The Securities Industry and Financial Markets Association (SIFMA) is urging the Financial Industry Regulatory Authority to change termination reporting and create tougher arbitration standards to provide firms with a safe harbor against defamation awards the trade group claims are made as a result of arbitrator confusion.

SIFMA said in a letter that there has been a significant increase in claims and damages awarded to brokers. The group proposed changing the form to limit firms' legal exposure, including replacing free-form text fields with drop-down, check-the-box disclosures regarding broker’s violations to reduce defamation disputes and provide a “safe harbor” to firms, SIFMA Deputy General Counsel Kevin M. Carroll said.

Within 30 days of a broker’s termination, Finra requires brokerage firms to file a Form U5 reporting the termination, the reasons for it and whether the registered person was under investigation or internal review. If a Form U5 contains inaccurate or misleading information, a firm's only recourse is to file a claim in Finra’s arbitration forum.

“Today, associated persons assert claims—in our view, inappropriately so—to expunge Form U5 information based upon the defamatory nature of the information. Unfortunately, arbitrators need not state if they found that all the elements of a defamation claim under governing law have been met. Notably, the only guidance that FINRA has issued to arbitrators and member firms relates solely to claims for expungement of Form U5 information that is deemed to be defamatory in nature, and not to actual claims for defamation.” Carroll said.

In 2020, U5 defamation claims were the fourth most common intra-industry claim. In recent years, Finra arbitration panels have issued a number of high-dollar damage awards in defamation cases, including punitive damages, Carroll said.

In late March, two ex-Northwestern Mutual reps won an $8 million dollar claim against the firm for wrongful termination regarding the defamatory nature of the firm’s U5 reporting.

Carroll said arbitrators may be inappropriately applying a defamatory nature of the information standard, instead of applying the actual elements of a defamation claim. Alternatively, arbitrators may be applying some form of wrongful termination standard in lieu of a defamation standard.

“The truth is that we just don’t know, given that arbitrators receive no Finra training or guidance on the proper standard to apply. Consequently, it seems likely that many arbitration panels may be applying the wrong standard, or the correct standard in an incorrect and/or differential manner, leading to uneven and unfair arbitration outcomes—which of course translate into uneven and unfair reporting on CRD and BrokerCheck,” he said.

If unfounded U5 defamation claims for money damages “are allowed to prevail and proliferate, then the value of the original U5 disclosure is diluted and countervailed by the competing narrative of the defamation damages award against the firm,” Carroll argued.

SIFMA asked Finra to provide instructions to arbitrators that state that they must make the following required findings:

• A defamation claim for monetary damages for a U5 statement cannot prevail if the relevant statement regarding the broker is a true statement of fact.
• Even if the statement is inaccurate, the defamation claim nevertheless cannot prevail if the statement was made in good faith and without malice in fact.

The trade group also wants Finra to amend Form U5. “The compelled narrative fields in the Form U5 create unnecessary legal exposure to defamation claims for firms. To the extent possible, the narrative fields should be entirely replaced with regulator-generated, drop-down menus of check-the-box disclosures. To the extent that a firm checks the appropriate boxes, without making other narrative comments, Finra should instruct arbitrators that the firm is entitled to safe harbor protection from a U5 defamation claim related to such disclosures,” Carroll said.

Attorney Robert Pearce, founder of Robert Wayne Pearce, PA, a national law firm that represents both brokers and investors, said it appears that SIFMA is just “trying to tilt Finra rules in the industry’s favor. The majority of defamation claims are denied, but they give brokers the ability to correct information that hurts their reputation,” he said.

“I think [SIFMA] is exaggerating the problems by seizing on a couple of big claims that recently hit. What does the investor learn about the reason for a broker’s termination determination based on a preset drop box explanation? Finra would have to come up with 100 boxes to explain the variety of reasons brokers are terminated. How does that enhance investor protection?” Pearce asked.