Foms in Need of Reform – Publication of U-4 Disclosures

 Proposed NASD Rules Will Allow Allegations Against Brokers to be Made Public

By Mark J. Astarita, Esq.


Some of you may recall my column from October, 1996, “The SEC’s Bad Form”, which addressed changes that the NASD proposed, and SEC approved, to Forms U-4 and U-5. The changes caused serious concerns regarding the rights of brokers unjustly accused of wrongdoing, and the effects of disclosure of those accusations before a decision was reached by a fact finder. Many registered representatives have been wondering what happened to those proposed changes, and perhaps hoped that the changes were forgotten.

The changes have not been forgotten, only bogged down in an administrative nightmare. There is now yet another rule proposal, introduced in October of this year. I am sorry to say that nothing has changed, and it appears that the changes are going to go into effect in January, 1998.

The proposed rule change also includes copies of the proposed new forms. Brokers are not going to be happy with the substantive changes to the rules, and firm compliance and registration personnel are in for some interesting times in trying to decipher how to complete the form.

First, the substantive changes. The proposed rule changes not only what a broker must disclose to the NASD and the states, but what the NASD will disclose to the public. If the change is approved, information regarding pending customer complaints, arbitrations and civil litigations will be made publicly available to anyone who desires to ask.

Yes, pending complaints – letters written by customers to the firms which accuse a broker of misconduct. Disclosing a complaint letter has always been required. But now, that same letter from your customer will now become a publicly disclosed event. If you thought rogue customers were a problem before, wait until they learn that their complaint letter is going to trigger a public disclosure.

Not only will regulators be investigating frivolous complaints, now your potential customers will be told of those same complaint letter, ones that have not been determined to have any validity whatsoever. The stakes involved in dealing with a rogue customer have just gone up.

This is of course, in addition to the proposal to release details of pending arbitrations – again where no fact finder has heard the case. This too has obvious due process problems. An arbitration complaint is merely an unsupported, unsworn, and unproven allegation, presumably by a customer who has some financial motivation to file same. Given the fact that a customer can file an arbitration complaint, alleging virtually anything he wants, for a filing fee of a couple of hundred dollars, the potential for abuse is enormous. The harm to the broker, whose potential customers decide not to use his services because of these unproven complaints, will never been fully known.

One must seriously wonder what benefit the disclosure of pending complaints and arbitrations has to the investor seeking information about a new broker. Does anyone really believe that customers will understand the legal niceties of due process, that the complaints are unproven, and untested? More likely, customers will not use a broker who has such a disclosable event, under the incorrect theory of where there is smoke there is fire.

A larger problem is that the disclosure of pending arbitrations will create another feeding ground for the rogue customer. While there are very few brokers with more than one pending arbitration proceeding, you can be sure that customers who are abusing the system will use the public disclosure system against those that do, and attempt to bring out other, unproven, allegations against the broker at the rogue customer’s hearing.

On the compliance and registration side, the form itself is a nightmare. The NASD has published a “proposed interim page 3 of Form U-4) to accommodate the new disclosures. Aside from the fact that the new form is simply a reworking of Page 3, so that it now includes twice as many questions as it did before, it is so poorly worded as to leave brokers and firms open to disciplinary proceedings for incorrectly completing an incomprehensible form.

For example, new question 22E has 6 subparts, but the introduction to the question (“Has any other Federal regulatory agency ever…) applies only to the first 5 subparts, and not the last. Questions 22D, and 22F are the almost identical to 22E, but for different entities, questions 22L and 22M are also virtually identical, and the question relating to customer complaint letters contains an explanation that is longer than the question itself. For brokers with a pending arbitration, there will now be two yes answers – one in response to whether there is an arbitration pending, and a second as to whether there is anything pending that could result in a yes answer to any other part.

There is also a “optional” disclosure certification on the form, relating to the completeness and accuracy of the information contained on the CRD system. While the instructions make it perfectly clear that the certification is optional, the signature line for the page appears directly below the certification. There is no way to signify that you are not signing the certification. One can only imagine how many brokers are going to be accused of signing the certification who never intended to, simply because they did not have the opportunity to review their CRD run. When something in wrong on the CRD, you can be sure that a regulator or a customer is going to accuse a broker of lying to the regulators when he signed the form.

The new Form U-5 is no better. It’s question regarding customer complaint letters is so long as to be incomprehensible, and a fair reading of it permits a broker-dealer to say no to the question when the Form intends there to be a yes answer. Amazingly enough, the question that took three separate questions, with multiple subparts on Form U-4, is asked in one question, without subparts, on Form U-5.

Confused? Don’t be. The NASD has included in the release a chart titled “Form Mapping for Proposed Interim Page 3 of Form U-4”, to explain the changes. Unfortunately, the explanation is more confusing than the form itself, and appears to acknowledge that the new form turns one “yes” from the old form into multiple “yes” answers on the new form.

There is a bright spot in this mess. From a fair reading of the new form, it appears that oral complaints are no longer subject to any reporting requirements, and the two year limitation on written complaints that do not go to arbitration or court has been retained.

However, the NASD and the SEC have once again ignored the rights and well being of its registrants. Then again, since no one submitted any comments on the original proposed changes, is this lack of concern surprising?

This article originally appeared in the December 1997 edition of Research Magazine.



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