Two US Senators recently demanded that FINRA explain how it plans to minimize the high rate of brokers who are involved in criminal activity or have been the subject of customer complaints.
Clearly Senators Warren and Cotton are not familiar with how the FINRA U-4 and U-5 process works. In addition, they are probably not overly familiar with the history of federal securities laws. As a brief background, the federal securities laws have been built on and continue to operate on the theory that “sunlight is the greatest disinfectant.” The laws have been built and we continue to operate under a fair market where people are free to make their own informed decisions. Senators Warren and Cotton should look past this misleading data and understand some common realities.
Broker Check lives up to the protections of federal securities law because nearly everyone has access to the internet these days. Before entrusting wealth to another person, every single investor should be smart enough to search the internet and research their investment professional.
The Senators cited a National Bureau of Economic Research (“BER”) working paper that suggested that one in thirteen advisors has a misconduct-related disclosure on their record. However, these Senators have been misled by the statistics.
The reporting process on Broker Check is controlled entirely by the broker-dealer or investment advisory firm and not the employee. The employer has every incentive to over-disclose complaints and rules violations for fear of subjecting the firm to a regulatory investigation by FINRA or their respective state regulator for failing to disclose an otherwise reportable event. I see this every day in my practice. The two most common issues that skew the NBER data are hyper-technical rule violations and bogus customer complaints.
For example, if an employee commits even the most minor rule violation, the employer may discharge an employee and then the firm must disclose the rule violation on the employee’s Form U5. Based on experience, the large broker dealers (Merrill Lynch, Morgan Stanley, and UBS) will protect their brands and images at all costs and get rid of an employee for minor rule violations. In addition, it doesn’t hurt that the firm gets to re-assign the terminated employee’s accounts to the house and reduce their payroll expense.
A perfect example of such minor violation was brought to my attention a couple of weeks ago. A client of mine inadvertently forgot to disclose to their employer that they were named a co-beneficiary to a client’s trust and were not related to the client. This is technically a violation of “industry standards of conduct” and the employee was discharged and the employer disclosed the event on her Broker Check. There were absolutely no allegations of fraud or undue influence that forced the grantor of the trust to name my client as a beneficiary. My client simply failed to read and comprehend a 500 page policies and procedures manual that required her employer’s consent before accepting this gift.
In addition to hyper-technical rule violations the most common events that make the NBER data misleading are spurious customer complaints. Form U4 and U5 require an employer to disclose every single written or verbal complaint made by a client where the client alleges losses over $5,000 subject to certain conditions. For example, assume that a client has a million dollars invested in the market and the market loses one-half-of-one-percent (.5%) overnight. Now assume that client is unhappy with his adviser. The client complains that his portfolio was unsuitable because he should not have been invested in a broad based market ETF. Now that advisor has an ugly disclosure on his Broker Check that will follow him the rest of his career.
If FINRA and its members and the advisor community had a bit more flexibility to determine whether complaints and rules violations actually had merit or whether an employee’s actions needed to be disclosed to the public, the NBER data would not appear so frightening.
Neither Senators Warren nor Cotton is subject to this ridiculous regime. As a former legislative aide myself, I know from experience. There wouldn’t be enough servers in the world if politicians had to disclose every constituent or lobbyist complaint to the public on a specific website. At some point, we need to take a sensible approach and place our trust back in humanity and people.