FINRA revives expungement proposal that died after pushback

After FINRA’s withdrawal of a broker expungement arbitration reform proposal, the regulator is now suggesting a “two-track approach” that includes the SEC adopting the tabled rule.

The reform proposal would have set up a specific roster of arbitrators selected at random to handle cases filed by financial advisors seeking expungement of client complaints, as well as giving more notice to state regulators about each proceeding. While critics of the existing system such as the North American State Securities Administrators Association and the Public Investors Advocate Bar Association Foundation praised certain aspects of the proposal, their qualms and the regulator’s talks with the SEC led FINRA to “temporarily” pull it back last May.

“FINRA’s Board of Governors continues to consider further changes to enhance the Special Roster Proposal. FINRA continues to believe it is important to pursue a two-track approach to improving the expungement process,” according to the regulator’s April 2022 discussion paper. “Moving forward with the Special Roster Proposal in the near term need not delay work that can be undertaken concurrently on developing additional enhancements to the current expungement process, or more fundamental alternatives to that process, with a view to better achieving in the long run the relevant policy goals in this space.”

FINRA CEO Robert Cook has pledged to work with the SEC, NASAA and other stakeholders on further changes to the rule, although the regulator’s public rhetoric and the lengthy white paper leave out the topic of cases involving claims of defamation against brokerage firms. 

FINRA’s September 2020 change boosting the cost of filing an expungement claim has significantly pushed down the number of “straight-in” claims by brokers seeking only the removal of client complaints. Still, out of 5,365 such cases resulting in awards between January 2016 and December 2021, at least 4,500, or 84%, approved expungement, according to FINRA.

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Critics view that rate as far too high for client complaints that often came more than a half dozen years before the brokers filed their cases and have resulted in substantial settlements of hundreds of thousands of dollars for the customers in some instances. PIABA and NASAA are calling for expungement cases to be turned into an “adversarial” proceeding with greater involvement from the clients who made the complaints and the regulators tasked with maintaining the Central Registration Depository tracking misconduct in the industry.

As it stands now, brokers are gaining approval for client claims to be removed on a questionable or even invalid basis under FINRA’s rules, according to PIABA Foundation President Lisa Bragança and board member Jason Doss. They cite awards in recent years granting removal of complaints after arbitrators found that the customer knew or should have known information from a product’s prospectus contradicting an advisor’s recommendations to them.

“We are trying to fix this process, and we appreciate that we are not necessarily whistling in the wind. They do seem to have heard some of the things that we're talking about,” Bragança said of FINRA. The arbitrators approving many expungements “are the most cooperative, and they have a long history of granting these things,” she said. “Most people don't want to see that they have been doing something wrong for so long. It’s going to be like turning an aircraft carrier.”

The process resembles the filing of an unopposed motion in court currently, Doss said, pointing out that advisors technically file the case against their brokerage and clients receive notice of the cases in the mail but rarely testify. FINRA’s “proposal still is inadequate,” he said.

“If they intend to submit the same proposal that they did before, they're going to have the same result,” Doss said. “The broker is not adverse to the firm. The firm is rolling over on it. … That problem is still going to be persistent. Unless that's fixed, whatever short-term solution they're proposing is not going to work.”

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Another problem stems from the sheer number of expungement-only cases that flared up in the interim period after a task force subcommittee examining arbitration delivered a series of reform proposals in 2015, according to Joe Borg, the co-chair of NASAA’s enforcement section and Alabama’s securities commissioner, as well as a member of the committee.

“I bet you there hadn't even been a dozen of them back when we did the report,” Borg said. “The bottom line is there's no adversary proceeding, and that gives me real concern. I’ve made that concern public, so it's no secret that I’m concerned about it. There's still nobody representing the investor.”

For its part, FINRA’s whitepaper outlines a series of potential reform proposals encompassing much of PIABA and NASAA’s suggestions, although it raises a series of questions about them and doesn’t ultimately take a position for or against the ideas. The regulator seeks “to engage in a broader discussion with other securities regulators, broker-dealer firms and other interested parties on the issue of expungement,” according to the report. 

“FINRA is committed to shaping the expungement process so that it operates as intended — as a remedy that is appropriate only in limited circumstances in accordance with the narrow standards in FINRA rules,” the report states. “Over the past several years, FINRA has taken numerous, meaningful steps to enhance the current expungement process, and FINRA intends to continue working on further improvements to this process. For example, FINRA believes that the Special Roster Proposal would address a number of significant issues in connection with the current expungement process, and FINRA intends to continue pursuing that proposal.”