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Opinion: Three Ways Regulators Throw Advisors Under the Bus

Financial services is the only industry where you are guilty after being found innocent.

Financial service is the only industry where you are guilty after being found innocent. Anyone can file a customer complaint against an advisor, and even after the claim is denied or closed with no action taken, a record of the complaint goes on FINRA’s BrokerCheck for the world to see. If an advisor wants to expunge the frivolous claim, you need to spend $10,000 to $20,000 to hire a securities attorney to have it removed. This is just one of numerous issues advisors face with the regulator. 

Chronic regulatory overreach persists, yet it is tolerated with little pushback. Here are three particularly egregious areas of concern. For perspective, I’m including input from Jodee Rager, chief compliance officer and president of Geneos Wealth Management, and securities attorney Jim Eccleston. 

Guilty After Being Proven Innocent

If a claim is under $25,000, broker/dealers are likely to just settle in order to save themselves the expense that comes with pursuing an arbitration. Whether the advisor is guilty or not (often not with these small claims), the advisor will likely have to pay his errors and omission insurance deductible and incur a disclosure on FINRA BrokerCheck. E&O carriers will insist on settling small claims even when the facts don’t support the allegations made by the claimant.  It’s too expensive and generally considered too risky to roll the dice with an arbitration panel. 

“Even in cases where disputes are proven false, settled for nuisance value, or flat out won in a hearing, the event can remain on the financial advisor's public record, unlike in any other industry,” says Rager. If an advisor has innocuous disclosures on their record, it can still impede their ability to change broker/dealers.

It is quite common for an advisor to have this kind of a mix of disclosures on their record:

  • Customer Dispute—$15,000 settlement paid
  • Customer Dispute—Denied
  • Customer Dispute—Withdrawn
  • Customer Dispute—Closed, no action taken

Pursuing a new broker/dealer, an advisor will have their disclosures screened by the prospective new b/d’s compliance department. You may deduce that only one disclosure matters ($15,000 settlement paid); the other three are nonevents, yet the compliance department may reject the advisor, saying their disclosures demonstrate a pattern.

Disclosures that are nonevents, or where the advisor is not involved, such as fraudulent products, should not be on an advisor’s record in the first place and any that are should be expunged at minimal cost. Yet an advisor’s ability to expunge pointless disclosures may be greatly restricted going forward. 

The SEC is currently looking to greatly limit advisors’ ability to expunge frivolous disclosures. If passed, advisors will be limited to incidents going back only one year from the date of filing of the expungement request. Of course, the cost to do expungements will also go up dramatically. For advisors, incidents on your CRD going back over a year will remain a permanent part of your record, even though it may have been a “Denied” or a “Closed, No Action Taken” result. This position taken by FINRA was supported by a lobby of claimants’ attorneys because keeping your license disclosures increases the chances that any future arbitration panel will conclude that an advisor has a pattern of wrongdoing. When this occurs, an advisor’s “first chance to make a good impression” will be taken away because of your past.  

The Problem With Arbitration Panels

Rager says that their outside counsel once had arbitration panels overseen by a milkman and a Walgreens clerk. To quote Seinfeld, “Not that there is anything wrong with that!” but it is common for us to hear about broker/dealers’ compliance personnel during audits having to educate regulators who don’t understand the nuances of variable annuities, alternative investments or structured products.

To expect a Walgreens clerk or a milkman to grasp the intricacies of a variable annuity is, to say the least, a stretch. Requiring arbitration panels with industry background and preferably with securities licenses would help ensure fairness.

“It should be troubling to the industry to have claims heard by so many non-industry panelists. The majority of customer disputes are complicated which means you have to find really talented experts to teach the panel the rules and product features. Even having the best defense, facts and experts doesn’t guarantee the panel is not going to issue an award to the claimant, and what’s really frustrating from my perspective, is they don’t have to explain the basis for their award. This makes it easy for them to ignore the good facts for the firm and advisor and award a sympathetic claimant,” Rager says.

“Arbitration explanations or ‘reasoned awards’ are available if both parties in a case agree in advance and pay a larger filing fee. Despite that availability, most parties choose not to request a ‘reasoned award.’ Why an additional cost has to be paid to hear the reasons for their decision is just one more example of regulatory gold digging,” says Ecclestone. With no explanation as to the basis of arbitration panels' decision, no one in the industry or claimant’s attorneys learn a lesson about why they lost, says Rager.

Allowing Boiler Plate Filings

Eccleston points out that “arbitration is unlike court, where court rules allow for boiler plate baseless claims to be dismissed early in the process. In arbitration, very few grounds exist to dismiss a case early. In all but a handful of situations, arbitration hearings must be conducted. As a result, our industry is awash in frivolous litigation because FINRA does not require that clients and their attorneys make good faith efforts to ensure that allegations have merit, or are at least based on a reasonable investigation.”

Rager points out that “rules of law were enacted to ensure that frivolous litigation is not filed and that there is a reasonable basis for the allegations, however, FINRA does not have an equivalent rule and as a result, claimants and their lawyers frequently bring baseless claims, making allegations that, for example, a firm failed to conduct due diligence on an investment or failed to supervise its representative without having any idea whatsoever of the actual due diligence conducted by the firm or how they supervise. Such unfounded allegations are widespread, and they harm hard-earned reputations.”

Perhaps FINRA can be an agent of change for fairness, but its history shows a propensity for being tone deaf. With a sharp decline in the number of broker/dealers and advisors over the past 10 years, you could say FINRA may be killing the golden goose. For those wanting to enter into the industry, bypassing FINRA is increasingly a prudent move. Rager says much of the industry is correct in thinking that being a FINRA member carries significant risks not present with non-FINRA members—including the requirement to arbitrate customer disputes. 

Jon Henschen is the founder of Henschen & Associates, an independent broker/dealer recruiting and consulting firm. 

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