Information contained in this publication is intended for informational purposes only and does not constitute legal advice or opinion, nor is it a substitute for the professional judgment of an attorney.
Under Financial Industry Regulatory Authority’s (FINRA) rules, whenever broker-dealers, registered investment advisers, or issuers of securities (FINRA member) terminate the employment of a FINRA-registered representative, including a licensed broker or financial advisor (an associated person) the member firm must file a Form U5 (the Uniform Termination Notice for Securities Industry Registration). The standard Form U5 must also be filed for current employees if the firm decides to terminate their registration with FINRA, even if the firm continues the employee’s employment in a non-registered capacity. The Form U5 must be filed within thirty days of the date of the termination event, and it requires a firm to provide accurate answers to various questions, including the reason for an associated person’s termination of their registration.
Statistics from FINRA Dispute Resolution demonstrate that Form U5 defamation cases are on the rise, with a reported 24% increase over the filing period from 2019 to 2020. In 2020, Form U5 defamation cases were the fourth most common intra-industry claim filed with FINRA, behind breach of contract, promissory notes, and compensation claims. FINRA arbitration panels have issued substantial awards in defamation cases, including awards of punitive damages.
It is critical that, when completing a Form U5 upon the termination of a registered representative, or amending a Form U5, firms provide true and accurate information to FINRA. To do so, it is equally important that firms understand what information FINRA is requesting and what options there are in terms of the narrative that a firm can provide. With that context, firms can take steps to reduce risk and avoid costly litigation of defamation claims.
The Termination Explanation on FINRA Form U5
Individuals who work on securities-related matters are required to register with FINRA by submitting a Form U4 (the Uniform Application for Securities Industry Registration or Transfer). Through the filing of a FINRA Form U4, employees agree to settle disputes with their employers through the FINRA arbitration process. Additionally, the Form U4 authorizes securities industry employers to furnish information regarding the history of all employees at the firm and reasons for termination.
Completing a Form U5 upon the termination of a registered representative’s employment may appear to be a simple task, especially when the registered representative’s departure is voluntary or amicable. However, a firm’s Compliance and Registration department should be aware of some nuances that may arise if the separation of the employee is contentious or less than voluntary.
First, the Form U5 must be filed within 30 days of the termination event, and a copy must be sent to the registered representative. In addition, a firm is obligated to amend a Form U5 when it learns of facts or circumstances that make a previously-filed Form U5 inaccurate or incomplete. The Form U5 is filed electronically with FINRA and maintained in FINRA’s Central Registration Depository (CRD), which is the system FINRA oversees for licensing and registration of member firms and associated persons.
Information in the CRD is relied upon for several important functions, including alerting FINRA and other state regulators where there could be disciplinary matters. In addition, the general public, including prospective employers and investors, also can view CRD-generated reports for detailed information about financial advisors and broker-dealer firms, on BrokerCheck.
Among other things, where a FINRA member firm terminates an individual’s registration because of the termination of their employment (i.e., a “full” termination), the Form U5 requires that the firm specify the reason for termination through a drop-down menu option. The selections offered are: “Voluntary,” “Deceased,” “Permitted to Resign,” “Discharged,” or “Other.” Where an associated person is “Discharged,” “Permitted to Resign,” or designated as “Other,” a member firm is required to provide a narrative explanation of the reason for the associated person’s separation. If the terminated employee violated any securities industry rules or regulations, the employer must provide an explanation of the violations. Also, the employer must explain if the terminated employee was under any internal investigation for the violation.
If the termination of the employee is a full termination, firms also are required to complete the disclosure questions located in Questions 7(A) through 7(F) of the Form U5. Firms must disclose whether a terminated representative was:
(1) the subject of an investigation by a governmental body or self-regulatory organization concerning investment-related business;
(2) under internal review for fraud or wrongful taking of property, or violating investment-related statutes, regulations, rules, or industry conduct standards;
(3) charged, convicted, or pleaded no contest to any felonies, or to certain misdemeanors;
(4) the subject of any disciplinary action by a governmental body or self-regulatory organization with jurisdiction over investment-related business;
(5) named in customer-initiated arbitration or civil action alleging they engaged in certain sales practice violations; or
(6) discharged, permitted to resign, or voluntarily resigned after allegations were made accusing the representative of fraud or wrongful taking of property, or violating investment-related statutes, regulations, rules, or industry conduct standards, or failing to supervise in connection with investment-related statutes, regulations, rules or industry conduct standards.
