I apologize for the long break between blog posts, but I have been preparing for a two-week FINRA Enforcement hearing…to be conducted by Zoom! As is typical of most Enforcement cases that go to hearing, the Staff has insisted that — surprise! — my clients be permanently barred. So, while the method of communication will be different, the rest will, it seems, sound rather familiar. I will let you know how it goes. The good news, however, is that Chris has stepped up big time with this post about FINRA’s efforts to render expungement not just “extraordinary,” but stupidly difficult to obtain even on a procedural basis. Just ask yourselves: who is behind this? Not brokers. Not BDs. Not complaining customers, because they could care less about expungement. The answer, of course, is PIABA, which once again has FINRA doing its bidding. Ugh. – Alan
The year 2020 has given us yet another reason to utter the phrase, “I remember the good old days.” About two weeks ago, FINRA finally submitted sweeping and significant proposed rule changes to the SEC that, once approved in the next few months, will make it much, much harder to expunge customer dispute disclosures. [If you want to jump straight to the bad news, and ignore the background and the mildly good news, skip the next two paragraphs.]
As regular readers of this blog already know, FINRA’s Code of Arbitration Procedure has long provided a method for registered representatives to seek to expunge, or remove, disclosures related to customer complaints from their permanent CRD records (and their publicly available profiles on BrokerCheck.com). Over the past several years, various groups who purportedly advocate to protect investors from bad brokers have regularly complained to FINRA that it is too easy for brokers to obtain expungement.
Back in December 2017, FINRA issued Regulatory Notice 17-42, which proposed sweeping changes to the expungement process, nearly all of which were aimed at making it more difficult for brokers to obtain expungement. Those proposed changes were so dramatic, and met with so much commentary from industry members, that it took FINRA three years to iron out the kinks, and thankfully, walk back some of its initial proposed changes (like requiring expungement awards to be unanimous from three-person arbitration panels, rather than just by a majority decision).
On September 14, 2020, FINRA’s first round of changes took effect, as set forth in Regulatory Notice 20-25. That change solely impacted the costs associated with making an expungement request. As I explained in my prior blog post, those changes caused the FINRA fees for expungement requests to jump from approximately $300 to $9,475 as a result of FINRA closing a loophole in its rules. Almost immediately after that change took effect, on September 22, 2020 FINRA filed a 557-page document with the SEC containing its much broader and much more comprehensive proposed changes to its expungement rules.
To be clear, FINRA’s decision to draft additional expungement rules was long overdue and a welcome sight for many people, like myself, who spend a lot of time helping brokers clean up their records from false and erroneous claims made against them. For many years, FINRA only had two paltry rules regarding expungement (Rules 2080 and 12805 / 13805); but, FINRA also maintained dozens of uncodified “rules” governing the expungement process that were only discernable to anyone willing to wade through a patchwork of FINRA arbitrator training materials and arbitrator “guidance,” none of which were actual rules. So, the decision to actually put all of these “rules” in one place is a helpful and welcome change.
The problem with the proposed rules, however, is that they make significant changes to the expungement process that will make it much harder to obtain expungement. There are two major changes that FINRA unabashedly admits will significantly limit the number of successful expungement requests made. First, the new rules apply a much stricter time limitation on expungement requests. Currently, the only limitation regarding when a broker can make an expungement request is FINRA’s eligibility rule (12206/13206), which states that no claim shall be eligible for arbitration if the occurrence or event that gave rise to the claim occurred more than six years ago.
Basically, if the disclosure at issue was made more than six years ago, this rule might bar your expungement request. I say “might” because up until recently, this rule was treated like any other defense – if the other side didn’t raise it, which they usually didn’t because expungement requests are often unopposed, then it would never rear its head. In fact, I have successfully expunged several disclosures that were over a decade old because they were unopposed and there was nobody on the other side of the table to argue that the expungement requests were filed too late. But recently, FINRA began instructing arbitrators that they can and should raise the eligibility rule on their own, sua sponte, and deny requests based on the application of that rule. This stems from a court ruling in Nevada that FINRA likes to cite which said arbitrators could do this: Horst v. FINRA A-18-777960-C (Dist. Ct. Nevada Oct 25, 2018). Importantly, however, the question of whether a claim ran afoul of the eligibility rule was always one for the Panel to decide, as the Supreme Court famously held in Howsam v Dean Witter, 537 US 79, 85-86 (2002). The upshot is that some arbitrators might apply the eligibility rule, and some might not.
