Expungement Under FINRA’s Rules: Why is it Granted?

By Dylan Donley, Spring 2014 Graduate Research Assistant

Last week, we discussed how often expungements are granted. As the PIABA expungement study noted, the SEC and FINRA maintain that the open and transparent disclosure of information relating to the histories of brokers and broker-dealers is of critical importance for investors and regulators alike. While the SEC and FINRA intended to have expungement relief be granted only as an extraordinary remedy to protect investors and provide necessary information to regulators, that may not be how it has played out in practice.  Why is that the case?

The PIABA study noted a number of factors that may have attributed to this result.

(1) The training required by FINRA for arbitrators to be able to rule upon expungement motions is limited. Under the procedures of FINRA at the time of the study, the required training for arbitrators to be able to rule upon expungement motions consisted of an online training course that takes approximately one hour, and a test that arbitrators must pass concerning the materials described in the online training course. According to FINRA’s website, the training explains “the role of CRD, provides an overview of the expungement process and gives an in-depth review of FINRA Rule 2080 and Code of Arbitration Procedure Rules 12805 and 13805 to ensure that arbitrators follow all procedural requirements before ordering expungement of a broker’s CRD record.” In order to pass the exam, arbitrators must answer eight out of 10 true/false questions correctly.

(2) The PIABA study opined that arbitrators do not appreciate the importance of the disclosure of information in the CRD system for investor protection on the basis that arbitrators were not applying FINRA Rules 2080 and 12805 to make expungement relief an extraordinary remedy despite FINRA and the SEC’s repeated statements that it should be, especially where the cases are resolved by settlement.

(3) Brokers and their counsel demanding or requesting as part of settlement negotiations that investors and their counsel agree to either expungement relief or agree not to oppose expungement relief is problematic.

How do we fix this issue?

In order to resolve the issues identified, the PIABA study included a number of recommendations:

(1) Proposed FINRA rule changes with respect to bargaining in settlement negotiations or conditions of settlement upon investor agreements to not oppose expungement or to agree to expungement.

(2) Proposed FINRA rule changes with respect to the procedures applicable to expungement motions, such as mandating FINRA use its authority to review expungement requests to ensure that the remedy is being treated as an extraordinary one. The PIABA study indicated that FINRA needed to play a more active role in the arbitrators’ rulings on expungement motions by reviewing and critically assessing all motions for expungement relief, rather than only becoming a part of the expungement proceedings when the broker or brokerage firm files an action in court seeking confirmation of an arbitration award granting expungement relief. Further, the study suggests that FINRA needs to review and critically assess settlement agreements arising out of FINRA arbitration proceedings, including requiring brokers to provide FINRA with the settlement agreement along with the expungement motion. The study also proposed a rule change that would require that any hearing on expungement motions be scheduled no sooner than 60 days after service of the motion on the investor and FINRA (so they have sufficient time to assess the motion).

(3) Proposed FINRA rule change making it a violation of FINRA Rule 2010 for brokers to negotiate for investors bringing the claims to agree to not oppose expungement relief, agree to expungement relief, or withdraw their claims against the broker or broker-dealer. FINRA Rule 2010 sets the commercial standards of conduct for brokers: “A member, in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.”

(4) Improved arbitrator training relating to expungement relief which would emphasize the “integrity of the disclosure information on the CRD system,” as well as ensuring arbitrators understood the necessary inquiry to make during expungement hearings. The necessary inquiry would include the following: (1) asking a broker whether he or she has other customer complaints pending, and if so, the number; (2) examining the broker’s CRD; (3) inquiring of the broker whether he or she is or has been the subject of any regulatory proceedings and if so, the outcome; (4) inquiring whether the broker has previously requested expungement relief and if so, the number of times it was granted or denied; and (5) inquiring whether in the settlement with the claimant having the claimant agree to not oppose expungement, agree to expungement relief, or withdraw his or her claim against the associated person was bargained for or required.

In sum, as the author of the PIABA expungement study Attorney Scott Ilgenfritz noted, “[t]o say that ‘expungement’ of customer claims from broker records is a major investor protection problem is an understatement. The result is that investors who are diligent enough to seek out information about brokers may be getting a woefully incomplete picture of the individual to whom they will entrust all or most of their nest egg… This clearly indicates that the current expungement procedures are seriously flawed.” This study served as a call to arms to regulators, including FINRA, to “step in and crack down on the granting of expungements, particularly in settled cases.” The PIABA study also provided recommendations that FINRA has taken to heart, as seen in its Notice to Arbitrators and Parties on Expanded Expungement Guidance. Be sure to check back in next week to learn about FINRA’s response to PIABA’s study.