Over the past 20 years, the Financial Industry Regulatory Authority (FINRA) has made it increasingly more difficult for brokers to expunge customer complaints and dispute information from their public records. FINRA recently proposed new rules (FINRA Regulatory Notice 17-42) that could dramatically alter the expungement process. This article discusses the evolution of FINRA’s expungement process and explores how the proposed changes could make expungement relief more difficult for brokers to obtain in the future.
The Central Registration Depository
In 1981, the Central Registration Depository (CRD) system was created by FINRA’s predecessor, the National Association of Securities Dealers (NASD). The CRD is an online registration and licensing system for the securities industry. Among other things, the CRD provides information about every broker’s employment history, registrations, and licenses, as well as customer complaints or regulatory actions brought against the broker. Essentially, the CRD system acts as a background check for each individual broker. Because a customer complaint is reported on a broker’s record regardless of the merit of the complaint, FINRA allows brokers to seek expungement of disputed customer complaints from their records. In the past 20 years, however, FINRA has made it significantly more difficult for brokers to obtain expungement relief.
In 1988, FINRA established BrokerCheck (then known as the Public Disclosure Program) to provide the public with information on members firms and their associated persons. More recently, BrokerCheck has become an online tool for investors to research their brokers (or prospective brokers). In 2015, FINRA launched a national advertising campaign encouraging customers to vet their brokers using BrokerCheck. And in 2016, FINRA began requiring firms to include a “readily apparent reference and hyperlink to BrokerCheck” on each firm’s initial webpage and any other webpage that displays the profile of one or more registered persons. FINRA statistics reflect that, in 2016, investors used BrokerCheck to conduct 111 million reviews of broker and firm records. Accordingly, FINRA BrokerCheck has significantly broadened the average investor’s access to a broker’s complaint history.
The Evolution of the Expungement Process
Court confirmation is required. Prior to 1999, brokers could obtain expungement relief solely through arbitration. However, in 1999, FINRA introduced the first substantial hurdle to the expungement process when it began requiring that a “court of competent jurisdiction” confirm expungement awards. This requirement provides an additional layer of review to the expungement process, which increases the costs and time associated with the expungement process.
FINRA identifies specific grounds for expungement. In 2004, FINRA enacted Rule 2080 in response to concerns that arbitrators were routinely granting expungement requests without thoroughly considering the underlying merits. Rule 2080(b)(1) provided three specific grounds for which expungement relief could be granted:
(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.
Although FINRA Rule 2080 does not expressly require that the arbitrators determine that one of the three grounds has been met, FINRA has provided guidance that the arbitrator should find one of these three grounds in order to grant expungement relief.
Firms are required to report allegations of sales practice violations even if the broker is not a named party. Prior to 2008, a customer dispute was reported on a broker’s record only if the broker was named as a party in the proceeding (i.e., a respondent or a defendant). Then, in 2008, FINRA revised member firms’ reporting obligations such that member firms were required to report, as customer complaints, allegations of sales practice violations made in arbitrations or lawsuits against brokers who were not named as parties in the proceeding. Per FINRA Regulatory Notice 08-20, arbitrations or civil lawsuits are reportable against a broker if the firm “made a good faith determination after a reasonable investigation that the alleged sales practice violation(s) involved the registered person.” Of course, this rule change resulted in more customer disputes being reported on brokers’ CRD records and precipitated a greater use of the expungement process to have unmeritorious complaints expunged.
FINRA implements new procedures for arbitrators considering requests for expungement relief. In January 2009, FINRA enacted Rule 12805, which implemented new requirements for arbitrators to follow when considering expungement requests. Specifically, arbitrators considering a request for expungement relief are required to (1) hold a recorded hearing session by telephone or in person, (2) review settlement documents and consider the amount of payments and conditions of the settlement, (3) provide a written explanation of the reasons for ordering expungement, and (4) assess forum fees against the parties requesting relief.
FINRA issues sweeping guidance on expungement. In 2014, after investor advocacy groups criticized FINRA for purportedly lax expungement standards, FINRA issued sweeping guidance to arbitrators that was designed to emphasize the “extraordinary” nature of expungement relief. Specifically, FINRA noted that expungement is an “extraordinary remedy that should be recommended only under appropriate circumstances.” FINRA further clarified that “[c]ustomer dispute information should be expunged only when it has no meaningful investor protection or regulatory value.” FINRA also took this opportunity to strengthen the position of customers in expungement proceedings. For instance, FINRA’s expanded expungement guidance stated the importance of allowing customers to participate in expungement hearings and explicitly noted that arbitrators should (1) allow customers (and their counsel) to attend expungement hearings, (2) allow customers to testify at expungement hearings, (3) allow customers to introduce evidence at expungement hearings, (4) allow customers to cross-examine the broker and other witnesses at expungement hearings, and (5) allow customers to present opening and closing arguments at expungement hearing.