FINRA’s proposed rule not only significantly shortens the time period available for filing expungement requests after a disclosure is made on a broker’s CRD record, but it also changes who decides that too much time has passed before the request was made. Under the proposed rules, a broker will have only two years from the time a customer arbitration/lawsuit ends to file an arbitration seeking expungement (or six years from the date of the disclosure, if the disclosure relates to a customer complaint that never materialized into an arbitration or lawsuit). Now, the proposed rule is a little more nuanced than that because brokers who are named as defendants in an arbitration / lawsuit will actually be required to request expungement in that customer’s case, and will only be permitted to file a separate arbitration to address the expungement issue (called a “straight-in” request by FINRA) if that customer’s case settles. But that is a much more detailed discussion for another day. The upshot of the proposed change, from a practical standpoint, is that brokers will have to request expungement of a customer complaint without waiting very long, or they will be forbidden from ever asking to have it expunged. And, once these changes are approved and take effect, there will be a short grace period, but after that, any old disclosures won’t be eligible for expungement.
More troubling than the shortened window for seeking expungement relief is the fact that the Director – not the arbitrators – will be deciding if the expungement request has been filed too late. According to FINRA’s proposal (p. 48), “The Director would also deny the forum with prejudice if an expungement request is ineligible under the proposed time limitation.” FINRA must have realized that arbitrators were not always following FINRA’s guidance to apply the eligibility rule, so FINRA took matters into its own hands and declared that it would take away the arbitrator’s authority to apply the timing rules and give itself the ultimate decision-making power to reject untimely filed expungement requests.
It is not at all clear why FINRA thinks it can grant itself this power, when the United States Supreme Court expressly stated “we find that the applicability of the NASD [nka FINRA] time limit rule is a matter presumptively for the arbitrator.” Howsam, 537 US at 85. Indeed, FINRA arbitrators – not the FINRA Director of Dispute Resolution – have always decided whether claims, including expungement claims, are timely filed. The proposed rule marks a huge shift in policy that takes this important decision away from arbitrators – who are neutral – and puts it in the hands of FINRA staff who are clearly predisposed against expungement.
FINRA flat out admits that it goal for these new time limitations is to dramatically decrease the number of expungement requests filed. According to FINRA’s proposal, approximately 75% of expungements filed between 2016 and 2019 would not have been permitted under the new proposed rules because they were filed either more than two years after the customer arbitration ended or more than six years after the customer complained without filing arbitration. While I understand that eligibility rules, statutes of limitation, and other rules imposing time limits on claims exist for a reason (i.e., because memories fade and documents get lost as years pass), in the case of expungement, this represents backwards thinking. Rather than disallowing expungement of old claims, wouldn’t it make more sense to allow expungement of really old customer complaints because they happened so long ago that they are not necessarily representative of a broker’s current character (particularly if the broker had a clean record for the past several years)? Under FINRA’s proposed rule, a broker with one complaint from 30 years ago would not be eligible to seek expungement of that complaint, while a broker with five complaints within the past two years would be permitted to seek to have them expunged. That makes no sense.
 For instance, did you know that customers who are not named parties in expungement arbitrations can actually show up at the arbitration, bring an attorney, make an opening statement, and present evidence opposing the expungement request, even though they are not a party? If you looked at the current FINRA rules 2080, 12805, and 13805, you would never know that. But, if you wade through dozens of pages of arbitrator training materials, you would learn that is exactly what FINRA allows. Now, the new proposed rules actually spell this, and many other nuances of the expungement process, in fairly well-written fashion.
 As a disclaimer, the goal here is not to explain all of the changes contained in FINRA’s 557-page submission to the SEC. I’ll save that post for when the SEC actually approves the changes and FINRA releases another Regulatory Notice.