Advisor Alert — FINRA Expungement Overhaul Presents New Requirements and Challenges for Brokers

On September 22, 2020, FINRA filed a proposed rule change (the Proposal) with the SEC, intended to impose new requirements on the expungement process. If approved by the SEC, the Proposal would amend existing procedures related to requests to expunge customer dispute information and would create a special arbitration roster. Within the context of customer dispute expungement, the Proposal would modify the process of expunging customer dispute information maintained in the Central Registration Depository (CRD). Brokers as well as member firms should be aware of these changes, which if approved by the SEC, likely would become effective sometime in 2021.

Information regarding customer disputes is maintained in the CRD. This information is submitted by registered securities firms, brokers, and regulatory authorities in response to questions set forth on uniform registration forms (Forms BD, BDW, BR, U4, U5, and U6). In turn, FINRA makes specific CRD information available through BrokerCheck, providing the public with access to information on registered and formerly registered brokers and broker-dealers.

It has long been FINRA’s position that while expungement of customer dispute information is by no means routine, it may nevertheless be appropriate in certain instances. Expungement is a part of the regulatory framework behind the CRD, contemplating that, in limited circumstances, the CRD may contain information about a broker that is incorrect. Certain FINRA rules relating to expungements – Rule 2080, Rule 12805, and Rule 13805 – illustrate this policy by requiring an arbitration award to specify which of the limited grounds for expungement support the award.

For example, under Rule 2080, expungement may be ordered if the claim, allegation, or information is factually impossible or clearly erroneous, or if the broker was not involved in the alleged wrongdoing, or if the claim, allegation, or information is false. It is advisable that data satisfying one or more of these criteria should be expunged from the CRD (and therefore from BrokerCheck) without delay, as more than 40 million searches of firms and brokers were conducted on BrokerCheck in 2019 alone.

Although removing legitimately erroneous or false information is more than appropriate, FINRA nonetheless has withstood criticism that the expungement process allows brokers to polish too many blemishes from their records. FINRA itself has also expressed concern about the adequacy of certain expungement processes. Accordingly, FINRA has spent the last several years crafting proposed regulatory changes that impose additional procedural hurdles and financial burdens on brokers seeking to expunge negative information.

Concluding that years-long process, the 557-page Proposal submitted to the SEC, following an earlier regulatory notice issued in 2017 (Notice 17-42), would make a plethora of changes to expungement request procedures. These include: (1) imposing new requirements on expungement requests filed during an investment-related, customer-initiated arbitration (customer arbitration) or filed separate from a customer arbitration (straight-in request); (2) establishing a roster of arbitrators with enhanced training and experience from which a three-person panel would be randomly selected to decide straight-in requests; (3) setting new procedural requirements for expungement hearings; (4) codifying and updating certain FINRA best practices guidance; (5) specifying procedures for requesting expungement of customer dispute information arising out of simplified arbitrations; and (6) establishing requirements for notifying state securities regulators and customers of expungement requests.

Of the many changes in the Proposal, the most salient points are as follows:

• Time Limits. Brokers filing a straight-in request must do so within 2 years of the close of the underlying customer arbitration or civil litigation case. If the disclosure at issue did not involve arbitration or litigation, the broker must file within 6 years of the customer complaint being reported to the CRD system. With respect to customer complaints reported to the CRD system before the rule change becomes effective (the Effective Date), brokers will have 2 years from the Effective Date to seek expungement of disclosures that arose from customer arbitration or civil litigation cases that closed on or prior to the Effective Date, and 6 years from the Effective Date to seek expungement of customer complaints reported to the CRD system on or prior to the Effective Date but not involving arbitration or litigation.

• Special Arbitrator Roster. Ranking arbitrators or stipulating to the use of specific arbitrators would not be allowed in straight-in requests. Rather, the Neutral List Selection System would randomly select 3 names from a special roster of arbitrators having certain training and experience. No fewer than 3 arbitrators could decide straight-in requests, although challenges for cause would still be permitted.

• Bars to Late Requests. A broker named as a party in a non-simplified customer arbitration would be required to request expungement during that arbitration or not at all. A broker engaged in a simplified arbitration, however, could make the request during the proceeding, or subsequently as a straight-in request.

• No Repeat Requests. Brokers cannot request expungement twice and must confirm that they have not done so.

The SEC is currently reviewing the Proposal and is accepting public comments through October 22, 2020. It should be noted that the Proposal follows separately issued amendments (Notice 20-25) increasing the minimum fees applicable to requests for expungement of customer disputes, effective September 14, 2020.

The attorneys at Giarrusso Law Group LLC have extensive experience with issues unique to the financial services industry, including expungement proceedings on behalf of brokers. To discuss any potential expungement claims, please contact us by phone at (201) 771-1115 or by email at info@gialawgroup.com for a no-cost and confidential consultation.