FINRA recently published a “Discussion Paper” on expungement of customer dispute information in which it outlines its plans going forward on revising the expungement process. Expungement_Discussion_Paper.pdf (finra.org) (Let me just start by applauding FINRA for trying hard to get this right. The current patchwork of expungement rules and guidance could use some improvements, and there are no easy answers – although I’ll provide some ideas at the end of this post.)
The upshot of the Discussion Paper is that FINRA is contemplating dual paths: (1) in the short term, revising and resubmitting some of its proposed rule changes that it withdrew from the SEC’s consideration back in May 2021, and (2) in the long term, creating an administrative process where FINRA or state regulators make expungement decisions, which would replace the current system of seeking expungement in arbitration. Let’s discuss.
As some of you may recall, FINRA published many proposed changes to the expungement process in Reg Notice 17-42, all the way back in 2017. After several rounds of comments, FINRA submitted those changes to the SEC, only to withdraw them in May 2021. That withdrawal occurred after PIABA (a trade group that works to protect investors) released a study and commentary where it argued expungement is granted too frequently and the proposed rule changes wouldn’t do enough to fix the system. The SEC also apparently had some concerns about at least one part of the proposed changes – the Special Roster Proposal. The Special Roster Proposal is exactly what it sounds like – a proposal to appoint arbitrators in expungement cases from a “special roster” of arbitrators who have been specifically trained by FINRA to handle expungement hearings.
The SEC’s concerns about the Special Roster Proposal haven’t been publicly discussed – yet. We will know soon enough because the Discussion Paper states that FINRA intends to continue pursuing approval of the Special Roster Proposal in some modified format that addresses the SEC’s concerns.
Let me just do a little speculating here as to what I think one concern might be: the Special Roster Proposal may result in appointing arbitrators who do not appear neutral. Traditionally, arbitrators are neutral triers of fact, just like judges and juries. The idea that arbitrators are supposed to be neutral is so fundamental to the arbitration process that one of the few bases for vacating an arbitration award is if an arbitrator demonstrated “evident partiality.” 9 U.S.C. § 10. The Special Roster Proposal included enhanced expungement training for the arbitrators on the roster regarding how to handle an expungement case and the actions they should take to ensure the customer’s side of the story is told, even if the customer does not participate.
This stems from FINRA attempting to correct the problem that most customers do not show up to participate in expungement hearings, so arbitrators might hear only one side of the story. The Special Roster Proposal would specifically authorize these specially trained expungement arbitrators to request documentary, testimonial, and other evidence they deem relevant to the deciding the claim. It almost deputizes the arbitrators to act as representatives of the customers.
When you combine these three aspects of the Special Roster Proposal (enhanced training from FINRA plus appointment by FINRA plus authorization to investigate evidence that might rebut the expungement request), you can start to see how an argument could be made that these arbitrators might be less than neutral. That could set up a decent argument to vacate any expungement request that gets denied.
I believe this concern that the Special Roster Proposal might destroy arbitrators’ appearance of impartiality is precisely the reason that FINRA is now suggesting it may attempt to create a new “administrative process” where FINRA and or state regulators decide expungement requests, rather than arbitrators. The Discussion Paper acknowledges that redesigning the expungement process altogether will take substantial time, but it is now something it is seriously considering as a way to fix “problems” with the current process. The main “problem,” of course, is that FINRA believes too many expungements are being filed and are being granted by arbitrators who are not seeing both sides of the story because customers chose not to participate in expungement hearings.
But will designing some kind of administrative proceeding where FINRA or the state regulators decide what to expunge really going to solve that problem? It may make it more difficult for registered reps to obtain expungement, but it won’t do anything to encourage customers to participate in the hearings. It also seems a little circular to have FINRA / state regulators deciding what must be disclosed in the first place, and then having those same institutions deciding what may be expunged. One winner in this situation might be broker-dealers who are often named in expungement arbitrations – and assessed large processing fees – even though they are not being accused of doing anything wrong and may choose not even to participate in the hearing. I’m sure they would be happy to be removed from the expungement process altogether since they are required to report customer complaints regardless of their accuracy or merit.
To be clear, the Discussion Paper states that this is just the beginning of the discussion on these issues, and FINRA invites a dialogue on many questions it raises in the Discussion Paper. Here are some of my own ideas about revising the expungement process that may be more impactful than simply creating a special “administrative proceeding” or using specialized arbitrators to hear expungement cases.
