Thursday, May 20, 2021
PIABA and the PIABA Foundation recently released a new study on stockbroker expungements within the FINRA forum. Their review of arbitration awards finds that FINRA's arbitrators continue to recommend expungement around 90% of the time. This doesn't surprise me. The entire system seems fundamentally broken and these expungement requests almost never receive any real scrutiny because there are no adversaries for most expungement requests.
FINRA has a pending proposal with the SEC which will make some changes to the process. It'll increase the number of arbitrators hearing these cases, eliminate the ability of parties to rank and strike arbitrators (which may reduce selection effects toward arbitrators who simply grant expungements), and create more procedural rights for non-party customers to participate in the hearings. I've commented on the proposal twice and FINRA has amended it twice.
There are different ways to look at this. One way is that the process is gradually getting better. There is some truth to this. The changes will make the panels a bit more balanced and may make it easier for non-party customers to participate in these hearings. That being said, many of the FINRA rules specify that "parties" have particular rights in these proceedings. What rights non-parties have will always be contested. Consider one problem we recently ran into. I took a team of UNLV Law students and opposed two different expungement requests on behalf of non-party customers last semester. The second case involved a widow who had lost hundreds of thousands of dollars over a decade ago. About a decade ago and shortly after her husband died, the case settled for hundreds of thousands.
In 2020, the stockbroker sought to expunge several customer disputes. The broker’s counsel transmitted notice to the widow roughly thirty days before the scheduled hearing. The widow was disturbed by the allegations that she and her late husband had made false claims. Although she did not desire to subject herself to a demeaning hearing where she and her late husband would be called liars, she asked the Clinic to appear on her behalf and contest the expungement. We made two main arguments: (i) the matter wasn't eligible for arbitration because of how much time had passed; and (ii) that the customer dispute information was accurate and did not merit expungement.
The eligibility argument is straightforward. FINRA Rule 13206 provides that “No claim shall be eligible for submission to arbitration under the Code where six years have elapsed from the occurrence or event giving rise to the claim.” If you measure the "occurrence" from the underlying settlement date, it seemingly falls well outside of FINRA’s eligibility period. Counsel for the broker argued that the panel should not take any notice of the widow's eligibility-period argument because FINRA rules only specify that “Parties” may make motions to dismiss.
This brings me back to the pending FINRA rule proposal. The changes will likely do some good, but anytime the existing FINRA rules speak in terms of "parties," stockbrokers will argue that non-party customers should not be able to make use of those rules. Although the process may improve to a degree if the SEC approves the proposal, these sorts of gaps and barriers will remain because the non-party customers are not parties.
In reality, these are not ordinary disputes between parties. These arbitrations are really about non-parties to the dispute: (i) whether the non-party customers made a "false" claim; (ii) FINRA's requirements that firms impose heightened supervision on brokers with strings of complaints; (iii) state regulators keeping a closer eye on brokers with histories of problems; (iv) potential future customers avoiding brokers with a history of problems; and, (v) cleaning up a broker's record because past customer disputes may be taken into account in another pending arbitration. Purging these records is really about taking information away from non-parties.
The other way to look at the proposal is that it just won't alter the fundamental problems with the process. The arbitrators deciding these cases are not making well-informed decisions because there is little incentive for anyone to provide them with information opposing granting expungement. Even with the changes, there isn't a good reason to believe that the arbitrators will make well-informed decisions here. Although it will be easier for customers to participate should they want to do so, the pending changes don't create any reason why non-party customers would want to subject themselves to the process. Unsurprisingly, they have not participated. We shouldn't expect them to participate in the future.