November 2, 2017
BrokeAndBroker.com Blog's publisher Bill Singer, Esq. has long criticized the Financial Industry Regulatory Authority's expungement protocol as unfair, burdensome, expensive, and moronic. Clearly, Bill doesn't feel strongly about the issue. Given that Bill represents both public customers and the industry in his law practice, he recognizes that FINRA has implemented a process that poses danger to the investing public by allowing what has taken on the nature of a cottage-industry for the mass production of expungements. On the other hand, Bill also sees that the need for many expungements is prompted by the lack of clarity and guidance in FINRA's rulebook.
As today's featured FINRA expungement arbitration case demonstrates, the industry's self-regulatory-organization is in denial. It persists in failing to comprehend the confusion caused by its vague proscriptions and reliance upon so-called notions of reasonableness. In the end, regulation is rarely, if ever, about reasonableness. Frankly, it's not supposed to be. It's supposed to be about protecting the investing public and ensuring the integrity of the financial services industry. You can't always accomplish both of those goals by being reasonable. Notwithstanding such challenges, regulation should always be about drawing bright, well-defined lines, and, thereafter, providing prompt, responsive, and fair answers to questions seeking interpretation of the rules.
Too much of FINRA's rulebook is indecipherable. Too much of what constitutes FINRA's role as an arbiter is cynically conducted via voicemail, non-responsive emails, and referrals to generic online explanations. FINRA member firms and their associated persons ought not be required to engage in civil disobedience in order to test the meaning of a vague rule.
Just say no isn't an effective regulatory or compliance regimen. Just say no is a coward's response to answering tough questions.
Case In Point
In a Financial Industry Regulatory Authority ("FINRA") Arbitration Statement of Claim filed in April 2017, associate persons Claimants Boshart and Fagan sought the expungement of their Central Registration Depository records ("CRD") In the Matter of the FINRA Arbitration Between Harvey Robert Boshart and James Campbell Fagan, Claimants, vs. Frederick Kobrick, Respondent (FINRA Arbitration 17-00982, October 30, 2017).
Respondent Kobrick appeared pro se, did not object to the expungement requests, and did not appear at the hearing.
The FINRA Arbitration Panel recommended the expungement from CRD of references to purported customer complaints filed by Respondent Kobrick based upon a finding that neither individual was involved in any investment-related sales practice violation, forgery, theft, misappropriation, or conversion of funds. In offering their rationale, FINRA arbitrators explained that:
The Claimants testified that the Respondent was sophisticated investor who had been the head of research at State Street Research, and whose assets exceeded $20 million. The Panel found that Claimant James Fagan introduced the Respondent to the Alliance Bernstein Global High Income Fund "ABGHI" as an investment that was a small portion of the Respondent's portfolio, well within his risk tolerance and that he was advised as to the risks of that investment. In an email dated January 2016, Mr. Kobrick alleged that Mr. Boshart and Mr. Fagan recommended a closed end mutual fund that was not suitable and failed to disclose the effect that a rise in interest rates would have on the fund's performance. Mr. Boshart, Mr. Fagan and J.P. Morgan denied that the ABGHI investment was unsuitable, but rather was well within the Respondent's risk tolerance and stated objectives. Mr. Fagan testified that the ABGHI investment was suitable, that Mr. Kobrick was familiar with bond funds, and had had a negative experience with bonds issued by the Commonwealth of Puerto Rico, that he believed Mr. Kobrick was informed of those risks, and the Respondent understood the risks involved with rising rates based on his market and investing experience and his overall net worth that exceeded $20 million. By emails dated February 17, 2016 and December 15, 2016, Mr. Kobrick stated that Mr. Boshart was not involved in the transaction, and that his prior emails were not intended to constitute a complaint against either of them, but were "spirited discussion(s)" about investments. To the extent they were treated by J.P. Morgan as a complaint, he asked that they be withdrawn. Mr. Fagan testified and the Panel concluded that the "claim, allegation or information" conveyed by Mr. Kobrick, as stated in his correspondence, was not intended to be a complaint. Based upon the testimony and the documentary evidence submitted, the Panel concluded that, to the extent the CRD reflects that a "claim, allegation or information" was made, that statement is clearly erroneous. In addition, the Panel concluded that, to the extent there was a claim, allegation or information as to Mr. Fagan's misconduct, it was false.
Bill Singer's Comment
The key issue in this expungement case involves distinguishing between a non-disclosable customer communication and a disclosable customer complaint. As presented in the AWC, Respondent Kobrick transmitted "prior emails" that were apparently interpreted by J.P. Morgan's compliance staff as containing grievances that required those communications to be handled as reportable customer complaints. The AWC does not provide the dates of these prior emails and does not present or summarize their language. Subsequent to his transmission of the "prior emails", by further emails dated February 17, 2016 and December 15, 2016, Kobrick states that:
[M]r. Boshart was not involved in the transaction, and that his prior emails were not intended to constitute a complaint against either of them, but were "spirited discussion(s)" about investments. To the extent they were treated by J.P. Morgan as a complaint, he asked that they be withdrawn. . .
