The latest FINRA proposal on removing client complaints from brokers' records is setting up a rulemaking debate that's likely to be long and contentious.
FINRA
The plan is raising some concerns in the industry and among attorneys who represent brokers, while drawing general praise from client advocates and state regulators.
"A number of the recommendations will improve the process," said Nicole Iannarone, an assistant professor at Drexel University's Thomas R. Kline School of Law who teaches courses on business arbitration. She noted that FINRA included many of the same items from its prior proposal and said they could have already "meaningfully reformed the system" last year.
Iannarone and others have called for FINRA to adopt further reforms than the ones in the latest plan by taking the cases out of arbitration and into an administrative process overseen by regulators. The reformists view expungement cases much differently from financial advisors and wealth managers who argue that the existing system provides brokers with the means to ensure the accuracy of disclosures on BrokerCheck and axe false allegations from their records.
"The changes proposed not only seem egregiously punitive to associated persons' ability to clear their names, they also appear to subvert the neutrality and autonomy of arbitrators' ability to determine whether the expungement criteria are met," Doc Kennedy, an attorney who represents advisors through his firm AdvisorLaw, wrote in an Aug. 9 letter to FINRA that may be the first formal comment filed to the regulator about the 300-page proposal.
What's in the proposal
FINRA's latest plan calls for appointing arbitrators from a randomly selected pool who have received bulked-up training on expungement cases, but it would add a few other major changes to the mix as well.
In one plank long sought by reformists, FINRA would bring state regulators into the expungement arbitration process in a formal way by alerting them to cases and enabling them to participate in hearings. The rule would also "impose strict time limits," like statutes of limitation, for broker expungement cases of three years after the clients' complaints appeared on BrokerCheck or two years following any decision in a related arbitration claim. In addition, it would codify best practices from FINRA's existing guidance, require arbitrators to unanimously agree to grant any expungements and mandate that at least three hear brokers' cases.
Over "many years," FINRA has been trying to "balance the interests of securities regulators in having accurate and relevant information to fulfill their regulatory responsibilities; the interests of investors in having access to accurate and meaningful information about associated persons with whom they may entrust their money; the interests of broker-dealer firms in having accurate information for use in making informed employment decisions; and the interests of the brokerage community in having a fair process to address inaccurate customer dispute information," according to the rule proposal.
"FINRA is concerned, however, that the current expungement process is not working as intended — as a remedy that is appropriate only in limited circumstances in accordance with the narrow standards in FINRA rules," the regulator said.
The reformers and the supporters of the existing system each cite statistics that explain their stances. FINRA's last new rule on expungement in September 2020 raised the price for brokers to file a claim and led to a substantial dropoff in the number of cases, according to the regulator. The supporters point out that arbitrators have only expunged 4% of the 35,000 customer complaints between 2015 and 2020.
On the other hand, the regulator's stats display the differing rates of success in cases that have the full participation of clients because they're part of a customer's arbitration case compared to the claims of brokers who file their own cases seeking expungement. The latter "straight-in" requests resulted in expungements in 84% of cases between 2016 and 2021, versus 58% in the course of clients' arbitration claims, according to figures included in the rule proposal.
Industry stakeholders
State regulators have emerged as some of the strongest critics of the current system. Alabama Securities Commissioner Joe Borg's agency filed a lawsuit in Florida state court against FINRA in a bid
NASAA is reviewing the new proposal and plans to offer its views in a comment letter to FINRA, President Melanie Senter Lubin said in an email.
"NASAA's view is, and has been, that expungement of customer complaint information is an extraordinary remedy and that, for too long, the existing expungement process has allowed expungement to happen on a routine, not extraordinary, basis," Senter Lubin, who is Maryland's securities commissioner as well, said. "Tightening the procedures surrounding expungement requests is vital to stopping the continuing threat to the integrity of records that hold critical information needed by investors to decide whom to trust with their financial investments and their financial well-being."
Brokerage firms and their industry trade groups are likely to push back against any provisions of the rule they see as limiting the ability to remove erroneous complaints from BrokerCheck. An advocacy group for independent brokerages, the Financial Services Institute, has pledged openness to some reforms in the past, with caveats. In a 2018 comment
"We support reasonable, unambiguous restrictions on the expungement of truthful, accurate information that is crucial for investor protection, but to be effective, it must also provide an avenue to remove information that is misleading, meaningless or has no regulatory or investor protection value," FSI Deputy General Counsel Robin Traxler said in a statement.
A question of timing
In certain ways, the brokerage firms' interests diverge from that of their registered representatives. The potential time restrictions in FINRA's latest proposal aren't taking into account the fact that many brokers may be unaware of client complaints for years if a case is settled prior to arbitration or if they retire or go to a new firm, according to Jenice Malecki, an attorney who represents advisors in expungement cases. A statute of limitations could take away the right to seek expungement from some brokers that way, she said.
"People who may leave the industry are not necessarily looking at BrokerCheck daily, weekly or monthly and do not think about updating their address with a registration system or former employer that they are no longer a part of," Malecki said. "The 'reach out' to brokers is abysmal. The firms want to do what they want to do, having little incentive to notify brokers in cases where brokers are no longer at the firm."
For the reformers, though, that time cutoff will end practices such as brokers repeatedly trying to remove the same complaint repeatedly or seeking it so far down the road that it won't be possible to locate any living clients who may wish to weigh in on the expungement. Other provisions are "codifying what's currently just guidance" about the degree that clients need to receive notice and participate in hearings, according to Christine Lazaro, the director of the Securities Arbitration Clinic at the St. John's University School of Law. "When it's in the rules, it's easier for arbitrators and parties to find," she said.
Next steps
Other reformers applauded the new proposal, too, with some reservations. The proposal "addresses some of the problems," but doesn't resolve "the big problem, which is whether expungement belongs in arbitration," said Michael Edmiston, an attorney with Jonathan W. Evans & Associates and the current president of the client lawyer organization the Public Investors Advocate Bar Association.
"Long term, it is a regulatory issue that should be addressed on the regulatory side, not on the arbitration side," he said. "I certainly support this as good, incremental steps going forward to remove some of the existing abuses in the process, but everyone, including FINRA in its white paper earlier this year, recognizes that there's more work to be done."
Advisors can play a direct role in those efforts by making their views known to FINRA as it considers the public comment on the
FINRA has "just created way too many complexities and nuances," for expungement, Kennedy said. "They've tried to make it so cumbersome in an effort to discourage it. I think they should be doing the opposite in making it more simple and reliable."
