FINRA Cracks Down on Expungements

2/7/2014

Recently, FINRA published guidance regarding additional procedures arbitrators must follow when considering motions for expungement. It is no coincidence that FINRA’s guidance was published a mere two days prior to the Public Investors Arbitration Bar Association’s (“PIABA”) publishing of its Expungement Study (October 16, 2013) berating FINRA for what it perceives as its arbitrators’ lax standards for granting expungement requests.

Expungement

A registered person must petition a court to remove (expunge) dispute related information from the Central Registration Depository (“CRD”) System. CRD provides data to regulators, FINRA members, and the public through the BrokerCheck system. Once a record is expunged, its information is no longer available to the public, regulators, or broker-dealer employers.

The conditions of FINRA waiving its participation in a registered person’s request for court ordered expungement are set forth in FINRA Rule 2080. The Rule allows registered persons involved in an arbitration to expunge the related CRD record if an arbitration panel or judge makes a finding of fact as to one or more of the following three instances:

(A) the claim, allegation or information is factually impossible or clearly erroneous;
(B) the registered person was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation or conversion of funds; or
(C) the claim, allegation or information is false.

PIABA Expungement Study

PIABA’s study focused on the rates at which arbitrators have granted expungement related to arbitrations resolved by settlement or stipulated awards. PIABA examined expungement rates for two distinct periods: January 1, 2007 through mid-May 2009 and mid-May 2008 through December 31, 2011. These periods were based on revised disclosure requirements FINRA implemented in May 2009. The revision required registered persons to disclose whether they were the subjects of litigation but not named as defendants/respondents. [1]

Prior to this revision, FINRA only required registered persons to disclose litigation where they were named. PIABA’s study highlights in its finding that for the period before the revised disclosure requirement took effect, 89% of expungement requests related to arbitrations resolved by settlement or stipulated awards. The granted expungement rate increased to 96.9% after the disclosure requirement revision. PIABA conceded that it expected the rate to increase as a result of the revised disclosure requirement, but criticized FINRA for allowing a rate it deemed “alarmingly high”. [2]

PIABA concluded that a primary reason for the number of granted expungement requests related to settlement negotiations and agreements that were premised on customers’ agreements to expungement or promises to not oppose requests for expungement. PIABA argued that these types of conditions are contrary to FINRA’s previous guidance – that to do so could be a violation of its rule regarding just and equitable principles of trade. It called on FINRA to police settlements for these types of conditions. [3]

Based on its analysis, PIABA concluded that FINRA arbitrators were too liberal in granting expungement requests. It called on FINRA to provide better training to its arbitrators and revise the expungement rule to require FINRA to:

1. Review settlement agreements prior to expungement hearings to ensure that customers were not coerced into agreeing to arbitration;
2. Provide state securities regulators notice of motions for expungement; and
3. Allow state securities regulators the right to attend expungement hearings and oppose expungement requests.

FINRA’s recent steps have addressed some of PIABA’s recommendations, but remain silent as FINRA’s direct oversight of the expungement process or involvement of state regulators.

FINRA Guidance

FINRA mainly relies on its arbitrators to determine whether to grant expungement. It believes that their role is critical in its ongoing effort to provide information to parties that may have involvement with registered persons. In December 2008, FINRA enacted Rules 12805 and 13805 requiring arbitrators to take the following actions with respect to considering motions for expungement:

1. Hold in-person or telephonic hearings;
2. Review settlement documents to determine settlement amounts and terms;
3. Provide brief explanation for reasons granting an expungement request; and
4. Assess forum fees for the hearing to the party requesting expungement.

With the enactment of these new rules, FINRA required arbitrators to certify that they understood them and revised its arbitrator training accordingly.

FINRA’s recently published guidance expanded the procedures arbitrators must undertake when considering a request for expungement. Under the expanded guidelines, arbitrators:

1. Should review relevant documents and evidence to ensure their receipt of all relevant information necessary to consider an expungement request;
2. Should require a current copy of the BrokerCheck report for the registered person requesting expungement and review the Disclosure Events reflected on the report;
3. Provide a complete explanation of their recommendation for expungement including the reason for granting the request and the information and documents relied on; and
4. Determine whether customer agreement not to oppose the request for expungement was a condition of an arbitration settlement.

Feeling the Effects

As a result of FINRA’s expanded guidance, future registered persons requesting expungement will likely find greater document production requirements and prolonged hearings as arbitrators strive to fulfill their increased responsibilities. Indeed, the Securities Arbitration Commentator reported that the first two weeks of November 2013 resulted in a rate of granted expungement requests of only 57%, well below the rates reported by PIABA the previous month. [4] Registered persons can also expect requests for expungement to undergo increased scrutiny. For example, one panel recently denied a request of expungement because the claimant, who had agreed to the expungement, refused to appear at the hearing. [5] In another case, a panel “reluctantly” refused to grant expungement because it “is an extraordinary remedy”. [6] Based on FINRA’s expanded guidance, the panel’s rationale essentially meant that it could not determine that the reporting of the arbitration had “no meaningful investor protection or regulatory value” which, based on FINRA’s guidance, it likely believed it needed in order to form a basis to grant the request. [7]

Instead of supporting its current system, FINRA agreed with PIABA’s concerns and emphasized in its response to PIABA’s study its commitment to further revise the expungement process and consider new rules, or revisions to current rules, regarding conditions on settlements. It is likely that FINRA will continue to increase its pressure on arbitrators causing registered persons to have an increased burden to prove their eligibility for expungement. It is not unreasonable to believe this new approach will also result in arbitrators granting fewer requests for expungement thereby leaving registered persons with permanent public records reflecting claims made against them – not actual findings of improper conduct. This in the end may ultimately lead many registered persons to continue to weigh with greater concern whether remaining in the industry is worth the economic and reputational expense related to the possibility of an unsubstantiated scarlet letter.

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[1] See FINRA Regulatory Notice 09-23 (May 18, 2009).
[2] PIABA Study: Stockbroker Arbitration Slates Wiped Clean 9 Out of 10 Times When Expungement Sought in Settled Cases (October 16, 2013).
[3] See Standards of Commercial Honor and Principles of Trade, NASD Rule 2110 superseded by FINRA Rule 2010 (Dec. 15, 2008).
[4] Securities Arbitration Alert 2013-44, Securities Arbitration Commentator (11/27/2013).
[5] Id.
[6] Id.
[7] FINRA Notice to Arbitrators and Parties on Expanded Expungement Guidance (October 14, 2013).