“Most investors won’t know what the term means, and firms don’t put any other details in [U5 termination forms], although in my experience reps often use an outside business to run a Ponzi scheme or commit fraud,” said Wojciechowski, who has represented investors for 16 years.
Meantime, more firms are being vague in U5 terminations because “they don’t want to get sued by reps for defamation,” said Wojciechowski. “There is a cottage industry that has sprung up to sue broker-dealers for what they put in U5s. And firms also don’t want to put something on there to alert guys like me or other clients. But lay people don’t know what that term means.”
While defense attorneys for broker-dealers that are brought to arbitration for such claims will often ask how they were supposed to know what a rep was doing in his or her outside business, three Finra rules require firms to supervise their reps to discern such activity.
For instance, Finra Rule 3110 requires a firm to establish and maintain a system to supervise the activities of its associated persons that is reasonably designed to achieve compliance with the applicable securities laws, regulations and Finra rules.
Generally, in many “outside business activity” cases, “there is sufficient evidence that the firm should know what outside activities a rep is engaged in. I always ask, when was the last time you had a compliance rep show up at this guy’s office? There are always red flags. A rep doesn’t just wake up in the morning and create a fraud scheme,” Wojciechowski said.
Firms also have internal compliance and supervisory policies and procedures that are geared toward detecting undisclosed outside business activities “because it is commonly through these outside businesses that financial advisors execute their worst schemes on their clients,” he added.