The NASD May Soon Protect Investors at Broker’s Expense
This time the National Association of Securities Dealers (NASD) has gone too far. On November 27, 1996, the association proposed to make full disclosure of the entire contents of the disciplinary and litigation section of a broker’s Central Registration Depository (CRD) record available to anyone who asks.
You read that right. Everything in item 22 of your Form U4 is going to be made available to anyone who asks for it over the phone or online.
In discussing this proposal with non-securities professionals, most were not upset. After all, securities professionals have long been the subject of extensive regulatory disclosure requirements. These disclosure requirements are intended to provide information to the various regulatory bodies so they can monitor effectively.
Since securities professionals are responsible for handling vast sums of money, often their clients’ life savings, their backgrounds should be fully checked to make sure that they are suitable for such an awesome responsibility. Or so the argument goes.
While there is much to be said for full disclosure of a broker’s background, disciplinary proceedings and customer complaints to regulators, there is a danger of real harm to the securities professional, and the industry in general, if that disclosure goes too far.
Today, anyone who is registered with the NASD must report the existence of any injunctions, disciplinary or regulatory orders from any regulatory agency, unsatisfied judgments or liens, prior bankruptcies, felony convictions or similar items, and customer arbitrations and litigation against them.
If that were the extent of the disclosure required on a Form U4, it would be difficult to argue against making such information public. After all, each of those events involves an independent finding of wrongdoing by the broker, and such information might be useful to an investor in deciding whether to use a particular broker’s services.
However, Form U4 requires disclosure of much more than closed matters in which guilt was established. The requirements mandate disclosure of any pending regulatory or disciplinary proceedings, pending customer arbitrations or litigation, and even the details concerning customer complaint letters written to a firm, even if there is never an arbitration or court case filed regarding the complaint.
This group of disclosures, of unsworn, unproven and unsubstantiated allegations, is troublesome to industry members and commentators. Given the serious nature of the regulatory process, it is somewhat unfair to require registrants to disclose unproven allegations. After all, anyone can say anything about anyone. Proving the allegation is the key, not making one.
However, the arguments against disclosing pending matters and customer complaint letters were met with these arguments: The NASD was pursuing a valid regulatory function; the information was a necessary part of effective regulatory oversight; and because the information was not made available to the general public, there could be no significant harm to an individual broker forced to disclose such matters.
Then the NASD began making some Form U4 information on closed matters publicly available by way of an 800 number. Although the hotline did not disclose pending proceedings, even this was somewhat unfair; a broker winning an arbitration still had the existence of the arbitration disclosed.
Now the NASD wants to go a step further and disclose pending matters, which involve unsworn and unsubstantiated allegations. This can only be viewed as an outrageous attack on the basic principal of fairness and due process.
In my years representing securities professionals, I have seen firms receive amazingly outrageous and false letters in which customers accuse their brokers of every imaginable fraudulent act known.
It’s possible that some customers believe that if they write enough — regardless of whether allegations are true — they stand a chance of getting some of their losses back. But the majority of these allegations never go to arbitration or court, and only half of those that do are proven to be accurate.
With an “accuracy” rate that must therefore be something significantly less than 50 percent, it is outrageous that the NASD is going to inform the general public of allegations that stand a less-than-even chance of being proven.
The NASD requires that customer complaint letters remain on brokers’ records for at least two years. Further, an arbitration proceeding takes approximately a year to complete. What does the NASD propose to do about brokers who have pending customer complaints on their records for a year or two that are then proven to be false? What are brokers going to do to regain the business they lost because of pending claims?
I know of a broker accused in an arbitration proceeding of engaging in unsuitable trading, including day trading, option trading and shorting for a period of three years. The account in question belonged to an invalid 92-year-old widow. The alleged losses were approximately $1.2 million dollars, the widow’s entire life savings. The broker was immediately fired from his firm and could not obtain a position at any other firm — no one would hire him with such a complaint pending.
The problem was, the complaint was a total fabrication. The 92-year-old widow’s son had trading authority and was a joint owner of the account. Virtually every trade in the account was at his insistence and pursuant to personal trading strategies that he had successfully used for a number of years before losing the money. The broker won the arbitration, and the customer was ordered to pay for damages suffered as a result of the outrageous allegations.
That broker was never fully compensated for the two years that he lost in the business, and while he is registered and working today, the impact of that arbitration was enormous. One can only imagine how many other brokers have similar allegations made in customer complaint letters, and the effect that disclosing such unsworn, unproven and unsubstantiated allegations will have on their potential and current customers.
Perhaps someone can conjure up a valid purpose behind this attack on the basic rights of industry members, but it is hard to imagine a purpose that will outweigh the permanent harm that this proposal is going to cause.
Assuming the SEC approves the rule change, I hope that a broker or a securities industry group will attack this regulation in court. Unfortunately, by the time this article appears, the decision will have been made.
Mark J. Astarita, Esq., is a partner in the New York City law firm of Sallah Astarita & Cox, LLC. He represents financial professionals in a wide variety of matters, including customer arbitrations. He can be reached at 212-509-6544 or by e-mail. This article originally appeared in the February 1997 edition of Research Magazine.