- Reduce the number of items being disclosed. This is not as controversial as it sounds. Just hear me out. Footnote 1 of the Discussion Paper acknowledges that FINRA makes public more information about its registered reps than is available for insurance agents, bankers, doctors, lawyers, and accountants. If regulators are concerned about the number of expungements taking place, we need to examine WHY they are happening. This is a situation where we know the egg definitely came before the chicken. What do I mean? The Discussion Paper acknowledges that changes in 2009 to a registered reps’ U4/U5 reporting requirements led to an increase in number of customer disputes being reported – and in a number of expungements being sought. The Discussion Paper also acknowledges that broker-dealers must report customer complaints even if they believe the allegations are “untrue, inaccurate or malicious.” That’s sort of the problem. If the goal of the CRD/BrokerCheck system is to maintain a record of “accurate” and “meaningful” information, as the Discussion Paper suggests, it seems contrary to that goal to require every little complaint to be disclosed, regardless of merit, and then sort it out later. Even if a completely erroneous complaint is expunged, it is still likely to remain on the broker’s BrokerCheck for the 9 to 12 months it takes to go through the expungement hearing and confirm it in court. That means the current system is perpetuating the publication of erroneous or inaccurate information until it can be expunged. That seems contrary to the goal of true and accurate reporting.
Instead of shooting first and asking questions later, maybe it should be the other way around. What if the rules simply worked like this:
- If an FC/BD loses an arbitration, it is reported.
- If an FC/BD wins an arbitration, it is not reported. They’ve already had a trier of fact decide the claim was meritless, so why require an additional expungement hearing? This change may have the benefit of encouraging FCs/BDs to go to a hearing more often.
- If a customer withdraws a complaint without receiving compensation, it is not reported.
- If a customer complains (but does not file an arbitration or lawsuit), and the BD denies the complaint, it is not reported.
- If an FC/BD settles a complaint, it is NOT reported unless it is (a) over a certain dollar amount, AND (b) a regulator takes some action with regard to the complaint. This one is obviously where the bulk of complaints fall. Currently, settled complaints must be reported if they are over a certain dollar amount. But just because a complaint is settled does not mean it had merit. Cases often settle because it is simply cheaper than funding litigation. Settlement by itself shouldn’t warrant a disclosure. Instead, maybe a settled complaint should only be reported if a regulator takes some formal action. FCs/BDs often receive exam inquiries from FINRA or other regulators after they get wind of a customer complaint. The regulators then gather info and decide if they want to take action. This is already occurring. Regulators are already assessing these customer complaints. If they decide to take further action by filing a Complaint or seeking a settlement with the FC/BD, then it should be reported. But if a regulator looks at a customer complaint that has settled and decides not to take any action, perhaps that suggests the complaint had no merit and should not be reported. The benefit of this method, from FINRA’s view, is that FINRA would ultimately be the one holding the keys to the castle – which seems to be what it wants. Instead of having FINRA decide what disclosures should be removed in an expungement administrative hearing, why not have FINRA decide which complaints should be disclosed in the first place, based on their examination findings? After all, if FINRA examiners decide the complaint doesn’t warrant any formal action, is it really something the public needs to know about?
- Give customers a financial incentive to participate in expungements. It seems that the biggest issue FINRA is trying to tackle with current expungement arbitrations is that the complaining customers do not participate, so the arbitrators only hear one side of the story. But customers have no incentive to participate. Occasionally, those who are truly disgruntled write an angry letter or show up to testify against the expungement. But that is rare. If customers had an incentive for participating, they might be more apt to do so. The best incentive is cold hard cash. Again, hear me out. I’m not talking about paying someone to give favorable testimony (although if that seems offensive to you, you should know it happens every day with expert witnesses). I am talking about telling customers who have already filed an arbitration and already paid a filing fee, “I know your case settled, but the broker is seeking expungement, so if you would tell your side of the story at the expungement hearing, we will give you back $____ of your filing fee.” In small cases, the filing fees are pretty low – as low as $50. But most claims of any decent size have a filing fee of $1,000 or more. Part of it could be set aside for this purpose. Or, FINRA could just tack on a refundable expungement fee when the customer files the arbitration. Let’s say it’s an additional $1,000 fee. If the customer settles, maybe give the broker six months to seek expungement. If the broker doesn’t seek expungement, the customer gets the expungement fee back. If the broker does seek expungement, the customer only gets the fee back if he/she submits a written statement or testifies at the expungement hearing. This could be implemented in the current arbitration expungement process or in a new administrative proceeding process that FINRA designs. This doesn’t work so well when the disclosure is simply a complaint that does not result in filing an arbitration or lawsuit. But should that really be disclosable anyway?