Broker expungement? Costs and difficulty set to rise this fall

Brokers who are planning to ask for the removal of old customer complaints from their official online records might consider submitting their request before Oct. 16.

That's when a slew of changes promising to make the formal process known as expungement even harder to achieve will take effect, according to a notice released Friday by the Financial Industry Regulatory Authority, the broker-dealer industry's self-regulator. 

Among other things, requests for the removal of customer complaints can be granted only by the unanimous consent of three-person arbitration panels. The new rules also will set stricter limits on when brokers can submit expungement requests and give state regulators and clients greater opportunities to weigh in on the proceedings.

The changes are generally meant to ensure expungement of customers complaints from FINRA's online BrokerCheck database remains an "extraordinary remedy" reserved for claims or allegations that are factually impossible, clearly erroneous or made against a person who wasn't involved in the disputed activity. One side effect, predicted Doc Kennedy, the founder of Westminster, Colorado-based AdvisorLaw, is that the new rules will drive advisors to look beyond FINRA when pursuing expungement requests.

The arbitration panels assembled and administered by FINRA aren't the only ones granted authority to remove erroneous complaints, Kennedy said. Groups like the Judicial Arbitration and Mediation Services, or JAMS, and the American Arbitration Association can also provide expungement.

Until now, Kennedy said, FINRA arbitration panels have been the preferred route because they tended to cost less than the alternatives. But that's likely to change after Oct. 16, he said.

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Kennedy said one perhaps insufficiently understood aspect of FINRA's new expungement rules is a provision that would require advisors seeking expungement to pay so-called member surcharges and member processing fees. These fees, which help to cover the costs of arbitration proceedings, come to $5,850 combined for cases involving customer complaints with no monetary amounts attached.

Add that to all the other expenses expungement seekers now must bear, Kennedy said, and the cost of going to arbitration is likely to include $10,900 in forum fees alone. FINRA, he said, will no longer be the cheap option.

Kennedy said that outcome seems to be by design.

"FINRA has been very clear that they don't want to make these decisions, and they are trying to discourage it," he said. "It's not that they are uninterested in removing false or erroneous complaints. But they don't want to be the ones who make the decision because they get so much heat from investor advocates about it."

A FINRA spokesman declined to comment.

Investor advocacy groups like the Public Investors Advocate Bar Association and North American Securities Administrators Association, representing state regulators, have been calling on FINRA for years to tighten up its procedures for expungement in response to perceptions that the supposedly extraordinary remedy was being granted too readily. PIABA likes to cite a study finding that FINRA arbitrators had agreed to erase complaint records in nearly 90% of the cases that came before them. In other words, when advisors were going to the extensive trouble of seeking expungement, they were usually obtaining it.

Kennedy's figures for his firm show the chances of victory can be strong. Since its founding in 2016, AdvisorLaw has gotten 2,408 disclosures expunged from online records, giving it a roughly 85% success rate.

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But as Kennedy and other lawyers with similar practices have been at pains to point out: With the cost of expungement so high, it's usually only advisors with the strongest cases who ever go to the trouble and expense of bringing their case before an arbitration panel. 

Hugh Berkson, the president of PIABA and a partner at Cleveland-based McCarthy Lebit Crystal & Liffman, said PIABA is generally supportive of the changes and is eager to see if they help reduce the success rate for expungement requests. He said the biggest flaw he sees is that the new procedures generally leave it to aggrieved clients and their advocates to argue for why complaint records shouldn't be removed from BrokerCheck and FINRA's underlying database called the Central Registration Depository, or CRD.

That task, he said, should fall more to regulators.

"This fundamental expungement structure still contemplates that the folks fighting to preserve the integrity of the CRD system are the claimants and their advocates," Berkson said.

Kennedy and other critics of FINRA's new expungement rule meanwhile often complain that FINRA and other regulators do little to substantiate information in customer complaints before adding it to the official record. That makes it easy for erroneous or outright incorrect information to slip through the netting. 

James Galvin, a securities attorney who handles a lot of expungement cases, said the brokerages who pay to support FINRA should make sure the self-regulator has enough resources to weed out factually impossible complaints before they appear in public databases.

"It's not right that they publish every little thing even if it's not even possible," Galvin said. "That would be defamation if they weren't a regulator."

Besides specifying that expungement can only be granted by a unanimous vote, FINRA's new rules place limits on how long brokers have to request the removal of records. They'll get no more than three years after the filing of a customer complaint, or two years after the closing of arbitration or civil litigation. 

The changes will further require that clients receive invitations to attend expungement hearings arising from their complaints. At the same time, arbitration panels will be prohibited from giving "evidentiary weight" to a customer's failure to appear. State regulators will similarly receive notice when expungement requests have been submitted and be invited to take part in the proceedings.

Some of FINRA's rule changes apply only to so-called "straight-in" requests, which occur when an advisor seeks expungement outside of arbitration hearings arising directly from customer complaints. Come Oct. 16, advisors will no longer be able to have straight-in requests heard by single arbitrators rather than three-member panels. 

The new rules also seek to prevent brokers in straight-in requests from "forum shopping" or exerting influence over which officials will be hearing their cases. To that end, expungement requestors will also no longer be able to have individual arbitrators struck. Instead, they will have to accept panel members selected at random from a pool of people with no ties to the securities industry but with training and experience in arbitration. 

FINRA's expungement changes were approved by the Securities and Exchange Commission following multiple rounds of revision made in response to comments from industry groups.