On July 29, 2022, FINRA submitted to the SEC for its approval a new set of rule changes that impose stricter requirements on its process governing the expungement of customer dispute information.[1]

FINRA’s current expungement rules provide a procedural mechanism whereby associated persons and Firms can obtain a court order directing FINRA to expunge reference to a customer dispute from an Associated Person’s Central Registration Depository (CRD) record.[2] Presently, the rules provide two paths for expungement requests to be made: 1) in the context of a customer-initiated arbitration proceeding wherein an associated person may ask the arbitration panel to issue an award recommending expungement (whether after a hearing on the merits concludes or after the parties reach a settlement); or 2) through a “straight-in” request whereby an associated person files a new arbitration proceeding against the Firm seeking expungement of the Firm’s previously reported customer dispute information.

Various stakeholders have raised concerns about the effectiveness and the fairness of FINRA’s expungement process for years now. FINRA has adopted numerous rules to strengthen its expungement framework in response.[3] One of the most significant changes in recent years has been FINRA’s amendment of its expungement rules to require minimum fees for expungement requests.[4] FINRA made its minimum fees rule change in response to an expungement strategy whereby registered representatives in filing their expungement claims sought nominal damages of $1 to avoid the higher fees associated with non-monetary claims, and to also qualify for a single a single arbitrator to preside over their expungement request instead of a three-person panel that by rule presides over non-monetary claims. FINRA made the rule change to prevent registered representatives and their attorneys from dodging the fee and arbitration panel composition requirements associated with non-monetary claims. Notably, in anticipation of the implementation date of the rule in September 2020, FINRA’s expungement claim filing data showed a spike in “straight-in” expungement claims leading up to September 2020. And following implementation of the rule, FINRA filing data showed a substantial decline in “straight-in” claims.[5] The entire scenario and the filing trends shown by the data pre and post minimum fee requirement has fueled further debate about the overall integrity and effectiveness of the FINRA expungement process.

So the spirited debate about FINRA’s expungement process continues. On the one hand, investor advocates and regulators have continued to point out that the overall quantity of expungement claims and the percentage of such claims being granted by FINRA arbitration panel show that the current FINRA Rules are still not restrictive enough to curb aggressive and dubious expungement claims made by registered representatives who are “gaming” the system which by design considers expungement to be an “extraordinary remedy.”[6] On the other hand, registered representatives and expungement advocates have raised concerns that FINRA’s complaint reporting process has always perpetuated an unfair “guilty until proven innocent” disclosure system on the brokerage community and that this unfair disclosure system that has only been exacerbated by an expungement process remains far too restrictive.[7]

FINRA’s latest rule change proposals respond to these concerns and are largely premised on substantial input that has been provided by PIABA, regulators, the brokerage industry, and advocates for registered representatives seeking expungement. FINRA’s aim is to better calibrate its expungement process to provide a remedy that is “appropriate only in limited circumstances in accordance with the narrow standards in FINRA rules.”[8]

The following key changes are included in FINRA’s July 29, 2022 proposal:

A. For All Requests for Expungement of Customer Dispute Information: a. Unanimous support by panel members for the requested expungement relief. b. Notification to state securities regulators of all expungement requests. c. Requirement that associated persons appear at the expungement hearing in person or by video conference. d. Facilitation of customer attendance and participation by notifying customers of the time, date, and place of prehearing conferences and the actual expungement hearing; codifying that customers are entitled to attend and participate in prehearing. conferences and the expungement hearing and to be represented, if they choose; and providing customers with access to all relevant documents filed in the arbitration. e. Specific authorization for panel to request any documentary, testimonial, or other evidence that it deems relevant from the broker-dealer firm or associate person seeking expungement. f. Requirement that Panel provide enough detail in the award to explain its rationale for including expungement relief in the Award. g. Precluding an associated person from requesting expungement of customer dispute information if a panel previously considered the merits of, or a court previously denied, a request to expunge the same customer dispute information. h. Prohibiting an associated person who withdraws an expungement request from refiling the request at a later date, thereby preventing “arbitrator shopping.”

B. For “Straight-In” Requests: a. Imposition of strict time limits within which associated persons may request expungement – FINRA DRS would deny the DRS forum if the expungement request is made: i. More than three years after the date the customer complaint was initially reported in the CRD system; or ii. More than two years after the close of the customer-initiated arbitration or civil litigation associated with the customer dispute information b. Requirement that straight-in requests be filed under the Industry Code against the broker-dealer firm at which the associate person was associated at the time of the events given rise to the customer dispute c. Permission for authorized representative of state securities regulators to attend and participate as a non-party in prehearing conferences and the expungement hearing to the same extent as customers could attend and participate d. Requirement that all straight-in requests be decided by a three-person panel, randomly selected from a roster of experienced public arbitrators with enhanced expungement training and with no significant ties to the industry (“Special Arbitrator Roster”) e. Prohibiting parties from: 1) agreeing to fewer than three arbitrators to consider their expungement requests; 2) striking any of the selected arbitrators; 3) stipulating to an arbitrator’s removal; or 4) stipulating to the use of pre-selected arbitrators.

C. For Expungement Requests Considered During a Customer Arbitration: a. Requirement that associated person named in customer arbitration to request expungement during that customer arbitration or forfeit the opportunity to request expungement thereby ensuring that the panel which hears that full merits of a customer arbitration also reviews a related expungement request. b. Conditioning and limiting the ability of a party to a customer arbitration to request expungement during the customer arbitration on behalf of an associate person who is the subject of a customer arbitration, but unnamed, so that the associated person cannot later claim they were not aware of the prior expungement request made on their behalf.

