Thursday, August 4, 2022

New FINRA Expungement Proposal

FINRA has returned to the SEC with a new proposed rule change to address problems with its expungement system.  Although the proposal continues to use arbitration to facilitate stockbroker expungements, the new proposal makes some significant changes over prior proposals.

A bit of history may help put this in context.  Two years ago, FINRA released a proposal to reform its expungement process. I wrote two comment letters in response to that proposal, prompting FINRA to amend the proposal twice.   The twice-revised proposal was ultimately withdrawn so FINRA could study the issue before returning with another proposal.  That new proposal is now here.  I put together this chart to track some of my recommendations to see what has been adopted and what has not.

Changes to FINRA Expungement Proposal Over Time

Edwards’ Request

Initial Rulemaking

2022 Rulemaking

Abandon Arbitration-facilitated expungement

Denied

Denied

Allow Non-Party Investor Advocate  Participation

Denied

Accepted

Require Expanded Duties of Candor

 

Denied

Denied

Improve Customer Notice

Accepted

Accepted

Provide Non-Party Customers With Full Pleadings

Accepted

Accepted

Specify Attorney Fees For Successful Opposition

Denied

Denied

Allow Non-Party Customers to Access Docket Online

Accepted

Accepted

Allow Non-Party Customers to Participate in Scheduling Decisions

Accepted

Accepted

Provide Notice After Filing, Not Initial Hearing

Accepted

Accepted

Create a Time Period for Customer Notice

Accepted

Accepted

Separate Expungement Arbitrators from Ordinary Arbitrators

Denied

Denied

Specify Some Standard of Proof

Denied

Denied

Require Unanimous Expungement Awards

Denied

Accepted

The new proposal includes a major change to the process, a pathway for state regulators or their representatives to appear at the fact-finding stage.  FINRA explains the change as follows:

The current expungement process does not include a mechanism to facilitate state securities regulator involvement in expungement hearings in the DRS arbitration forum. The proposed rule change would provide a mechanism for an authorized representative to provide the state securities regulators’ position or positions on an expungement request in writing or by attending and participating in the expungement hearing in person or by video conference. This attendance and participation by an authorized representative of the state securities regulators would be limited to straight-in requests, where the panel may otherwise only hear evidence from the party requesting expungement.

This is undoubtedly a big step in the right direction.  Expungements effectively wipe a state securities regulator's memory.  By deleting information from the CRD, it removes information from the regulator's files.  State securities regulators should be able to appear at the key stage to advocate for their interests.  It's difficult to target your oversight toward brokerages with the most customer complaints if the customer complaints keep getting expunged.

My immediate concern is that I do not see a good reason for limiting this simply to straight-in requests.  Most customer cases settle.  After that, customers and their counsel have little interest in providing the panel with information.  Functionally, the only evidentiary hearing in many matters will be the expungement hearing tacked on to a settled matter.  Even within the proposal, FINRA itself has recognized that expungement hearings in settled cases are in a similar posture to straight-in requests.   It explained that although most concerns have been focused on straight-in requests, "[s]ome of these concerns, however, also apply to expungement requests filed in customer arbitrations that settle, where the panel from the customer arbitration then holds a hearing to consider the expungement request."  Given the similarity, it doesn't seem appropriate to limit state regulators to only straight-in requests.

FINRA has a tough job here to balance competing interests.  It aims to provide a way for stockbrokers to challenge complaints on their record. It also has an obligation to ensure the integrity of the CRD database.  These changes will likely result in more informed decisions by arbitrators.  Of course, given the incentive structure favoring customer apathy and broker participation, the system will likely continue to grant far too many expungements.  But it's a step in a better direction for now.

https://lawprofessors.typepad.com/business_law/2022/08/new-finra-expungement-proposal.html

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