Barron's (May 20, 2021) - Brokers are erasing client complaints from their regulatory records at a brisk pace, potentially creating blindspots for state securities regulators and consumers, according to a new study.

Through a process known as expungement, brokers have been increasingly seeking to wipe their records clean of complaints that would otherwise be available to regulators as well as investors through BrokerCheck, an online public database maintained by industry self-regulator Finra.

The number of expungements granted through Finra arbitration has soared to 545 in 2018 from 59 in 2015, according to the Public Investors Advocate Bar Association, an attorneys’ organization. In a new report updating those statistics, Piaba found another 700 expungements were granted, erasing a total of 1,360 individual complaints for the period Aug. 1, 2019 to Oct. 31, 2020.

“Brokers know they can win the expungement lottery nine out of 10 times. It’s open season on these public records,” says Lisa Bragança, Piaba Foundation vice president and a co-author of the study.

“BrokerCheck is no longer a reliable record,” says Bragança, who is a former branch chief in the division of enforcement of the Securities & Exchange Commission.

Expungement is intended to allow brokers and advisors who are registered with Finra to remove meritless complaints from their public regulatory records. The process, however, is riddled with abuse and valid complaints are being removed from the public record, according to Piaba.

“Expungement was intended to be extraordinary relief,” says Jason Doss, president of the Piaba foundation, a co-author of the report, and an attorney with the Doss Firm, an Atlanta-based law firm.

Brokers are increasingly using what Piaba calls a straight-in expungement case, in which a broker initiates an arbitration claim against their current or former brokerage firm solely for the purpose of seeking expungement. Under Finra rules, an arbitrator can grant an expungement request if he or she finds that it meets one of three standards: the claim, allegation, or information is factually impossible or clearly erroneous; the registered person was not involved in the alleged misconduct; or the original allegation is false.

Firms object to expungements only 2% of the time, and investors face too many hurdles to participate in the process, leading arbitrators to rubber stamp requests, according to Piaba.

The customer who made the original complaint is not a party to the arbitration, and though they are permitted to participate, it’s too often costly and a hassle, attorneys say. Investors are given short notice, sometimes just days before the arbitration hearing, and they need to rehire a lawyer. In addition, they’re often deprived of the opportunity to see documents and evidence submitted as part of the expungement hearing, Doss says.

“It’s designed for people not to participate,” he says.

Piaba’s report is the third critical study the organization has done of the expungement process since 2013. Finra has 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 of a complaint from a broker’s record.

Last year, Finra moved to end the so-called $1 dollar expungement trick. Brokers were previously filing expungement claims in arbitration for a small amount, typically a single dollar, which would permit them to avoid higher arbitration fees and qualify for a hearing by a single arbitrator.

Piaba’s new report also lands at a moment when Finra, which is the industry’s self-regulator, is seeking SEC approval later this month further to tweak how expungements are granted. Finra’s new proposal would provide additional notification of expungement requests to state securities regulators, who are currently given no heads up until after the request is granted by a Finra arbitrator or arbitration panel. The proposal would also establish short timeframes to request expungements and provide more training to arbitrators who hear such requests, according to the organization.

“Finra’s current rule proposal addresses many of the concerns raised by Piaba,” a spokeswoman for the organization said in a statement. But far from all. 

Piaba contends Finra’s remedy suggesting more training for arbitrators is no remedy at all, arguing that it’s review of the data shows that adding more arbitrator training will not rectify abuses of the system. Instead, Piaba recommends creating a new investor advocate position to participate in the expungement process.

“If Finra is going to have a monopoly on the expungement process, we need someone that is responsible for minding the store—to make sure that valid customer complaints are not erased from the public record,” says Bragança, who is also an attorney with Chicago-based Bragança Law.

Piaba says its data shows that arbitrators are much more likely to deny expungement requests when the broker-dealer respondent opposes expungement and are more likely to deny expungement when investors oppose expungement. 

“While we appreciate that Finra has taken steps to address abuses of the expungement process, the bottom line is that the current Finra proposal at the SEC isn’t good enough,” Bragança says.