Barron's (June 10, 2021) - Wall Street regulator Finra has temporarily withdrawn a proposal to change the process by which advisors can remove client complaints from their regulatory records.
Finra withdrew its proposal “following consultations” with staff at the Securities and Exchange Commission, the regulator said in a statement.
The announcement comes after Piaba, an association of attorneys who represent investors, criticized the proposal for not going far enough to close what Piaba alleges are loopholes that permit advisors to erase valid client complaints. Overuse of the process, known as expungement, is depriving the public and state securities regulators, who rely on a shared database with Finra, of needed information, the association says.
“We’re happy with the withdrawal,” says Jason Doss, a Marietta, Ga.-based attorney and president of the Piaba Foundation, which is related to the association and issued a report last month critical of Finra’s proposal. “It’s better to be right than rush things with a bad proposal that could perpetuate problems.”
Finra, a self-regulatory organization run by its member securities firms, submits proposed rule changes to the SEC for review.
A spokeswoman for Finra declined to provide additional comment on the proposal’s withdrawal. An SEC spokesperson did not return a request for comment on the proposal.
Expungement is intended to be an “extraordinary remedy” to remove client complaints from an advisors’ regulatory records, which are part of the the Central Registration Depository system, according to Finra. State securities regulators rely on it, as does Finra’s BrokerCheck website, which the public can use to review an advisor’s regulatory record.
Advisors can seek expungement of customer complaints through Finra’s arbitration system. If an arbitrator or panel of arbitrators grants the request, the advisor has to obtain a court order to complete the process.
“The expungement framework seeks to balance the important benefits of disclosing information about customer disputes to investors and regulators with the goal of protecting brokers from the publication of inaccurate allegations against them,” Finra’s website states.
From 2015 to 2020, 35,000 customer complaints were entered into advisors’ regulatory records, and approximately 1,550, or 4%, of those had been expunged as of May 25, 2021, according to Finra.
Among other changes, the regulator’s withdrawn proposal would have provided more training for arbitrators who decide whether to grant advisors’ expungement requests as well as more notification for state securities regulators of expungement requests.
The Piaba Foundation has said additional training wouldn’t resolve alleged problems plaguing the expungement process. For example, it’s too easy to obtain an expungement because the requests are largely unopposed, according to the foundation’s study. Firms object to expungements only 2% of the time and investors face too many hurdles to participate in the process, such as little notification about expungement requests regarding a complaint they submitted, the study says.
The foundation recommended creating an independent investor advocate to provide a potential counterpoint in expungement hearings.
The current system “puts the full burden on the arbitrator to be that advocate, because no one is providing information contrary to an expungement request,” Doss says. “It’s not that the complaints lack merit; it’s that the expungements are unopposed. Not all the stakeholders are being represented in these things.”
Finra responded to previous criticism by tweaking expungement rules, such as by prohibiting firms from conditioning a settlement of a customer’s complaint on the customer consenting to—or not opposing—expungement. It also ended a practice by which advisors could secure an expungement for as little as $1. Once the latter change was enacted, the number of so-called straight-in expungement cases fell 95% from the third quarter to the fourth quarter of 2020, according to Finra.
Finra says it will work with an organization of state securities regulators to redesign the current expungement process. It will also release data and a discussion paper analyzing expungements and convene discussion groups to review it.
“Finra is committed to limiting the expungement process so that it operates as intended—as an extraordinary remedy, only appropriate in limited circumstances when the CRD information is clearly inaccurate,” the regulator said in its statement.
Nancy Hendrickson, a Chicago-based attorney at law firm O’Hagan Meyer, says she hopes Finra takes feedback from advisors as part of its review. “The process can be cumbersome for reps who are basically innocent of any wrongdoing,” says Hendrickson, who represents advisors. It can also cost thousands of dollars in hearing and attorney fees.
Hendrickson gives as an example the experience of an advisor she represented in an expungement hearing. An arbitration panel ruled that the “claim, allegation, or information is false”, granted his expungement request, and assigned the advisor $1,125 in hearing session fees, according to a copy of the award. Even after that, “we’re not done,” Hendrickson says. “We still have to go to court to get the court to sign off on it and then send it to Finra. He’s several weeks, perhaps months, to getting this off his record.”