OBSERVATIONS

The proposed changes may make the expungement process align better with FINRA’s mandate to provide reliable and accurate customer dispute information through CRD and a corresponding mechanism to remove bad data from CRD, but that outcome remains unclear. What is clear is that FINRA’s proposed rule amendments will make the process more restrictive, time consuming and expensive for all of those who seek this “extraordinary remedy.”

FINRA’s proposed rule changes respond to legitimate and reasonable requests for change that have been made by PIABA and the investing public, the regulatory community, and the securities industry. The calls for change and FINRA’s resulting rule proposal, in large part, have been a reasonable response to what many investor advocates and industry professionals believe have been and remain an unhealthy level of dubious expungement claims and litigation strategies that taint the overall process and diminish valid and meritorious expungement claims in the eyes of the public. Having observed the full spectrum of expungement requests from the mostly meritorious to the occasionally frivolous during in-person, video/zoom, and telephonic expungement hearings for well-over one decade now, it is understandable that PIABA and regulators, including FINRA, feel obliged to continue to make changes aimed at facilitating meritorious expungement claims while doing more to curb, flag, and filter out the frivolous ones.

Despite FINRA’s well-intentioned effort here, FINRA’s recently submitted expungement rule changes may not optimize FINRA’s aims of investor protection. First, while the key changes are noted by FINRA’s July 29, 2022 filing with the SEC do not highlight the change and its impact, it is worth noting that, in addition to the key changes outlined in this article, FINRA actually seeks to limit the grounds on which FINRA arbitrators may grant expungement relief strictly to those provided by FINRA Rule 2080(b)(1) (i.e., error, mistake, or falsity).[9] FINRA is doing so even though FINRA Code of Arbitration Procedure Rules 12805(c) and 13805(c) explicitly encompass the full “Rule 2080” grounds, including 2080(b)(1) and 2080(b)(2). Through its proposed rule changes, FINRA is seeking to formally invalidate what the FINRA Code of Arbitration Procedure and FINRA Rules currently permit based on the plain language of FINRA Rule 2080, viz: FINRA arbitrators (and courts) have the authority to grant expungement on equitable grounds, including without limitation the grounds listed in Rule 2080(b)(2), and are not limited to the grounds for expungement provided by Rule 2080(b)(1). The SEC has never approved what some (including SIFMA) have characterized as FINRA’s improper and erroneous limitation on the right to expungement even though FINRA has for years now instructed arbitrators to apply this incorrect and unapproved rule interpretation to actual expungement requests.[10] FINRA arbitrators have always been permitted to exercise their judgment and make decisions in accordance with applicable law and to also make decisions on equitable grounds.

FINRA’s action of invalidating this path towards expungement seems unnecessary. Under 2080(b)(2), a Panel may grant expungement only where they find the request has merit and that granting expungement would not adversely affect investor protection, CRD system integrity, or regulatory requirements. Coupling this existing requirement with the additional restrictions FINRA seeks to add to the expungement process (e.g., permission for regulatory community participation and requirement that panel provide explanation of its expungement rationale, among other changes), eliminating an expungement arbitration panel’s ability to rule on equitable grounds seems at odds with the entire arbitration ecosystem FINRA oversees. Instead of restricting a Panel’s ability to decide expungement requests, FINRA should trust its arbitrators based on their experience, their qualifications, the enhanced training FINRA provides to them on expungement that they can and will make just and reasonable decisions whether by reference to Rule 2080(b)(1) or 2080(b)(2)

Second, FINRA’s focus on eliminating industry arbitrators in favor of an all-public roster seems at odds with the goal of investor protection. For example, securities industry compliance, regulatory, and litigation professionals are often far better suited than public arbitrators to properly understand, appreciate, analyze, and directly question the dubious expungement requests that are of concern to PIABA and regulators that FINRA is seeking to minimize through its proposed rule changes. Dubious expungement requests are rightfully of concern to FINRA, PIABA, and regulators, not to mention the broker-dealers who have employed the registered representative making dubious expungement requests or who wish to avoid hiring such registered representatives and rely on CRD in part in-order to do so. Penalizing seasoned compliance and legal professionals by excluding them as potential arbitrators to preside over the expungement process strictly because they have connection with the “industry” seems to be premised on the stereotype that any arbitrator associated with the industry is going to lean in favor of granting an expungement request regardless of its merits. However, it is far more reasonable to expect that compliance and legal professionals with industry backgrounds will be best positioned to objectively assess against the backdrop of their industry experience an expungement presentation in a way that aligns with FINRA’s goals of investor protection far more than a public arbitrator with zero industry experience. Stated differently, no amount of specialized and enhanced FINRA training provided to a public arbitrator can replace the years if not the decades of professional compliance and legal expertise that many industry arbitrators bring to the expungement process presently. While FINRA’s proposal to the extent that it contemplates removing associated persons (e.g., financial advisors and branch managers) may be understandable, depriving investors, regulators, and the industry of the expertise and good judgment that seasoned compliance and industry legal professionals bring to the expungement process subverts rather than promotes FINRA’s investor protection mandate.

In summary, should FINRA’s proposed rule changes be approved, the expungement process will become more challenging and expensive for associated persons and Firms seeking expungement of customer dispute information from FINRA’s CRD system. Accordingly, for associated persons considering expungement, it may be worth seeking expungement now before the SEC approves FINRA’s proposed rule changes.