InvestmentNews (August 4, 2022) - A major modification to the proposal would allow state regulators to participate in arbitration hearings that determine whether to clear a broker's record of a customer dispute.
A revised Finra proposal that makes it harder for brokers to clear their records of customer disputes has gained the backing of previous critics because it allows state regulators to weigh in on expungement decisions.
The Financial Industry Regulatory Authority Inc. last week filed with the Securities and Exchange Commission a new version of a proposal, which would establish a special roster of arbitrators to hear expungement requests.
Finra withdrew the original proposal in May 2021 after talks with SEC staff indicated the agency had concerns about it. The Finra board approved a modified version at its May board meeting, and the broker-dealer self-regulator sent it to the SEC last Friday for approval.
The proposal now has a provision that requires that state regulators be notified of all expungement requests and be allowed to participate in hearings involving so-called straight-in expungement requests, or those that are filed by a registered representative separately from a customer arbitration.
Getting regulators involved in expungement decisions was one of the goals of critics of the original Finra proposal. They argue that expungement hearings usually involve only brokers seeking to clear their records and financial firms, which also want the disputes removed from a rep’s BrokerCheck profile. The involvement of a regulator provides some opposition.
Jason Doss, a former president of the Public Investors Advocate Bar Association, said Finra is going in the right direction.
“Overall, it’s a big improvement from the last proposed rule they submitted to the SEC,” said Doss, owner of the Doss Firm and founding director of the PIABA Foundation. “This closes that loophole. We’re very happy that they listened. I think it needs to be approved.”
Benjamin Edwards, an associate professor of law at the University of Nevada Las Vegas, said Finra made progress by including the state regulator provision.
“This is a very significant change, and I think it is a very good one,” Edwards said. He added that he would like to see further revisions, such as explicit instructions for arbitrators regarding the evidence that should be used to rule on expungements.
The organization representing state regulators, the North American Securities Administrators Association, said it is reviewing the Finra proposal.
“NASAA is concerned that for some expungements an advocate is not present to offer arguments against and/or evidence in opposition to an expungement request,” Melanie Senter Lubin, Maryland securities commissioner and NASAA president, said in a statement. “We will evaluate the current proposal to see if it addresses this concern.”
NASAA has been one of the leading proponents of expungement reform. It asserts that tightening procedures will protect the integrity of broker records that are used by investors choosing financial professionals, by firms hiring them and by regulators licensing them.
“NASAA’s view is, and has been, that expungement of customer complaint information is an extraordinary remedy and that, for too long, the process has allowed expungement to happen on a routine, not extraordinary, basis,” Lubin said. “NASAA appreciates efforts to tighten the existing processes and procedures and will continue our engagement with FINRA on this and possibly other future efforts.”
The proposal sets a three-year deadline for straight-in expungement requests from the time that a customer complaint was reported in the Central Registration Depository. The deadline is two years from the close of a customer-initiated arbitration or related civil litigation. Another provision requires that straight-in requests be decided by a three-person arbitration panel selected from a roster of experienced public arbitrators.
The proposal also tightens rules related to all expungement requests, such as implementing the special roster of arbitrators and requiring the unanimous agreement of an arbitration panel in order to grant expungement.
The expungement process has long been a thorn in Finra’s side. Two recent PIABA studies asserted that Finra arbitrators approve expungement 90% of the time. Finra has countered that criticism but also has made expungement reform efforts over the years.
“Finra is concerned, however, that the current expungement process is not working as intended — as a remedy that is appropriate only in limited circumstances in accordance with the narrow standards in Finra rules,” the proposal states.
The current proposal drew Doss’ and Edwards’ backing to the extent that it would improve the way the Finra dispute resolution system handles expungement requests. But they both doubt that the Finra arbitration forum is the appropriate place for such decisions.
“At the end of the day, this is a regulatory problem,” Doss said. “Expungement shouldn’t be in arbitration at all.”
Arbitrators too often are presented only with one side of the expungement request — arguments from those who are seeking to clear their records, Edwards said.
“Even with these changes [to the proposal], arbitration remains poorly suited to surfacing all the relevant information and making a fully formed decision,” he said. “There’s every reason to believe the arbitration process gets it wrong an enormous percentage of the time. Arbitration is prone to errors.”
Edwards acknowledged that expungement reform is challenging.
“Finra does have a tough job here of trying to strike the right balance,” he said.