FINRA Proposes Significant Amendments to Expungement Rules

On July 29, 2022, FINRA filed a proposed rule change with the SEC seeking to modify the expungement process to address certain concerns articulated by the Public Investor Advocacy Bar Association (“PIABA”) regarding the integrity of the process. The SEC is currently soliciting comments on the proposed rule change, and if the SEC approves the proposed changes FINRA will subsequently announce when the amended rule(s) will become effective.  To the extent FINRA’s proposed amendments are adopted, it will become more difficult, and more costly, for Associated Persons to expunge customer dispute information from their CRD records. A link to the proposed rule change can be found here.

1. FINRA’s Current Expungement Process

FINRA is mandated by federal statute to collect and maintain registration information regarding its registered financial professionals (“Associated Persons”).  To satisfy this requirement, FINRA operates the Central Registration Depository (CRD) system, where its member broker-dealers report customer complaints and customer arbitrations naming or involving Associated Persons.

Under certain circumstances, Associated Persons or their broker-dealers can obtain a court order directing FINRA to expunge reference to customer dispute information from their CRDs.  There are primarily two ways for an Associated Person to seek expungement through a FINRA arbitration: a “customer-initiated” request and a “straight-in” request.   A customer-initiated request is when at the conclusion of a customer-initiated arbitration, the Associated Person, who was a party to the arbitration, asks the arbitration Panel to issue an award recommending expungement of the arbitration from the CRD system. This can be done after the Panel conducts a hearing on the merits or after the parties settle their dispute.  Alternatively, a “straight-in” request is when the Associated Person initiates a new arbitration proceeding that is separate from the customer-initiated proceeding specifically for the purpose of seeking expungement of a previously reported customer complaint.

Currently, FINRA Rule 2080 governs FINRA’s expungement process and permits arbitrators to issue an arbitration award recommending expungement if the Associated Person can establish through a recorded evidentiary hearing that: (1) the claim or allegation is factually impossible or clearly erroneous; (2) the Associated Person was not involved in the alleged conduct; or (3) the claim or allegation is false.  In cases involving settlements, arbitrators are additionally directed to review the settlement documents and consider the settlement amount and any other terms and conditions of the settlement.

To the extent an Associated Person is successful in obtaining a FINRA award recommending expungement, (s)he must then have the award confirmed in a court proceeding and provide FINRA with a court order directing it to expunge the customer dispute information – FINRA will only expunge the information upon receipt of a court order. [1]

2. Expungement Statistics

FINRA reviewed expungement proceedings from January 2016 to December 2021 and found that the success rate of expungement requests varied depending on the type of proceeding. A copy of the discussion can be found here.

3. FINRA’s Concerns About the Current Expungement Process

FINRA has identified the following concerns that primarily relate to “straight-in” expungement requests: A copy of the discussion can be found here.

• Many “straight-in” requests involve old customer disputes. Accordingly, obtaining documentation relating to the dispute becomes more challenging.  FINRA explained that approximately one-third of the straight in requests filed between 2016 and 2021 were filed within six years of the customer dispute being reported.  The other two-thirds of the straight-in requests were filed more than six years after the customer dispute was originally reported.

• Customers typically do not participate. FINRA requires Associated Persons to give notice to the customer of the expungement proceeding.  However, in “straight-in-requests” the customer typically does not participate.  Accordingly, the Panel usually only receives information from the Associated Person requesting expungement.

• The Associated Person changed broker-dealers. Often when Associated Persons file expungement requests, they name the broker-dealer they are currently registered with as a respondent to the arbitration, not the one where they were registered when they received the complaint.  Accordingly, the broker-dealer named in the arbitration may not have any relevant records. It also may have an interest in supporting the expungement to allow their Associated Persons to remove negative information from their CRD records.

• Arbitrator Shopping. Some Associated Persons are making repeated attempts to expunge the same customer dispute information.  They are filing “straight-in” requests instead of pursing expungement requests in a customer-initiated arbitration in an effort to obtain a new arbitration panel who has not heard the merits of the case.

4. Proposed Rule Change

In an effort to address these concerns, on July 29, 2022, FINRA filed a proposed rule change with the SEC seeking to impose additional requirements on expungement requests. A link to the proposed rule change can be found here.  Key proposed changes include:

For All Requests for Expungement of Customer Dispute Information:

• Requiring that the panel deciding the expungement request issue an award containing expungement relief only if the panel unanimously finds that the information to be expunged in factually impossible, clearly erroneous or false, or that the Associated Person was not involved in the alleged misconduct.

• Providing state securities regulators with notification of all expungement requests.

• Requiring the Associated Person to appear at the expungement hearing in person or by video conference.

• Facilitating customer attendance and participation by notifying customers of the time, date and place of any prehearing conferences and the 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.

• Specifically authorizing the panel to request any documentary, testimonial or other evidence that it deems relevant from the broker-dealer firm or Associated Person seeking expungement.

• Requiring that the panel provide enough detail in the award to explain its rationale for including expungement relief in the award.

• 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.

• Prohibiting an Associated Person who withdraws an expungement request from re-filing the request at a later date, thereby preventing “arbitrator shopping.”

For “Straight-in Requests”: Proposed Rule 13805:

• Imposing strict time limits within which Associated Persons may request expungement – FINRA Dispute Resolution Services (“DRS”) would deny the DRS arbitration forum if the expungement request is made:

• • More than three (3) years after the date the customer complaint was initially reported in the CRD system or

• • More than two (2) years after the close of the customer-initiated arbitration or civil litigation associated with the customer dispute information

• Requiring that straight-in requests be filed under the Industry Code against the broker-dealer firm at which the associated person was associated at the time of the events giving rise to the customer dispute.

• Permitting an 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.

• Requiring 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.

• Prohibiting the 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.

For Expungement Requests Considered During a Customer Arbitration: Proposed Rule 12805

• Requiring an Associated Person named in a customer arbitration to request expungement during that customer arbitration or forfeit the opportunity to request expungement in any subsequent proceeding, thereby ensuring that the panel that hears the full merits of a customer arbitration also reviews a related expungement request.

• Conditioning and limiting the ability of a party to a customer arbitration to request expungement during the customer arbitration on behalf of an Associated 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.

In sum, these proposed rule changes, if adopted, will make it significantly more difficult to obtain expungements before FINRA.  Accordingly, if an Associated Person is considering seeking expungement of a prior customer complaint or arbitration, s(he) should consider doing so before any rule changes are adopted.

WSS is closely monitoring the proposed rule changes and will provide an update when the SEC has ruled upon it. If you have any questions regarding the expungement process and how the proposed rule change may affect you, please contact Michael Schwartzberg, Chair of the WSS Securities Litigation and Regulatory Group, or Jessica Levine, a Partner in the Group with substantial experience in expungement matters.

[1] Associated Persons may also seek expungement by a “direct- to-court” expungement action, where the Associated Person seeks a court order directing FINRA to expunge customer dispute information without first obtaining a FINRA award.  These types of expungements are filed much less frequently with an average of just 17 per year filed between 2016 and 2021.