physical harm or violence to any person, regardless of whether he/she is employed by Allstate. Not securities related.”

Claims and Defenses Raised

Tilkey sued Allstate for compelled self-published defamation to prospective employers and Allstate defended by claiming Form U5 privilege. Allstate asserted that California Civil Code section 47 makes a communication absolutely privileged if made in an official proceeding authorized by law, and disclosures on a Form U5 that may form the basis of a FINRA investigation should be considered a communication made in anticipation of an action or other official proceeding. See Fontani v. Wells Fargo Investments, LLC, 129 Cal.App.4^th 719,732 (2005) (holding that a Form U5 filing constitutes a communication before an official proceeding).

Carve out Established by the Tilkey Court

In analyzing the Form U5, the Court found that “FINRA does not ask for information about nonsecurities-related activities because that information falls outside its scope of regulation.” The Court then set an outer boundary to the absolute privilege standard by finding:

“the absolute privilege extends to communications required by FINRA, i.e., fraud- and securities-related information. However, the communication of Tilkey’s termination here did not regard improper securities-related conduct, and Allstate did not limit its responses to fraud- and securities-related information.”

The Court even went on to offer hypothetical Form U5 language that, had it been used by Allstate, may have received absolute immunity:

“Termination of employment by parent property and casualty insurance company after allegations of engaging behavior that are in violation of company policy. Not securities related.”

Takeaway

I firmly believe that Form U5 abuses exist in the securities industry and that firms should pay up when they improperly tarnish someone’s reputation. And I support the qualified immunity standard embraced by the majority of the states, which I believe balances the interests of the individual, the firm and the regulatory community. Even FINRA itself supported the qualified immunity standard in Notice to Members 97-77.

With all of that said, I respectfully believe that the Tilkey court got it wrong as it relates to the Form U5 analysis. I say this because guidance published by FINRA directly rebuts the Court’s findings. In 2010, FINRA published Regulatory Notice 10-39 (titled Form U5: Obligation to Provide Timely, Complete and Accurate Information on Form U5), in which FINRA stated that:

“[F]or purposes of Section 3 of Form U5, it is not sufficient for a firm to report only that a person’s registration was terminated because that person violated ‘firm policy.’ If a firm is obligated to report that a registered person was terminated because he or she violated a firm policy, the firm must identify the policy, [and] provide sufficient facts and circumstances to enable the reader to understand what conduct was involved …”

Second, I believe the Court is wrong when claiming that FINRAs interest in Form U5 disclosure is limited only to “fraud and securities-related conduct.” FINRA routinely prosecutes non-fraud and non-securities-related violations pursuant to FINRA Rule 2010, which is a rule specifically designed to enable FINRA to regulate ethical norms in the industry. And when completing a Form U5, FINRA specifically advised member firms to interpret the term “investment related” in an “expansive manner.” Regulatory Notice 10-39 at 2. “Accordingly, a firm may be required to provide an affirmative answer even if the matter is not securities-related.” Id. at 3 (emphasis added).

Given that the Court’s analysis cannot be squared with FINRAs guidance, I would expect Allstate to appeal to California’s highest court.

Herskovits PLLC has a nationwide practice representing parties in securities-industry disputes. Feel free to call us at 212-897-5410 for a consultation.