If any of the above scenarios apply, the firm must elaborate by completing additional Disclosure Reporting Pages (“DRP”). In completing Form U5, FINRA instructs member firms to construe the term “investment-related” expansively and the term does not relate only to securities. See FINRA Regulatory Notice 10-39. An affirmative response to these disclosure questions can be particularly damaging to a broker’s or financial advisor’s prospects of future employment in the securities industry.
Considerations for Completing Form U5
In Regulatory Notice 10-39, FINRA has provided member firms guidance in completing the Form U5, explaining that member firms have an “obligation to provide timely, complete and accurate information on Form U5.” FINRA directs member firms to “provide sufficient detail when responding to Form U5 questions such that a reasonable person may understand the circumstances that triggered the affirmative response.” See FINRA Regulatory Notice 10-39. Further, a member firm “may not parse through the questions in a manner that would allow the firm to avoid responding affirmatively to a question.” Id.
Mindful of FINRA’s requirements, firms should deploy proactive measures for accurate, but cautious filings that satisfy the regulatory requirements and minimize the likelihood of defamation lawsuits for Form U5 filings. Firms that incorporate the following strategies may reduce their risk and exposure to defamation claims brought at FINRA.
First, when an involuntary termination is considered for an eligible Form U5 employee, a firm should conduct a thorough investigation, preserving and reviewing all relevant documents. The drafting process for the Form U5 and the termination explanation should closely align with the supporting documents from the investigation. In drafting the Form U5, the member firm must be diligent in confirming that the termination narrative and disclosures are consistent with the reasons for termination provided in the investigation documents. Evidence that a firm conducted a good faith investigation prior to the termination, along with separate and detailed documentation that is consistent with the disclosures on the Form U5, could demonstrate at any potential arbitration that the alleged defamatory statement was not knowingly made or recklessly false.
Second, when drafting Form U5’s termination explanations, firms should be as succinct as possible and avoid the use of any emotional language. Instead, firms should strive to use certain standard, “coded” answers. The point of this narrative is to put FINRA on notice of why the termination event occurred, and not to be vengeful or “whitewash” the employee. A firm is not required to provide information about the employee on a Form U5 that has nothing to do with their competence as a registered representative. For instance, where the reason for termination may be that the registered representative violated the company’s leave policies by taking vacation in excess of time allotted, then the firm likely can meet its regulatory obligations with the following simple narrative:
Reason for Termination: Discharged
Narrative: Violation of Company-Policy relating to leave of absence; not a compliance or securities related violation.
Here, using the standard “coded” language, “not a compliance or securities related violation,” signals to FINRA, and to the public, that securities violations are not implicated. In summary, the explanation sections of a Form U5 should be concise as possible and convey only the information needed to meet a firm’s regulatory requirements. Such an approach can help reduce a firm’s risk of defamation claims.
Third, a firm should establish written procedures for the drafting and approval of Form U5 filings. This protocol should include both a representative from the firm’s legal and compliance teams, and should be consistently followed. It is also prudent to include in the procedures consultation with outside counsel who are familiar with the Form U5 reporting requirements. In instances in which a firm intends to file a “negative” U5 (often the case any time a DRP question is answered in the affirmative), the firm should take additional pre-filing steps to protect against liability that could arise from a Form U5 defamation claim, including a careful review of the investigation files.
Finally, in certain instances, firms can incorporate additional steps in their Form U5 drafting process to include an independent panel review of the form to ensure accuracy prior to filing with the CRD, or, even asking the registered representative to review the Form U5 language before the form is filed. This latter approach is not intended to suggest that the firm should alter the Form U5 language based upon the registered representative’s request, as the firm’s obligation is simply to truthfully and accurately report the required information on the Form U5. The registered representative, however, may potentially identify certain ways to state a fact and phrase the termination language of the Form U5 that remain truthful and accurate but that are less offensive to the representative. In turn, this step may result in the representative’s decision not to pursue a U5 defamation claim or at a minimum, result in some evidence of the absence of malice in the publication of the final Form U5.
