Thursday, September 24, 2020

FINRA Proposal to Update Expungement Rules

FINRA recently filed a rule proposal with the SEC to alter, yet again, it's rules for facilitating the deletion of customer complaint information from the Central Registration Depository database.  The proposal will likely do some good, but doesn't seem to meaningfully increase the likelihood that this adversarial process will reliably surface relevant information.  Still, FINRA contends that the changes aim to "place an arbitrator or panel in a better position to determine whether to recommend expungement of customer dispute information, and thereby help ensure the accuracy of the customer dispute information contained in the CRD system and displayed through BrokerCheck."  The raft of proposed changes effectively concede that for years the current system has not ensured that arbitrators were well-situated to decide these expungement claims.

For the most part, the proposal codifies existing guidance, adds some time limits, and aims to address other known issues.  For example, a broker would not be able to request expungement if "more than six years have elapsed since the date that the customer complaint was initially reported to the CRD system" or more than two years after the close of an arbitration filing.  The proposal also bars "straight-in" expungement requests against customers--something that only rarely occurs.  Although it doesn't seem to set out the form of notice a broker must use to tell a customer they will be calling them a liar in an expungement hearing, it does require the broker to give the panel a copy of the notice sent to the customer.  

Notably, the proposal also tackles the current lopsided selection effect for arbitrators who grant expungements.  The new proposal just gives the parties in a straight-in expungement request three random arbitrators. This is how the proposal describes the change, "to minimize the potential for party influence in the arbitrator selection process, the proposed rule change would require NLSS randomly to select the three public chairpersons from the Special Arbitrator Roster to decide an expungement request filed by an associated person."  This is a meaningful improvement from the current system which allows only named parties to rank and strike arbitrators--likely skewing the selection process in favor of the most reliable rubber stamps.

Collectively, the proposed changes seem likely to do some good.  Yet they all seem to mostly nibble around the edges of the problem.  The proposal doesn't solve the major incentive mismatch.  Customers have no real reason to burn their resources (likely already depleted because of an investment loss) to oppose an expungement request.  The customers have nothing to gain.  They have no real reason to make sure that a panel receives a complete briefing on the relevant facts and issues.  In contrast, the broker and respondent (which is often the broker's employer) do have real reasons to want to get the request granted.  The proposed changes may take away some of the thumbs currently on the scales, but they don't seem likely to reliably produce informed decisions by the arbitrators considering these requests.

Assuming this goes into effect, my prediction is that grant rates for expungements probably will not substantially change.  Absent some other factor influencing the process, I doubt customers will participate in much greater percentages than they now do.

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