But its threshold for reporting settlements would rise to $15,000

Investment News (May 5, 2008 11:01 pm) — The Financial Industry Regulatory Authority Inc. aims to close a major loophole in its disciplinary reporting process.

Late last month, New York- and Washington-based Finra asked for comment on long-awaited changes to disclosure forms that would end a practice that plaintiff’s attorneys and state regulators have been complaining about for some time.

Under current practice, registered representatives don’t have to report a customer arbitration claim if the lawsuit doesn’t name the rep as a respondent.

“We were incredulous that these [arbitration claims] weren’t being reported,” said Laurence Schultz, president of the Public Investors Arbitration Bar Association of Norman, Okla.

PIABA has complained about the practice for years, he said.

“You would think regulatory people would look out for investors, but it took them years to move on it,” said Mr. Schultz, who is also a partner at Driggers Schultz & Herbst PC in Troy, Mich.

As part of the same rule filing, Finra is raising the threshold for reporting customer settlements to $15,000, from $10,000. The move appears to benefit the industry.

The Securities Industry and Financial Markets Association of New York and Washington doesn’t oppose the proposed changes, said Travis Larsen, a SIFMA spokesman.

The proposal is “a very good move for investor protection, for helping firms in their hiring, and we as regulators in making better licensing decisions,” said Melanie Senter Lubin, securities commissioner for the state of Maryland in Baltimore.

She is the chairwoman of a steering committee that deals with disclosure issues for the North American Securities Administrators Association of Washington.

The number of complaints slipping through the cracks could be significant, since many plaintiffs’ actions do not name brokers as respondents. And with many thousands of cases filed every year, missing disclosure items could amount to a “few thousand” cases every year, said Robert Banks of the Banks Law Office PC in Portland, Ore., a plaintiff’s attorney and former PIABA president.

But for individual brokers who face customer complaints at the hands of firm-level product failures, the new rules could create problems, said Marc Dobin, co-founder of Dobin & Jenks LLP in Jupiter, Fla., an attorney who does primarily defense work.

With the freeze-up of the auction-rate-securities market, for example, “there were statement stuffers touting the securities as a viable alternative to money markets,” Mr. Dobin said. “Will that [auction-rate-securities] complaint be a reportable event against the broker, even though [the alleged misrepresentation] came in a statement stuffer?”

Finra is proposing to close the reporting loophole by revising disclosure questions on forms U-4 and U-5.

The U-4 is the application form for registered representatives, and the U-5 is the termination form.

Comments on the changes are due May 27.

HIGHER THRESHOLD

The higher reporting threshold has support from both the industry and some plaintiff’s attorneys who say that it will make settling smaller claims easier.

“In smaller cases, [the plaintiff] may be arguing [for] $15,000 and the firm will say they can’t pay more than $9,999,” just under the re-portable amount, said William Jacobson, associate clinical professor and director of the Cornell Securities Law Clinic in Ithaca, N.Y., which helps investors who can’t afford an attorney.

The proposed $15,000 “is a more realistic threshold,” he said.

“It is logical for such dollar benchmarks to either be indexed for inflation or adjusted occasionally,” Mr. Larsen said.

Some plaintiff’s attorneys don’t like the idea.

There may be economic reasons to settle claims for under $15,000, “but those are still claims of wrongdoing against the broker,” Mr. Schultz said. “Most investors would like to know about them.”

The Finra rule proposal would also allow firms to change the reason and explanation for a termination by filing an amended U-5.

That could benefit individual reps by allowing them to get a U-5 cleaned up without going to arbitration, Mr. Dobin said.

Separately, last month, the Securities and Exchange Commission put out for comment a Finra proposal to crack down on the rubber-stamping of requests to expunge information from the disciplinary database.

The comment period closed April 24, and the rule is now awaiting SEC action.

Regulators have been concerned about brokers’ getting customers to agree to expunge a reported claim in exchange for a payment.

Customers care more about getting a check than worrying about the integrity of the disciplinary database, so they go along with it, ob-servers say. And with no opposition to the expungement request, arbitrators are likely to approve the rules.

Under the proposed new expungement rules, arbitrators would have to hold a hearing and review the terms of the settlement, including the amount paid to the customer, before customer-related disciplinary information could be removed.

Where a case is settled and a separate expungement hearing is needed, brokers would have to pay for the hearing.
REMOVING BLACK MARKS

Observers say the expungement rules would make it harder for brokers to get black marks removed from their records.

What’s more, some critics say arbitrators should not make expungement decisions. That task is the responsibility of regulators, they contend.

Unlike an adversarial proceeding, an expungement hearing involves only the broker making the request, said Seth Lipner, a partner at Deutsch & Lipner of Garden City, N.Y., who represents investors.

“There is no public advocate,” Mr. Lipner said. “Anytime you have an unopposed proceeding, it’s likely that [an expungement request is] going to be granted,” he said.

“Arbitrators don’t really have an obligation to police the [disciplinary database],” Mr. Schulz said.