Associated persons often file arbitration claims with FINRA relating to their Form U5, including claims under state law alleging that the language the member firm used on the U5 was false and defamatory. As a form of relief, in addition to monetary damages, associated persons can request that the arbitration panel expunge information from the Form U5. FINRA’s Code of Arbitration Procedure has special procedures relating to expungement claims (which will be featured in a future publication). By understanding the Form U5 procedures, and tailoring their protocols, firms can reduce their risk of costly defamation claims while meeting their regulatory obligations.
Defamation Claims at FINRA Arbitration
With the rise of Form U5 defamation claims filed at FINRA, and the risk of significant monetary damages, it is essential that member firms understand the implications of filing an inaccurate Form U5 and be cognizant of the potential for defamation claims to be brought by associated persons at FINRA arbitration.
A disparaging or unflattering Form U5 can make it difficult for a terminated representative to attract clients or secure new employment. The only way a terminated representative can compel changes to the Form U5 is to bring a defamation suit at FINRA against the firm that filed it.
Although defamation laws vary by state, in general, a statement is defamatory if it is a false statement of fact that has the potential to harm a person’s reputation by either: (1) deterring third persons from associating or dealing with them; or (2) lowering the esteem in which they are held in the community.
Privilege can be a defense to a Form U5 defamation claim, recognizing that the general public, including investors, have a strong interest in ensuring regulators like FINRA are aware of and able to investigate and adjudicate charges of misconduct by registered representatives. The degree of privilege afforded to the Form U5 varies among the states, however. Notably, most states provide a qualified privilege that protects member firms from defamation lawsuits for any Form U5 statements made in good faith, without malice or recklessly. See, e.g., Baravati v. Josephthal, Lyon & Ross, Inc., 28 F.3d 704 (7th Cir. 1994) (Illinois law). Fifteen states (Hawaii, Idaho, Indiana, Iowa, Kansas, Maine, Michigan, Minnesota, Mississippi, Missouri, New Mexico, Oklahoma, South Carolina, South Dakota, and Vermont and the U.S. Virgin Islands) have adopted the 2002 version of the Uniform Securities Act providing qualified immunity to persons who make defamatory statements in connection with a filing like the U5 that is required by law or industry rules. Meanwhile, New York provides for an absolute privilege for defamatory statements arising from Form U5s. See Rosenberg v. Metlife, Inc., 8 N.Y.3d 359, 361-68 (2007).
Whether state law affords firms absolute, qualified, or no immunity, at the end of the day, most U5 defamation claims are compelled to proceed to arbitration, not court, and FINRA arbitrators often do not evaluate whether a privilege applies until all evidence has been entered. Further, FINRA arbitrators often focus their awards on simply whether the Form U5 disclosures are inaccurate or false, and not whether the claimant can satisfy each element of a defamation claim. Brokers have been successful in receiving substantial arbitration awards in their defamation claims against major brokerage firms.
Recommendations for Employers
Our experience in defending Form U5 defamation claims at FINRA arbitration has provided us with several recommendations for employers to reduce potential exposure. Firms should consider:
- conducting thorough, well-documented investigations and ensuring that Form U5 termination explanations are consistent with and supported by the investigation;
- in drafting Form U5s, complying with all regulatory reporting requirements while being as concise and unemotional as possible, relying on certain standard “coded” language when appropriate;
- establishing and following written procedures for Form U5 filings, which include review by representatives from the firm’s legal and compliance teams, as well as knowledgeable outside counsel; and
- in certain cases, seeking review of the Form U5 language by an independent panel, or perhaps requesting that the terminated representative review the language for potential alternatives.
Firms that incorporate these measures may minimize their risks of costly defamation claims, or, if a Form U5 defamation claim is filed, may find that such claims will be easier to defend. It is essential that firms seek advice from counsel who are familiar with FINRA’s reporting requirements for Form U5 filings and are experienced in FINRA’s intra-industry arbitration disputes. In filing an answer to the statement of claim, and defending defamation claims at FINRA arbitration, member firms and their counsel must thoroughly research arbitrators, understand the relevant state defamation laws and potential privileges, and be prepared to convince the FINRA arbitration panel why monetary damages for the required Form U5 filing are not justified. Employers with questions about Form U5 procedures or specific factual situations may contact our FINRA team.