Thursday, January 21, 2021
Amid the transition, the SEC continues to oversee rulemaking on expungement. I gave some initial thoughts in my last post before putting another comment letter together. FINRA does deserve some real credit for attempting to improve the process. Still, you shouldn't have much confidence in the overall system because it's not built in a way that is likely to surface relevant information for the arbitrators making the only meaningful decisions in the process. Today, if you find out a broker had an expungement, all you really know is that the broker is three times as dangerous to you as the average broker. You should probably just avoid doing business with the broker. It's hard to see how winning expungements in the current system would cause rational and well-informed investors to trust a broker if they knew about the expungement.
Under the current rules and the Amended Proposal, arbitrators will continue to apply inconsistent evidentiary standards before recommending expungements. My initial letter showcased an arbitrator using a preponderance standard. This second one presented another one who concluded that something more than a preponderance standard must apply. Despite the inconsistent standards already being applied within its forum, FINRA has declined to articulate a standard of proof for expungement matters. Which arbitrator had it right? FINRA has so far declined to answer the question.
Admittedly, this isn't something you'd ordinarily define for arbitrators. For regular civil matters, the parties should simply brief the arbitrators on it and the arbitrators should decide. But expungements are not ordinary civil matters and these decisions affect people who never agreed to be bound by any submission agreement. It strips information from other investors, state regulators, the SEC, and even FINRA. Besides, the parties to straight-in expungements usually all benefit from an expungement recommendation. Don't expect them to encourage arbitrators to apply rigorous standards. Consider the recent high-risk broker rule. Identifying high-risk brokers requires data.
There is also an interesting statutory angle for a possible challenge to the system. The statute requiring registered securities associations (today, FINRA) to make information available to the public also contains some interesting language. It says that FINRA "shall adopt rules establishing an administrative process for disputing the accuracy of information provided in response to inquiries under this subsection in consultation with any registered national securities exchange providing information pursuant to paragraph (1)(B)(ii)." (15 U.S.C.A. § 78o-3(i)(3))
Does the current arbitration-process qualify as an "administrative process" for disputing information? I don't think that it does. But how to read this language ultimately depends on how you define "administrative process" and I haven't found any guidance in the statute. I suggested that the SEC should hold a hearing on the Amended Proposal, something it doesn't do all that often, to gather more information.