Form U-5 Defamation

1. IntroductionThe extent to which securities professionals with significant disciplinary histories or multiple investor complaints manage to remain in the securities industry has attraced considerable attention in recent years. Members of the Securities and Exchange Commission (SEC) and officials of the various securities self-regulatory organizations (SROs) have expressed concern over the ability of some problem representatives to move from employment with one broker-dealer to another and have explored ways of protecting investors from such individuals.(1)Oddly enough, for over a decade a reporting form has existed that was designed to offer regulators and potential employers a means of identifying problem representatives. The form, known as the Uniform Termination Notice for Securities Industry Registration (Form U-5) must be filed whenever an individual's employment with a broker-dealer is terminated.(2) The form requires the broker-dealer to report the reasons for the termination and whether the terminated individual had been accused of or found to have engaged in investment-related misconduct. The itlformation reporeed on the Form U-5 is shared among national and state regulatory bodies and is made available to broker-dealers who consider employing the individual in the future. In thepry, the wide availability of Form U-5 information should substantially limit the ability of problem representatives to remain in the securities industry.In practice, however, the Form U-5 has had limited efficacy as an early warning device. One of the most frequently cited explanations for this is brbker-dealers' concerns about defamation liability if they report adverse information on the Form U-5.(3) In fact, some broker-dealers maintain given the substantial defamation exposure that they may face if they accurately complete the Fdrm U-5 -- that it is wiser for them simply to give depaiting employees "clean" Forms U-5, whether warranted or not.When this occurs, regulators do not receive accurate information about the reasons for terminations, prospective employers are not alerted to potential problems, and investors continue to be exposed to problem representatives. Further, such nondisclosure can subject broker-deaers to civil actions by subsequent investors who are injured by a problem representative or can result in SRO disciplinary actions against the broker-dealer. Thus, the proper handling of Form U-5 reporting presents a dilemma to brdker-dealers: Those that fail to report accurately and completely the reasons for an individual's termination may face negligence or disciplinaj actions, while those that respond accurately and completely to the Form U-5's questions may face defamation suits.The concerns over potential defamation exposure are so strong that many broker-dealers maintain that candid Form U-5 reporting will not occur until such reporting is protected by either an absolute.or qualified privilege against defamation liability.(4) Privilege supporters argue that the policies underlying existing common-law defamation privileges support a Form U-5 priilege, or that such a privilege should be created by statute, or by SEC or SRO rules.This Article begins by briefly reviewing the background and uses of the Form U-5 bifore addressing the limited precedents in the area of Form U-5 defamation. Much of the concern over Form U-5 defamation awards has stemmed from an extremely small number of instances in which substantial damages.were awarded in cases that involved relatively innocuous Form U-5 infonnation. These csises, yvhich have received. substantial publicity, appear to form the basis for the perception that arge Form U-5 defamation awards are routine in nonmeritorious cases.The attention such cases attract is disproportionate to either the volume of defamation claims filed or to the number of defamation awards entered against broker-dealers to date. As discussed in detail below, the available information indicates that arbitration claims alleging Form U-5 defamation are not routine. …