FINRA also touched on the increasing number of “expungement only” arbitrations (i.e., when a broker files an arbitration against a member firm solely to seek expungement) and added the requirement that arbitrators order brokers to provide customers with a copy of the expungement request so that they are on notice of the expungement proceeding.
Proposed Amendments to Expungement Rules
As detailed above, FINRA enacted a number of safeguards to the expungement process from 1999 through 2017. However, the biggest changes may be yet to come. On December 6, 2017, FINRA issued Regulatory Notice 17-42, which announced a variety of proposed changes that would dramatically alter the expungement landscape. If codified as currently drafted, the proposed amendments would significantly increase the burden for brokers seeking to expunge customer complaints. For starters, the proposed changes would increase the cost of the expungement process, shorten the time period for requesting expungement, and restrict the avenues for pursuing expungement relief. Below is a breakdown of the most notable proposed changes.
Increased fees for expungement requests. Under the proposal, the minimum filing fee for expungement requests would be $1,425. Currently, if a financial advisor seeks expungement in a single-arbitrator (simplified) proceeding, the filing fee can be as low as $50.
One-year limitation on requesting expungement relief. Under the proposal, brokers are required to seek expungement of a customer complaint within one year of the close of the underlying customer case (if it was not decided in the customer case) or within one year of the member firm’s initial report of the customer complaint to the CRD (if the complaint did not result in a customer case). Currently, there is no time limitation for brokers seeking expungement of a customer complaint.
FINRA to select arbitrators from the Expungement Arbitrator Roster. Under the proposal, FINRA would establish a roster of arbitrators with additional qualifications to decide expungement requests. In addition, instead of the parties ranking arbitrators, FINRA would randomly select three arbitrators from the Expungement Arbitrator Roster.
Brokers who seek expungement outside the underlying customer case must file an expungement request under the Industry Code against the member firm. Under the proposal, if an expungement request is not decided in the underlying customer case or the broker is seeking to expunge a customer complaint that did not result in a customer case, the broker would be required to file the request under the Industry Code against the firm at which the broker was associated at the time of the events giving rise to the dispute.
Brokers required to request expungement in the underlying customer case. Under the proposal, brokers who are named as a party would be required to request expungement in the underlying customer case, and both the broker and firm would be assessed the applicable fees (and the broker would be prohibited from seeking expungement in a separate action). However, where the underlying case is closed other than by award, the broker would be required to commence a new expungement case naming the member firm.
Additional standards for recommending expungement. Under the proposal, a three-person arbitration panel must unanimously agree that expungement is appropriate (in a customer case, only a majority is required). In addition to the arbitration panel finding a basis for expungement under FINRA Rule 2080(b)(1), the proposal would also require the arbitration panel to find that the customer dispute information has “no investor protection or regulatory value.”
Expungement hearings must be in person or via videoconference. Under the proposal, brokers must participate in the expungement hearing, and the expungement hearing would be held either in person or through videoconference (at the arbitration panel’s discretion).
If the proposed changes are implemented, the results will include increased costs for brokers and member firms to seek expungement, the time period for brokers to seek expungement will be significantly reduced, and the likelihood of success will be diminished. At a minimum, member firms and associated persons will need to consider carefully whether filing a request for expungement is worth the effort (and expense).
In sum, the proposed amendments to the expungement rules contain a number of substantive changes to the expungement process, and on the whole, the proposed changes will negatively affect a broker seeking expungement. If adopted, the proposal will increase the time and expense associated with the already costly and time-consuming expungement process, which will undoubtedly result in fewer expungement requests. What’s left to be determined is whether fewer expungement requests will actually result in increased investor protection or regulatory value.
W. Preston Martin is a principal in Bressler, Amery & Ross in Birmingham, Alabama.
This article was drafted in conjunction with an ABA regional CLE workshop, “FINRA Expungement: Current Problems, Solutions, and Recent Trends,” held on February 9, 2018 in Tampa, Florida. The workshop was cosponsored by the Securities Litigation Committee and the Alternative Dispute Resolution Committee of the Section of Litigation.