FinancialPlanning (May 24, 2021) – With the SEC expected to approve the latest FINRA arbitration expungement reform this week, client attorneys released data that they argue shows the changes aren’t going far enough. The danger, they say, is that the ease of getting client complaints removed from brokers’ records makes them harder for investors and regulators to assess adequately.

Arbitrators granted broker expungement requests in 636 out of 700 decisions between August 2019 and October 2020, or 91% of the time, according to a study released this month by the Public Investors Advocate Bar Association Foundation. The number of cases involving expungement has soared from just 59 in 2015.

After a rule change last year significantly increased the cost of filing a claim to remove a client complaint disclosure from BrokerCheck, FINRA now proposes to assign three arbitrators at random from a specific pool to judge the cases and provide official notice to state regulators, among other provisions of a rule due for SEC review by May 28.

The proposal is “putting out new fires” without “fixing why the house is on fire in the first place,” PIABA Foundation President Jason Doss says. He cites what the organization called the “$1.00 trick,” in which, prior to the last rule change, brokers often sought monetary damages of $1 in order to reduce the number of arbitrators and the price of filing a claim.

“They’ll just game it another way because there’s nobody there watching and nobody there to stop them,” Doss says. “There are complaints that should be expunged. There should be a process, but this is just not the right process.”

Representatives for the SEC didn’t respond to requests for comment.

Doss and other client attorneys are calling for much more participation by the clients at issue in the complaints as well as by state-level regulators, with the creation of an advocate’s office that would be either incorporated into arbitrations or oversee expungement requests independently.

Right now, the supposedly “extraordinary remedy” garners little participation that could be considered adversarial to reps trying to clean their records of prior complaints: brokerages objected in just 2% out of nearly 1,800 cases PIABA tracked with data from the Securities Arbitration Commentator law journal. And fewer than 14% had any participation from clients.

Although an earlier FINRA rule change prohibits settlements from including provisions forbidding the clients from opposing expungement, PIABA says firms could still accuse them of breaches of confidentiality or non-disparagement clauses. Furthermore, the notice to harmed clients “comes in very, very late, maybe a week or two before the hearing,” says Teresa Verges, director of the Investor Rights Clinic at the University of Miami School of Law.

“It’s a difficult process to go through,” Verges says. “Many of them feel ashamed that this happened to them. They want to put this behind them. There’s very little incentive for the customer to come in and testify.”

She describes FINRA’s newest proposal as important but only making “incremental” improvements to the process. FINRA spokeswoman Michelle Ong says that the regulator remains committed to “working collaboratively” with PIABA, the North American Securities Administrators Association and other stakeholders on additional expungement reforms.

“FINRA’s current rule proposal addresses many of the concerns raised by PIABA,” Ong said in a statement. “In particular, the proposal provides additional notification to state securities regulators. It also makes important changes to the expungement process such as the random selection of three arbitrators, establishing shorter timeframes to bring expungement claims, and requiring specially trained and qualified arbitrators in most expungement contexts.”

Through NASAA, state regulators have said they “generally” support the new rule, according to their October comment on it to the SEC. They praised new requirements that advisors named in a client complaint must request expungement during the underlying arbitration rather than in a separate action, as well as the time limits. The new notice of expungement filings to state regulators within 30 days “falls short” of addressing their concerns, though, the letter states.

There would still be “no meaningful disclosure of information on which to assess the expungement request, nor would there be a legal mechanism to facilitate regulator involvement,” NASAA President Lisa Hopkins wrote. “The bottom line is that the proposal fails to provide a pathway to contest the expungement relief request during the arbitration should a state determine it is appropriate to do so.”

In addition, FINRA should “impose a higher level of scrutiny” on what’s put on BrokerCheck in the first place, according to Colleen Honigsberg, an associate professor of law at Stanford Law School. Brokers that have had their records expunged are more than three times as likely to commit more misconduct in the future, according to a study by Honigsberg and another researcher accepted for publication in the Journal of Financial Economics.

Brokers requested expungement of 12% of client complaints between 2007 and 2016, and arbitrators approved it in 84% of the cases that went before them, the researchers found.

“There are times when misconduct can be applied to brokers who really were not part of it; I wouldn’t get rid of the process overall,” Honigsberg says. “If they’re going to tighten the expungement rules, which they probably should, then FINRA should take more accountability about what shows up on BrokerCheck.”

As the SEC considers FINRA’s latest proposal, the number of expungement cases continues to rise, notes Verges of the Investor Rights Clinic. The proposal doesn’t provide for cross examinations and a testing of the evidence as to whether the listed complaints are without merit, adding up to the “fundamental problem” that it’s not a “real adversarial process,” she says.

“Those are important improvements,” Verges says. “I wonder whether it will be enough. I’m skeptical it will be enough, quite frankly.”