Brokers

Brokerage Regulator Finra Trying Again With Expungement Reform

Brokerage industry regulator Finra is planning to take another stab at reforming the process by which brokers can clear client complaints from their records, with a fresh proposal coming as early as this year.

Finra tackled the issue in 2020 when it submitted a plan to create a roster of specially trained arbitrators to handle expungement requests to the Securities and Exchange Commission, which oversees the regulator and must approve its major rule changes. But that proposal, contentious from the start, bogged down amid discussions with SEC staffers, and Finra withdrew it last May.

Finra won’t divulge its timetable for reissuing a proposal for expungement reform, but it acknowledges that the system is in sore need of an overhaul.

“Finra remains committed to enhancing the current expungement process and is actively working on refining the proposal,” a spokeswoman for the group said in an email.

Last month, Finra issued a discussion paper enumerating its concerns with the process as it stands today and reiterating its commitment to reproposing a reform framework. It also indicated that the revised proposal likely will have much in common with the original, which it noted had already been through an extensive public comment process and “would immediately and materially mitigate a number of concerns with the existing process.”

Finra also floated the idea of a more overarching reform of the expungement process, but acknowledged that the so-called Special Roster Proposal could be enacted much faster.

“If I was a betting man, [I’d say] by end of year they’ll have the latest proposal to the SEC,” said Andrew Stoltmann, a Chicago attorney and former president of the Public Investors Advocate Bar Association (Piaba), a group that has been deeply engaged in Finra’s arbitration process and a frequent critic of it.

“I would anticipate that in two years, Finra will be done with this,” Stoltmann said, noting the tortured history of expungement reform and the challenge Finra faces in placating consumer advocates, brokerage firms, lawmakers, and other constituencies that have taken shots at the expungement process over the years. “I think Finra is sick of being the punching bag on this issue,” he said.

‘Straight-in’ issues. One of the key concerns Finra’s proposal sought to address involved so-called straight-in expungement requests. A broker can ask to have a complaint removed through the arbitration proceeding that deals with the alleged misconduct, but a straight-in request is made separately from that process, and often long afterward. 

In practice, this often means that the client is not involved, so the broker’s request is essentially unopposed. Finra proposed to set time limits for expungement requests of two years from the conclusion of a dispute that was litigated in court or handled in arbitration, and six years from the time that a complaint was initially lodged with the Central Registration Depository (CRD) that Finra maintains along with the North American Securities Administrators Association.

About two-thirds of the nearly 6,500 straight-in requests lodged with Finra over a five-year period ending in 2021 were made more than six years after the initial complaint was filed, the regulator said.

The proposal would also require that all straight-in expungement requests be overseen by a specially trained three-person panel “randomly selected from a roster of experienced public arbitrators, with no significant ties to the industry,” Finra wrote in the discussion paper published in April.

Finra also sought to eliminate the so-called practice of arbitrator shopping by prohibiting parties involved in expungement requests from preselecting or striking any individual arbitrators. Brokers would not be able to seek expungement of the complaint if an arbitration panel or court had initially denied their request to wipe their record clean. Brokers who withdrew an expungement request would also be barred from refiling that same request at a later date in the hopes of securing a more favorable panel of arbitrators.

“Finra is concerned that ‘arbitrator shopping’ and repeated attempts to seek expungement of the same customer dispute information are inconsistent with the arbitration process and threaten the integrity of the information in the CRD system,” the regulator wrote in its April paper.

Finra points out that the expungement process involves only a small portion of the brokerage industry. In an analysis of customer disputes from January 2016 through December 2021, Finra reported that 8% of registered brokers had a complaint on their record at any point during the sample period. Of those, one in 10 had customer-dispute information removed during the sample period, or 0.8% of the overall brokerage population.

But in real numbers, that amounted to 7,400 brokers who successfully had information cleared from their records over a five-year time period. And critics of Finra’s system argue that in too many cases expungement requests are given a rubber-stamp approval, rather than the serious consideration they deserve. 

However, there are  cases when a broker committed no wrong-doing and was unfairly accused, and an expungement may be warranted.  

“No one else is subjected to having their whole professional life put into an internet database,” observes Bill Singer, a veteran securities attorney. “I get it. The flip side of it is, well, there aren’t that many jobs where you’re handling my life savings.”

What’s next. When Finra announced the withdrawal of its expungement proposal last year, it said that after publishing a discussion paper, which it recently released, it would convene a series of meetings for interested parties to weigh in before ultimately resubmitting a reform proposal to the SEC.

Clearly, it won’t be an easy process. In addition to the friction between investor advocates and Wall Street firms, Finra also has to navigate the concerns of state regulators who aren’t always accepting of decisions to expunge customer complaints from the database they jointly administer, as well as the political pressure that the issue can create.

Even historic Finra foes like Stoltmann give the regulator credit for its work in trying to overhaul the system.

“I’ve been a huge critic of Finra over the years, but what I’ll say is they’re trying to get this expungement issue right,” he said. “It’s just a mind-numbingly complex issue for them. I think they continue to struggle with it.”

Write to advisor.editors@barrons.com

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