Financial advisors are subject to the most stringent reporting requirements of any regulated profession in the United States. (The term “financial advisors” refer to both registered representatives of broker-dealers licensed and registered through Finra, as well as advisors subject to the jurisdiction of the Securities and Exchange Commission and/or the laws of the various states.) No other professional industry is required to publicly report detailed personal and financial information, or the reasons for their departure from each job. The theory is that disclosures promote consumer protection: every financial institution and customer have the right to know about the advisor’s record of employment discipline, dishonesty and customer complaints. But the absolute power entrusted to securities firms is often misused and abused. A counterweight is a matter of necessity.
Securities laws mandate that advisors must register with and be monitored by the self-regulatory organizations (SROs). These organizations use the Uniform Application for Securities Industry Registration or Transfer (Form U-4) to track advisors’ activities. Securities firms must use the Uniform Termination Notice for Securities Industry Registration (Form U-5) to terminate an advisor’s registration and, where indicated, provide detailed reasons for the advisor’s departure. The U-5 functions as a report card that follows advisors throughout their careers. For those not in the industry, imagine that your former employers have the right to make a public statement about you after you leave. The securities industry has shown at times a propensity to weaponize U-5 disclosures to damage a departing advisor’ reputation and opportunities for re-employment.
Securities firms have misused the U-5 in several serious ways for decades: (i) terminating an advisor for questionable (or even illegal) reasons and “covering their tracks” by falsely reporting advisor misconduct; (ii) retaliating against a voluntarily departing advisor by falsely reporting misconduct; and (iii) coercing “voluntary” resignations, one-sided severance agreements, release of owed compensation and other unethical concessions by threatening a negative U-5 disclosure. In short, securities firms with bad intentions find the Form U-5 a resourceful way to gain control or to get even.
A negative U-5 disclosure has the unpleasant effect of piquing the interest of the SROs charged with administering the securities industry. It can trigger investigations by Finra, the SEC and other government agencies. Investigations are stressful, time consuming and can be unduly costly if disciplinary actions ensue. Thus, the U-5 grants the securities firms unchecked power over the financial advisors.
While most state laws provide that securities firms have only quasi-immunity for false U-5 statements, California granted securities firms total immunity from civil liability for Form U-5 disclosures. In Fontani v. Wells Fargo Investments, LLC (Fontani v. Wells Fargo Investments, LLC,  129 Cal.App.4th 719 ), a financial advisor sued his former employer for describing the reasons for his termination in his U-5 as violating company policies and “… misrepresenting information in the sale of annuities…” On appeal, the Court held that a Form U-5 is “absolutely privileged under Civil Code §47(b),” as a communication made “in anticipation of an action or other official proceeding.” The financial advisor was thus unable to hold his prior firm liable for what he alleged were misstatements.
In our view, Fontani was simply wrong and is irreconcilable with California’s liberal employment laws. Firms in other industries are prohibited from maliciously impairing one’s employment prospects by providing false information. In fact, California Labor Code section 1050 expressly prohibits this conduct. Why, then, would securities firms be immune from liability for the same thing? As the obscure philosopher Benjamin Franklin Parker once said, “With great power comes great responsibility.” If the cartoon moral authority in the Spider-verse gets it, how can the real-life California courts let this persist? At last, one case has finally come to the rescue. At least partially.