Securities Firms Can Now Be Sued for Weaponizing Form U-5 Statements

  • Feb 5 2021

FEBRUARY 4, 2021 

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, [2005] 129 Cal.App.4th 719 [2005]), 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.

In April 2020, Tilkey v. Allstate Ins. Co. (Tilkey vs. Allstate Ins. Co., 56 Cal. App. 5th 521 [2020]) held for the first time that securities firms in California can face civil liability for Form U-5 disclosures for non-securities-related reasons for termination. (This article is not intended to state or suggest that securities-related reasons are absolutely immune from civil liability, however, the Finra rules are beyond the scope of this article.) Michael Tilkey (Mr. Tilkey) was an advisor with Allstate Insurance Company (Allstate) for 30 years when he was arrested for disorderly conduct and attached domestic violence charges. Mr. Tilkey allegedly pounded on an apartment door to be let in after being locked out by his girlfriend. Mr. Tilkey was not convicted of any charges, and an Allstate investigator reviewed the arrest report and concluded that the event was “not reportable” to Finra and did not violate Allstate’s policies. Allstate terminated Mr. Tilkey regardless and stated on his U-5 that the reason for termination was “…threatening behavior and/or acts of physical harm or violence to any person, regardless of whether he/she is employed by Allstate. Not securities related.”

Mr. Tilkey sued Allstate in San Diego County Superior Court for wrongful termination and defamation. The jury found that Allstate’s statements about Mr. Tilkey were false and returned a verdict in his favor for $1,702,915 for defamation, $960,222 for wrongful termination and $15,978,822 for punitive damages. Allstate appealed and argued, among other things, that it cannot be liable for defamation for Form U-5 disclosures because California recognizes an absolute privilege for Form U-5 disclosures. The California Court of Appeal disagreed and affirmed the full defamation award, but ultimately reversed the wrongful termination verdict and reduced punitive damages to $2,554,372.50.  At the end of the day, Mr. Tilkey’s total award was $4,257,287.50.

Tilkey followed Fontani only for the limited proposition that the privilege applies to Form U-5 disclosures involving “improper securities conduct, theft, or allegations or charges of fraud or dishonesty…” but held that the privilege does not apply to “non-securities-related” disclosure information. Because Mr. Tilkey’s Form U-5 disclosure did not involve privileged activities, the court found that Allstate was not immunized from defamation liability for the Form U-5 disclosure. Once the jury determined that Allstate’s statements that Mr. Tilkey threatened another person were false, Allstate’s fate was sealed.

We think Tilkey was correctly decided and long overdue. Financial advisors deserve the right to reasonable workplace mobility that is free from unlawful retaliation, discrimination, and unethical business practices. The Tilkey decision is a step in the right direction to ensure important rights for all securities professionals, particularly for those falsely accused of non-work-related misconduct.

Brandon S. Reif is managing partner at Reif Law Group, P.C. As one of the leading attorneys in the securities and financial services industries,

Rebecca E. MacLaren is a partner at Reif Law Group, P.C. specializing in securities regulatory matters.

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