Within thirty days of terminating an associated person’s registration, FINRA member firms are required to file a Uniform Termination Notice for Securities Industry Registration, commonly called a Form U5. The member firm must disclose on the Form U5 whether the registered representative’s separation from the firm was voluntary, a permitted resignation or a termination. If the member firm discloses that the individual was “permitted to resign,” “discharged” or “other,” it is required to explain the circumstances surrounding the separation. Towards this end, pursuant to FINRA NTM 10-39, this explanation must provide sufficient detail such that “a reasonable person may understand the circumstances that triggered the affirmative response.” These termination explanations become part of the associated person’s Central Registration Depository (“CRD”) record, which future employers and the public (through FINRA’s BrokerCheck) have access to and frequently rely on.
To the extent registered representatives believe that the information on their Form U5 is inaccurate, the only option for them to amend the Form is to initiate an expungement proceeding against their former firm. Accordingly, despite member firms’ efforts to provide accurate disclosure information on Form U5s, increasingly companies have found themselves vulnerable to legal claims from former registered representatives who do not agree with the company’s stated reason for their termination. Further, registered representatives will frequently file arbitrations not only seeking expungement, but also seeking monetary damages for defamation claims and/or wrongful termination claims. As a result, these arbitrations often pose a threat for potentially large damage awards and high defense costs.
The FINRA rules that typically govern expungements in customer cases (i.e. Rule 2080, 2081, 12805 and 13805) do not apply to intra-industry U5 expungement claims, unless the information to be expunged also involves customer dispute information. In intra-industry disputes, FINRA can only expunge U5 information to the extent it is directed to do so by an arbitration award and provided with language to replace the original disclosure. If arbitrators recommend expungement of non-customer dispute information and determine that the original disclosure language is defamatory in nature, FINRA may expunge the information without a court order. However, to the extent an award does not include a finding of defamation, FINRA will expunge the information only if the arbitration award is confirmed by a court of competent jurisdiction.
Given that defamation is often a central issue in U5 expungement claims, it is important to consider that certain states (e.g., California and New York) have held that statements on U5s are protected by an absolute privilege, whereas other states, including Connecticut and Florida, have applied a qualified privilege standard. (An absolute privilege immunizes member firms from defamation claims, whereas a qualified privilege recognizes that member firms have some obligation to make U5 disclosures, while allowing recovery for defamation if the associated person can establish that the firm acted intentionally, recklessly or with malice, depending on the state.) However, given that FINRA is an equitable forum, arbitrators generally focus on whether the U5 disclosures are inaccurate or false, not whether the registered representative can satisfy each legal element of a defamation claim.
In light of FINRA’s specific procedural requirements, U5 expungement claims can be challenging to resolve in advance of a hearing. To the extent member firms want to resolve these cases, there are typically two options: (1) settle the case and permit the registered representative to pursue an expungement hearing without the firm’s participation or (2) settle the case and agree to a stipulated arbitration award with proposed disclosure language.
Settling in advance of an expungement hearing is often the easier course of action for member firms. This strategy places the burden on the registered representative to prove that the original U5 disclosure was defamatory and to propose alternative disclosure language to the arbitration panel. However, given that member firms typically will not participate in the final expungement hearing, this resolution strategy will often result in the arbitration panel finding that the original U5 disclosure language was defamatory and issuing a publicly available arbitration award stating same.
In contrast, negotiating a stipulated arbitration award requires the parties to agree to proposed replacement disclosure language. This negotiation can be challenging, particularly in light of the member firm’s obligation to provide complete and accurate information on the registered representative’s U5. However, if the parties can agree to proposed alternative disclosure language, and the registered representative is willing to have the arbitration award confirmed by a court, this strategy allows member firms to avoid a ruling that the original U5 disclosure language was defamatory.