Skip to main content

Finra Plan + Auction-Rate Mess = Anxiety

Dow Jones Newswires

A proposed rule meant to improve public disclosure of customer complaints against brokers is making some in the industry nervous about whether a wave of auction-rate securities lawsuits may unfairly blemish brokers’ records.

Published last week by the Financial Industry Regulatory Authority, or Finra, the rule would require brokers to include on their records arbitration claims that allege misconduct in how they sold products – even if the brokers themselves aren’t specifically named in the complaints.

The change would reconcile an inconsistency that has existed for years. Presently, if a customer lodges a written complaint about sales practices to a firm but doesn’t name the broker involved, the firm must try to identify the employee involved, and that complaint then goes on the broker’s public record. Currently, if an arbitration claim doesn’t name a broker – even if it refers to the broker’s bad behavior – there’s no need to put the complaint on the broker’s record.

The timing of the proposed rule change is causing some consternation among brokers who worry that it may be hard to draw a distinction between claims alleging sales practices complaints and those alleging product failures, such as the rising tide of complaints caused by the failure of the auction-rate securities market.

In 2001, 25% of arbitration complaints didn’t name brokers, according to Finra. Now that number is closer to 50%.

The change is due to legal strategy, according to people who represent different sides in customer disputes. The idea is that making a broker a respondent ropes in a person who may fight aggressively to prevent a black mark from appearing on his or her record. A firm on its own may be more willing to offer a settlement for the sake of expediency.

Those who favor the rule change say that legal strategies shouldn’t impede public disclosure.

The fact that “it’s more efficient for an investor to get something resolved if the representative isn’t a party shouldn’t dictate whether other investors should know there was a complaint,” said Melanie Lubin, Maryland securities commissioner.

Investors’ advocates argue that full disclosure gives investors access to information that can help them pick a broker. Some brokers are upset by the potential change, saying that putting allegations on their records results in an “innocent until proven guilty” standard.

But with waves of arbitration claims over auction-rate securities coming in, some brokers and the lawyers who represent them are even more nervous than they would otherwise be.

“It’s not fair to mark up a broker’s record in a toxic product case, if the broker is as ignorant as you are,” said David Robbins, a Manhattan lawyer who represents both brokers and investors in arbitration claims. “Under this rule, it will.”

Because brokers are the customer’s main contact at a firm, they were the ones who sold auction-rate securities to their clients. But some industry observers argue that the on-the-ground sales team wasn’t responsible for the market’s collapse, and had no way of knowing it would occur. Brokers don’t want to see their records marred for selling what they say they understood to be perfectly safe products.

Even some investors’ advocates who think the rule serves an overall good acknowledge that it could prove unfair to brokers when it comes to product failure cases.

“I have no problem pointing fingers at brokers when I believe there has been wrongful conduct ,” said an investors’ attorney in Beverly Hills, Calif.,who said he’s spent the last six weeks working on auction-rate securities claims. But “when it’s a massive product failure, it’s rarely if ever the fault of the broker.”

Regulators point out that brokers have an opportunity to share their side of the story on their public records. And Lubin said the new version of the paperwork that brokers and firms must fill out would specifically ask whether the broker was alleged to have been involved in sales practices violations. That leaves room for brokers and firms to determine whether a case is ultimately a sales practice issue.

“The question dictates what needs to be disclosed,” she said. “They parse very carefully whether or not a yes answer is appropriate.” When it comes to how to categorize auction-rate securities complaints, she said, “It’s going to take a while to unwind.”

Finra is accepting comments on the proposed rule until May 27.