Categories: Financial Services

By: John F. Fullerton III

A recent New York state court decision granted a fairly unique petition to disqualify the attorney for a group of former employees from representing them in an intra-industry arbitration at FINRA. Why?  Because the lawyer had turned himself into a fact witness by negotiating the termination explanation in the U5 notice of two of the employees. The decision raises an interesting question about whether the same logic could be applied in a U5 expungement hearing at FINRA when there have been discussions between counsel about the U5 language, regardless of whether or not the employee ultimately “accepts” the U5 language the employer reports.

 Disqualifying Counsel Who “Negotiated” U5 Language

In the case, New England Securities Corp. v. Stone (PDF), the employer, a registered broker-dealer of insurance products, discharged two registered salespeople.  They retained the same attorney, who called the company’s in-house counsel to discuss how the terminations would be characterized in the Uniform Termination Notice for Securities Industry Registration (Form U5)  (PDF).  Form U5 requires firms to indicate whether a termination was full, give a Reason for Termination (“Discharged,” “Other,” “Permitted to Resign,” “Deceased,” or “Voluntary”), and a Termination Explanation if the reason for termination was “Permitted to Resign,” “Discharged,” or “Other.”  FINRA requires member firms to “provide sufficient detail when responding to Form U5 questions such that a reasonable person may understand the circumstances that triggered the affirmative response.” In a discussion not uncommon in the financial industry, the in-house attorney made clear that the company did not negotiate U5 language, but “would be open to suggestions if they made sense.”  Extensive discussions ensued, and ultimately, the lawyer for the employees indicated that his clients had “accepted” the U5 language.

Thereafter, the company filed a statement of claim at FINRA against the same two former employees, claiming that they had breached their contractual obligations by soliciting policyholders to cancel their policies and other employees to resign and join them at their new employer.  The former employees, through the same lawyer who “negotiated” their U5 language, asserted several counterclaims, including tortious interference with prospective business advantage, negligence, and failure to supervise—all of which were based on the claim that the U5 language was “false” and “inaccurate”!

The company responded by commencing a special proceeding in state court to disqualify the employees’ attorney under Rule 3.7 of the New York Rules of Professional Conduct  (PDF), which provides in relevant part that a “lawyer shall not act as advocate before a tribunal in a matter in which the lawyer is likely to be a witness on a significant issue of fact.”  After a thorough analysis, the court granted the petition and enjoined the attorney from representing the employees in any manner at or in connection with the arbitration, because he “was a direct participant in the communications that are at issue, rendering his testimony indispensable in order for the Firm to defend [the] counterclaims.”  Only the lawyer could explain why his clients had “accepted” U5 language that they now claimed was “false” and “inaccurate.”

 Other Applications?

While the decision supports a similar strategy in a similar case, it might have broader possibilities as well.  Discussions between in-house counsel and employee’s attorneys about U5 language do occur, notwithstanding the appropriate position taken by most employers that, at the end of the day, the language is non-negotiatiable and the company has an obligation to provide accurate information on the U5 regardless of the employee’s wishes. Indeed, some attorneys encourage employees to be proactive about attempting to discuss the U5 language with the employer at or around the time of discharge; and in many cases the employees are already represented by counsel if they are disputing the discharge itself or the compensation they are owed as a result. What happens in a situation in which such discussions have occurred between the company and employee’s lawyer, and, regardless of the outcome of those discussions, the employee later seeks to challenge the U5 language through the same attorney?

FINRA will expunge information from the Central Registration Depository, without a court order, if an arbitration panel awards expungement relief based on the defamatory nature of the information contained in the U5, and explicitly states in the award that it is recommending expungement on that basis.  Regardless whether the parties came to an “agreement” on the U5 language or not, if the employee later seeks expungement through the same lawyer who engaged in discussions on his behalf with the company, the employee’s lawyer could arguably have become a necessary fact witness in the expungement hearing.  Thus, the New England Securities decision highlights the intriguing possibility of similarly moving to disqualify counsel from a FINRA expungement petition and hearing, if the facts and circumstances support it and it makes strategic sense to make the attempt.

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