In law, the term “expungement” refers to a court-ordered process in which the legal record of an arrest or a criminal conviction is “sealed” or erased in the eyes of the law. For most purposes, someone checking the criminal records will find no evidence of the expunged crime. But the concept of expungement isn’t solely a product of the criminal courts. FINRA, the Financial Industry Regulatory Authority, also permits its regulated stock brokers to obtain a form of expungement.
Each stock broker has an employment history maintained in what is called the Central Registration Depository or “CRD.” FINRA operates this central licensing and registration system for the U.S. securities industry and its regulators. The CRD contains the registration records of more than 6,800 registered broker-dealers and the qualification, employment, and disclosure histories of more than 660,000 active registered individuals. When a broker is the subject of a customer complaint, the details must be reported to FINRA and included in the CRD.
Some years ago, it became common practice for firms to condition settlements on a claimant’s agreement to approve (or at least not oppose) expungement of the claim from a broker’s record. In order for this ploy to result in expungement, the broker had to represent to regulators that he or she had been falsely accused and the claimant, who had been paid to not dispute this contention, had to impliedly play the role of a false accuser. Claimants’ lawyers argued that it was bad public policy for FINRA to permit this tactic. Expungement not only sanitized the records of bad brokers but also undermined the ability of investors to conduct adequate due diligence before retaining a broker.
In response, FINRA didn’t bar the tactic of paying for expungement but it did at least change the rules to make it somewhat more difficult for brokers to obtain expungements.
Now FINRA’s getting ready to take a step backward on one aspect of expungement. Here’s how.
Because a brokerage firm is fully responsible in damages for the sales abuses of any broker who sells products on its behalf — even if that broker is not sued individually — many claimant lawyers follow a practice of naming only the brokerage firm as a formal respondent when commencing arbitration. (We here at stockmarketloss.com usually name the brokerage firm and the broker, but there’s no clear best approach and there are good reasons for going either way.) Even if the broker is not named as a party, however, the details of his or her misconduct will be described in a statement of claim submitted by the aggrieved customer. The broker who has been accused of sales practice violations but not directly pursued in the arbitration (let’s refer to him or her as the “unpursued broker”) is nonetheless properly treated by FINRA as a subject of the allegations for purposes of his or her professional record, and a notation of the claims will be posted in forms submitted to the CRD.
An unpursued broker who contends that the allegations in a case are unfounded or that he or she has been incorrectly identified as involved can ask his current or former firm that is a party to the arbitration to request expungement on his behalf; try to intervene in the arbitration; or file a new arbitration to request expungement relief, naming the customer or firm as a respondent.
FINRA has now proposed a new procedure that would allow the unpursued broker to be granted expungement after an arbitration proceeding, through the initiation of a separate proceeding limited solely to the question of entitlement to expungement. No respondents could be named, so the customers would not be a party. But in our view, the proposed procedure has some big problems.
First, while a customer would be permitted to appear and testify in-person or by phone, there’s no requirement that the customer be given any sort of notice that the broker is seeking expungement. Consequently, there’s no guarantee that a customer who wants to be heard will be afforded the opportunity.
Second, the broker isn’t limited to demanding relevant documents from FINRA and the brokerage firm. The broker also can demand documents from the customer. The customer must respond by either complying or objecting in writing with detailed explanations for the objections. This burdens customers who already have gone through the process of supporting their claims, and it’s an unwarranted burden given that the broker could have intervened in the original arbitration and chose not to do so.
Third, customers can actually be subpoenaed to testify if no other record of their arbitration testimony exists. This is even more harassing and intrusive than having to produce documents.
And fourth, only one arbitrator from the original panel of three will be assigned to hear the expungement request. We think this is absurd given that all three panelists participated in the underlying result upon which the expungement request is based. The procedure will seem even more absurd in situations in which a 2-1 majority decided there were sales violations but the minority arbitrator, who was alone in thinking there was no wrongdoing, is selected to decide the expungement claim.
Thus, as is often the case when FINRA proposes a new rule to the SEC, the first version is a botched job. But fortunately, when FINRA seeks to file proposed rules that govern the conduct of member firms, FINRA first solicits comments on the proposal from members, investors, and the general public. We’ll be submitting our comments, as will many others, and FINRA could well change the rule or even withdraw it.
If you’re interested in adding your own view:
- Mail written comments to:
Marcia E. Asquith
Senior Vice President and Corporate Secretary
1735 K Street, NW
Washington DC 20006-1500; or
- Send an email to firstname.lastname@example.org . Note: PDF is the preferred format for comments submitted as email attachments. Microsoft Word and WordPerfect formats are also accepted.
Hugh Berkson is a Securities Attorney with McCarthy, Lebit, Crystal & Liffman, Co. LPA. Hugh is rated AV® Preeminent™ by Martindale-Hubbell®.
He obtained a business degree in Finance from the University of Texas at Austin in 1989, and is a 1994 graduate of Case Western Reserve University School of Law, where he was a member of the Order of the Barristers and received both the American Jurisprudence Award, (National Mock Trial) in 1993 and the Jonathan M. Ault Mock Trial Prize for 1993-1994.