Long overdue, FINRA's expungement reforms are still inadequate

FINRA's recent reforms to its expungement process, which allows the removal of old customer complaints from a broker's official online records, offer some meaningful improvements to a long-broken procedure. But they fail to address the larger issue: The expungement process deletes public information without a good system in place to ensure informed decisions. 

For far too long brokers and brokerage firms have been able to double-team lone arbitrators without anyone in the room to insist on protection for the public's interest. In many "straight-in" expungement hearings, only brokers and brokerage firms appeared before a single arbitrator, meaning that every advocate in the room stands to benefit from expungements. Although the customers who make the complaints can appear at expungement hearings, short notice and the lack of incentive renders that eventuality impractical and unlikely. An expungement study conducted by PIABA and the PIABA Foundation before the current rules took effect in mid-October found that from January 2019 through August 2023, brokers won expungement requests 90% of the time; brokerage firms stood idle and mounted no opposition in 92% of these cases; and customers whose complaints were expunged appeared at only about 10% of the expungement hearings.

But why anyone ever expected customers to shoulder the burden of defending the public record has always been baffling. Showing up to defend a complaint appears a thankless task, since the entire hearing usually revolves around calling the customer, in effect, a liar and insisting that their complaints are false. Fighting an expungement requires time and treasure — resources the customer cannot recover even if arbitrators deny the expungement request. In short, it's amazing that even 10% of customers ride out to fight for the public's right to know their stories.

The newly approved rules aim to fix some long-standing flaws in the process and create the possibility of adversarial scrutiny. For instance, brokers seeking to delete customer complaints must now convince a panel of three randomly assigned arbitrators instead of choosing which arbitrators will preside — in other words, allowing them to select the most reliable rubber stamps. State securities regulators may now, when they feel it is warranted, appear at arbitration hearings to advocate against deleting information they would prefer to keep on file.

But although the new changes will improve the system, they will likely still fall short of providing a real check on brokers' ability to delete public records. State regulators may struggle to stand up the necessary resources to review and respond to expungement requests, and state legislatures must appropriate additional funds to staff up state regulators in response to this need.

Down the memory hole
To be sure, some brokers and industry lawyers contend that the expungement system functions properly and that the thousands of deleted customer complaints were bogus to start with. This is nonsense. One 2018 academic study presented evidence that a broker who has secured an expungement is more than three times as likely than the "average broker" to engage in new misconduct, and that brokers who receive expungement are more likely to reoffend than brokers denied expungement. In short, the expungement system appears to embolden bad brokers. Once they learn they can memory-hole misconduct, they grow more rapacious. 

Reading through expungement awards can confirm the statistical conclusions from the academic research. Consider the weak reasoning supporting an expungement award for one broker, Gregory Brian VanWinkle, in 2017. In one expungement hearing, a single arbitrator erased 24 investor complaints after finding that VanWinkle sold investors an annuity product without understanding the product's terms. In granting the expungement requests, the arbitrator reasoned that the annuity issuer "changed the death benefit with nothing calling attention to the change except language in a very long prospectus." Shifting the blame away from the broker who had a responsibility to understand the product he sold, the arbitrator declared that "the fault lies with the issuer, not [VanWinkle], and none of the allegations raised involved actions by [VanWinkle]." 

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This absurd reasoning only established that the investors were right to complain about VanWinkle. Investors follow advice from brokers on the theory that the brokers know what they are talking about. Indeed, FINRA's former suitability rule required brokers to have an "understanding of the potential risks and rewards associated with the recommended security or strategy."

Ultimately, the current reforms offer incremental improvements that will likely slow the deletion of valuable public records. Sadly, however, the current system continues to outsource expungement decisions away from FINRA — the primary regulator for brokerage firms — and onto independent contractor arbitrators. This system leaves the responsibility for educating those arbitrators about reasons not to grant expungements to complaining customers and thinly resourced state regulators.

This approach benefits FINRA because it allows it to avoid entangling itself on these issues. It also shifts costs away from FINRA. After all, parties seeking expungements pay hefty fees to FINRA for arbitration costs. Yet the public pays the price when FINRA  outsources responsibility for wise expungement decisions to poorly informed arbitrators who usually only hear from the brokers seeking expungement. 

Ultimately, FINRA should take this issue out of arbitration entirely and have its Office of Hearing Officers make decisions about which matters merit expungement. Unlike the broken arbitration process, this system would allow for error correction because decisions can be appealed to FINRA's National Adjudicatory Council, its board of governors, the SEC and the federal courts.