In public customer Kobrick's two emails spaced over a period of some ten months in 2016, he asserts that "his prior emails were not intended to constitute a complaint" against either Respondent. Moreover, in the event that J.P. Morgan deemed the emails to constitute "complaints," Kobrick "asked that they be withdrawn."
Notwithstanding Kobrick's efforts at clarification his intent, that doesn't necessarily alter the fact that for some periods of time, his subject communications existed without his expression of intent and without his instructions to withdraw them if they were erroneously deemed complaints. As such, prior to Kobrick's February 2016 and December 2016 emails to J.P. Morgan, his "prior emails" may have been interpreted in good-faith by the firm as "complaints" requiring regulatory disclosure.
All of which presents some interesting issues for in-house compliance staff. Does it -- or should it -- matter how a customer wants to characterize a given communication? By way of illustration, just because I call a banana an orange doesn't make it so -- and you're sure as hell not going to get orange juice out of a banana. As such, let's take a look at some pertinent FINRA rules addressing the nature of customer complaints:
FINRA Rule 4513: Records of Written Customer Complaints
(a) Each member shall keep and preserve in each office of supervisory jurisdiction either a separate file of all written customer complaints that relate to that office (including complaints that relate to activities supervised from that office) and action taken by the member, if any, or a separate record of such complaints and a clear reference to the files in that office containing the correspondence connected with such complaints. Rather than keep and preserve the customer complaint records required under this Rule at the office of supervisory jurisdiction, the member may choose to make them promptly available at that office, upon request of FINRA. Customer complaint records shall be preserved for a period of at least four years.
(b) For purposes of this Rule, "customer complaint" means any grievance by a customer or any person authorized to act on behalf of the customer involving the activities of the member or a person associated with the member in connection with the solicitation or execution of any transaction or the disposition of securities or funds of that customer.
FINRA Rule 4530: Reporting Requirements
(a) Each member shall promptly report to FINRA, but in any event not later than 30 calendar days, after the member knows or should have known of the existence of any of the following:
(1) the member or an associated person of the member:
. . .
(B) is the subject of any written customer complaint involving allegations of theft or misappropriation of funds or securities or of forgery;
. . .
(G) is a defendant or respondent in any securities- or commodities-related civil litigation or arbitration, is a defendant or respondent in any financial-related insurance civil litigation or arbitration, or is the subject of any claim for damages by a customer, broker or dealer that relates to the provision of financial services or relates to a financial transaction, and such civil litigation, arbitration or claim for damages has been disposed of by judgment, award or settlement for an amount exceeding $15,000. However, when the member is the defendant or respondent or is the subject of any claim for damages by a customer, broker or dealer, then the reporting to FINRA shall be required only when such judgment, award or settlement is for an amount exceeding $25,000; or . . .
. . .
(d) Each member shall report to FINRA statistical and summary information regarding written customer complaints in such detail as FINRA shall specify by the 15th day of the month following the calendar quarter in which customer complaints are received by the member.
(e) Nothing contained in this Rule shall eliminate, reduce or otherwise abrogate the responsibilities of a member or person associated with a member to promptly disclose required information on the Forms BD, U4 or U5, as applicable, to make any other required filings or to respond to FINRA with respect to any customer complaint, examination or inquiry.In addition, members are required to comply with the reporting obligations under paragraphs (a), (b) and (d) of this Rule, regardless of whether the information is reported or disclosed pursuant to any other rule or requirement, including the requirements of the Form BD. However, a member need not report: (1) an event otherwise required to be reported under paragraph (a)(1) of this Rule if the member discloses the event on the Form U4, consistent with the requirements of that form, and indicates, in such manner and format that FINRA may require, that such disclosure satisfies the requirements of paragraph (a)(1) of this Rule, as applicable; or (2) an event otherwise required to be reported under paragraphs (a) or (b) of this Rule if the member discloses the event on the Form U5, consistent with the requirements of that form
As with far too many rules that bedevil virtually every regulated industry, we find that the definition of what constitutes a reportable "complaint" requires us to first figure out just what constitutes a "grievance," which is not defined in the FINRA Rulebook. Accordingly, what happens if a:
As set forth in FINRA's online "Rule 4350 Frequently Asked Questions":
- FINRA member firm decides in good faith that a given customer communication is an expression of a "grievance;" and,
- reports the communication as a "Complaint;" but
- thereafter, the customer requests that the so-called Complaint be considered merely a non-grievance-expressing communication, or, in the alternative;
- the customer says that if a FINRA member firm won't comply with the requested reclassification that the Complaint be deemed withdrawn?
2.11 A few days ago, a member firm received a written customer complaint alleging that the firm engaged in securities fraud. Later that same day, the customer withdrew the complaint. Does the firm have an obligation to report the complaint for purposes of FINRA Rule 4530(d)?
Yes. A written customer complaint subject to FINRA Rules 4530(a)(1)(B) or 4530(d) must be reported within the prescribed timeframe, regardless of whether the customer subsequently withdraws it.
