Financial Planning (May 1, 2024) - By Dan Shaw

For nearly half a year advisors have been living under new FINRA rules that make it harder to scrub erroneous customer complaints from their online records.

And as predicted, the number of requests for the removal of those records — through a process known as expungement — has shown a marked decline. That's according to new data the Financial Industry Regulatory Authority began releasing in April.

In the first quarter of the year, advisors submitted only 15 requests for the removal of customer dispute information from online records by FINRA arbitration panels

Stephan Louviere, a lawyer representing advisors in many expungement cases, calls the figure "shockingly low." 

"There was a time not long ago when we'd probably have that many in a week," he said.

Dochtor Kennedy, the founder of Westminster, Colorado-based AdvisorLaw, agreed that there's no question that there has been a steep decline in expungement requests that are being brought before FINRA arbitration panels.

When his firm takes on expungement cases these days, it's more likely to pursue them through forums outside of FINRA. Those include both the regular court system and organizations like the Judicial Arbitration and Mediation Services (JAMS) and the American Arbitration Association. 

"It's probably two to three for every one we file with FINRA," Kennedy said.

Expungement costs now exceed $10K

As evident as the dropoff is to Kennedy and other expungement lawyers, it isn't immediately apparent from FINRA's new data. For one, the new numbers don't go back past Oct. 16.

That's the date FINRA put in effect new policies meant to ensure expungement remains the "extraordinary remedy" it was always intended to be. The rule changes generally set stricter time limits on when brokers can submit expungement requests and give state regulators and clients more opportunities to weigh in on expungement proceedings. They've also added greatly to the cost of having erroneous and misleading information removed from FINRA's online BrokerCheck database.

Even with the small set of data now published on FINRA's site, a declining trend is noticeable. Nearly 55 expungement requests were filed between Oct. 16 and Dec. 31 last year, well above the 15 for this year's first quarter.

"FINRA is committed to continuing to enhance its dispute resolution forum, and providing more transparency of expungement data is part of that commitment," Richard Berry, FINRA executive vice president of dispute resolution, said in a statement.

Expungement lawyers have long predicted the new rules would lead to a sharp falloff. That's in large part because of the much greater expense. 

Kennedy has estimated that the surcharges and other sorts of forum fees that expungement seekers must bear under the new rules easily exceed $10,000. The biggest driver of that is $5,850 in fees Kennedy believes FINRA has shifted over from brokerage firms to advisors.

Also making the going tougher is a rule change that requires almost all expungement cases to be decided by unanimous approval of three-member arbitration panels. Before, a simple majority was enough.

"They've ratcheted up the cost and ratcheted down the probability of success," Kennedy said. "So now you are probably always going to lose that very risk-averse client who was barely willing to do it with better odds previously."

Kennedy said the demand for the expungement complaints is still strong; it's just that the desire to take those cases before FINRA is dwindling.

"They've taken the superhighway and turned it into a country road with a stop sign every two blocks," Kennedy said.

Expungement categories

FINRA's new rules do not apply to all varieties of expungement requests. Kennedy said he's still taking plenty of disputes between advisors and brokerage firms to FINRA arbitration. These often involve employment termination and other matters that have to be reported on industry documents called U5 forms.

On requests for the removal of customer complaints, FINRA's data falls into three buckets. There are figures for "simplified customer arbitrations." These are disputes involving $50,000 or less and usually go before single arbitrators. There are also nonsimplified customer arbitrations, which involve more than $50,000 and go before three-member panels. Finally, there are so-called straight-in requests, which are filed by advisors outside of proceedings arising directly from customer disputes.

Of the three types, the biggest decline was in the number for nonsimplified arbitration. There were 35 of those requests filed after Oct. 16 through the end of last year but only two in the first three months of this year. 

FINRA's data will eventually reflect the number of expungement requests that were not only made but also granted or denied in a given quarter. But since expungement proceedings often take well over a half a year to complete, no results for the latest batches of cases are known yet.

Putting the new data to use

Benjamin Edwards, a professor of law at the William S. Boyd School of Law at the University of Nevada-Las Vegas, said he's hopeful the data will eventually prove useful for gauging whether the recent reforms to expungement proceedings are having the intended effect. Edwards said one big change in the new rules is meant to make sure state securities regulators are always invited to participate in FINRA arbitration hearings.

Studies conducted by the Public Investors Advocate Bar Association and its sister group the PIABA Foundation have found that when state regulators do have a say, the chances of expungement being granted fall substantially. But Edwards, who serves on the PIABA board of directors, said he's skeptical most states have set aside the resources needed to make sure their securities watchdogs can put in frequent appearances at FINRA hearings.

"We all know that state legislatures have not appropriated sufficient additional funding for this new responsibility that has been dumped into their laps," Edwards said.

Expungement still too easy?

FINRA's changes to expungement procedures came largely in response to complaints from PIABA and other groups representing aggrieved investors that the reputational remedy was being granted too readily. FINRA policy seeks to reserve expungement for claims or allegations that are factually impossible, clearly erroneous or made against a person not involved in disputed activity. 

But through their own studies of arbitration award data, PIABA and the PIABA Foundation have found evidence that arbitrators are granting expungement in nearly 90% of the cases that came before them. The conclusion has generally given rise to two entrenched positions on FINRA's expungement policies.

On one side, investor advocates argue the high approval rate shows expungement can be had virtually for the asking. On the other, lawyers representing advisors say the numbers merely show that it's only people who have the best chances of succeeding before arbitration panels who go to the extensive trouble of bringing a case.

Advisor advocates also note that FINRA does very little investigating of customer complaints before adding them to its Central Registration Depository database and publishing them on BrokerCheck. That virtually ensures, they argue, that a high percentage of online disclosures contain erroneous and misleading information.

John D. Stewart, a senior associate in Baritz & Colman's New York office and a lawyer who represents advisors in expungement hearings, said FINRA's newly public expungement numbers are unlikely to resolve the debate. That's true not just for the number of expungement requests but also for the coming tallies of cases decided for or against applicants.

If the approval rate remains high, Stewart said, there will always be the possibility that expungement requests are being brought only by advisors with the best chances of success. Stewart said most arbitration decisions now come with detailed explanations for why the panel ruled the way it did.

"Even if the arbitration report shows something about the numbers going up or down, most people will use those numbers to confirm what their position was already," Stewart said.

Rush to expunge

Stewart said there's another possible explanation for the apparent decline in expungement requests. With most advisors knowing the hurdles were going to get a little higher on Oct. 16, anyone who was contemplating having their records cleared was likely to request the remedy before that date.

That likely had a "front-loading" effect, Stewart said, and may have depleted the demand for expungement for a while. Also, advisors "probably don't want to be the canary in the coal mine," he said, and be one of the first to bring an expungement case under the new rules.

Joe Peiffer, the president of PIABA and the founder of New Orleans-based Peiffer Wolf Carr Kane Conway & Wise, agreed there most likely was what he called a "scumbag bum rush" to seek expungement before the Oct. 16 rule change. He said he welcomes the insight FINRA's new data will give into whether the recent expungement reforms are working as intended.

"The real question is: Are we going back to the way it was before we thought we fixed it or not?" he said. "And if it turns out all this stuff works, I'll be the first person to say so."

Kennedy said his own firm's internal data show no decline in expungement demand once requests submitted outside FINRA are also taken into account. It's just that many more of those cases are now going to alternative forums.

"The market has already digested that initial rush," Kennedy said. "So there is no meaningful difference."

Dan Shaw

Reporter, Financial Planning