You may think that the above FINRA FAQ is dispositive of the issue in today's featured AWC. It is not. The above Q&A starts with the premise that the firm "received a written customer complaint" and that the customer subsequently requested its withdrawal. Consequently, in FINRA's above example, there is no debate about the threshold issue of whether the written customer communication was a "complaint." In the case of Respondent Kobrick's "prior emails," the customer is insisting that he did not intend them to constitute complaints but, rather, what he calls a "spirited discussion;" and, further, if J.P. Morgan has characterized Kobrick's emails as a "complaint," the customer is insisting that since such was never his intent that the brokerage firm deem the mischaracterized complaints as having been withdrawn.
FINRA member firm compliance departments uniformly characterize far too many "communications" from customers as involving a "complaint," when, in fact, the communication is merely an inquiry or comment. Further, not every customer complaint necessarily rises to the level of an event requiring disclosure; for example, a complaint that a stockbroker was rude on the telephone or that the firm's online platform is not user-friendly would not (absent more) require a regulatory disclosure.
Additionally, even if a communication involves what may be deemed a complaint, another important determination is whether the communication emanated from a customer or was transmitted subject to the customer's authorization (through a lawyer or agent as two common examples). At times, a customer's family member or friend may complain to an employer brokerage firm about a stockbroker who is servicing the subject customer. If the sender of that complaint is not the customer and not a "person authorized to act on behalf of the customer," then that communication may not require regulatory disclosure -- which is not to suggest that a firm's compliance department should not inquire as to the issues raised.
A peculiar quirk of FINRA's rules is that the self-regulator's reporting requirements require the prompt reporting of "any written complaint" but do not similarly address the mere "oral complaint. " Additionally, FINRA's reporting requirement limits the reporting of "any written customer complaint" to those "involving allegations of theft or misappropriation of funds or securities or forgery."
As if any normal human being would not, by now, be crumbling under the weight of FINRA's rules and their lack of meaningful guidance, you have to add to that pressing weight the need to discern between the obligations imposed upon a FINRA member firm to report events to the self-regulatory organization and the separate disclosure obligations of the Uniform Application for Securities Industry Registration or Transfer("Form U4"). Notably, under the Form U4 heading "Customer Complaint/Arbitration/Civil Litigation Disclosure," we find, in part, the following:
(2) Have you ever been the subject of an investment-related, consumer-initiated (written or oral) complaint, which alleged that you were involved in one or more sales practice violations, and which:
(a) was settled, prior to 05/18/2009, for an amount of $10,000 or more, or;
(b) was settled, on or after 05/18/2009, for an amount of $15,000 or more?
(3) Within the past twenty four (24) months, have you been the subject of an investment-related, consumer-initiated, written complaint, not otherwise reported under question 14I(2) above, which:
(a) alleged that you were involved in one or more sales practice violations and contained a claim for compensatory damages of $5,000 or more (if no damage amount is alleged, the complaint must be reported unless the firm has made a good faith determination that the damages from the alleged conduct would be less than $5,000), or;
(b) alleged that you were involved in forgery, theft, misappropriation or conversion of funds or securities?
Ah yes, the regulatory minefield for the unwary:
- FINRA Rule 4530(a)(1)(B) requires prompt reporting when an associated person is "the subject of any written customer complaint involving allegations of theft or misappropriation of funds or securities or of forgery."
- Form U4, Item 14I (2) requires reporting of both written and oral investment-related, consumer-initiated complaints alleging a sales practice violation that settled for $15,000 or more.
To add to the confusion, Item 14I(3) on the U4 requires the reporting of only written
investment-related, consumer initiated complaints made within the past 24-months alleging at least $5,000 in compensatory damages; but if no monetary amount is alleged, "the complaint must be reported unless the firm has made a good faith determination that the damages from the alleged conduct would be less than $5,000." On the other hand, if that same 24-month-complaint merely alleged that "you were involved in forgery, theft, misappropriation or conversion of funds or securities," then it has to be disclosed regardless of the dollars alleged.
Yeah, I know, that's all crystal clear.
For no other reason than exhaustion, let's just stop here. The important takeaway is that FINRA's regulatory scheme assumes too much and depends upon unmanageable notions such as common sense and reasonableness. Common sense? Reasonableness? Try referencing those concepts if you're a registered rep, associated person, or compliance office with the need to figure out just what constitutes a "grievance."
For FINRA's legion of apologists and self-serving lackeys, go ahead, criticize my analysis all you want. Just keep in mind that an independent panel of three arbitrators found that Respondent Kobrick had not transmitted a communication that rose to the level of a reportable "complaint." Also, keep in mind that any number of competent J.P. Morgan compliance and legal staff likely reviewed Kobrick's communications and concluded that they were, in fact, reportable complaints -- otherwise, there would not have been any need for the two Claimants to have filed an expungement arbitration. Who in that mix of facts was reasonable? Who exercised common sense? How could so many folks reference the same FINRA rules yet come away with such different conclusions?