By George C. Miller, Partner of Shustak Reynolds & Partners, P.C. posted on Wednesday, May 3, 2023.

George C. Miller

Partner

Location: San Diego, California
Phone: (619) 696-9500 (Ext. 105)
Direct: (619) 501-8270
Email: [email protected]

On April 12, 2023, the SEC approved long-anticipated changes to FINRA’s expungement rules that will make the expungement process more challenging, and likely more expensive, for registered representatives. While the SEC has approved the new rules, FINRA has not yet announced when they take effect.

Rule 2080 of FINRA’s Code of Arbitration Procedure governs the expungement of customer complaints. Arbitrators may issue an award recommending expungement only upon a showing that: (1) the claim or allegation is factually impossible or clearly erroneous; (2) the representative was not involved in the alleged conduct; or (3) the claim or allegation is false. Until the rule change, expungement claims could be heard before a panel of three arbitrators, or a single arbitrator upon agreement of the parties. In either case, the arbitrator(s) are required to conduct an evidentiary hearing before issuing an award. An expungement award must then be confirmed by a court of competent jurisdiction. Other CRD disclosures not involving client complaints (e.g., employment-related, and other non-investment disclosures) are not governed by Rule 2080 and may be expunged if they are “defamatory in nature.” Those expungement awards need not be confirmed in court.

Investor advocates have criticized the Rule 2080 expungement process in recent years, citing the high percentage of registered representatives who win their expungement claims. They claimed registered representatives frequently sought to expunge old disputes involving investors who were unlikely to oppose the request, and that representatives and their counsel “shopped” for arbitrators who were more likely to grant expungement. Lost in those complaints, however, is the fact registered persons must disclose any customer complaint, regardless of its merit, provided that it meets certain dollar thresholds. Time will tell if the rule change actually discourages reps from seeking to expunge accurate disclosures, or merely frustrates their ability to expunge disclosures that never should have been reported to CRD in the first place. 

Nevertheless, to address those concerns, over the past several years FINRA has submitted to the SEC and sought comment on a number of proposed rule changes – all of which sought to make the expungement process more difficult. The most recent proposed rule, which FINRA submitted to the SEC in the summer of 2022, and which the SEC approved this April, prescribes the following key changes:

• Panel of three (3) arbitrators: A panel of three arbitrators must unanimously conclude that the customer complaint is factually impossible, clearly erroneous/false, or that the representative was not involved in the alleged misconduct.
• Appearance at the hearing: The registered person must appear at the hearing in person, or by video conference as opposed to appearing by telephone.
• Notice to customer: Customers must be notified of the time, date, and place of the hearing and any pre-hearing conferences.
• Expanded discovery: Arbitrators may request documents or testimony directly from the parties.
• Reasoned awards: The panel must provide sufficient detail in its award to justify any decision to award expungement.
• Prior adjudication: Parties would be prohibited from requesting expungement of any disputes on which a panel previously considered the merits (e.g., disclosures relating to a prior arbitration award).
• No arbitrator “shopping”: Representatives cannot re-file an expungement request after it has been withdrawn, the notion being this will prevent arbitrator “shopping.”

In addition, for “straight-in” expungement requests, where a representative commences a new arbitration solely for purposes of seeking expungement, the new rule includes the following changes: 

• Time limitation: Representatives cannot pursue expungement if more than 3 years have passed since the customer complaint was submitted to the CRD, or 2 years after the conclusion of a customer-initiated arbitration (whichever is shorter).
• Claim against disclosing B-D: The claim must be filed against the broker-dealer who made the disclosure.
• Regulatory notice: FINRA will notify state regulators within 15 days of receiving a straight-in expungement request and allow a representative of the state regulator to attend and participate in the hearing as a non-party.
• Arbitration panel: The panel will consist of arbitrators specially-qualified to consider expungement requests, and the parties will not be permitted to rank panel members or stipulate to a single arbitrator. The parties may, however, challenge an appointed arbitrator for cause.
• No straight-in requests: When named in a customer arbitration, representatives will be prohibited from pursuing a straight-in claim. Instead, they must seek expungement in answering the statement of claim, or in a separate request to be filed no later than 60 days before the hearing begins.

Our FINRA and financial services attorneys are highly experienced in the FINRA arbitration and expungement process. Any representatives who have been named in an arbitration, or who are considering expungement should consult with qualified counsel.

Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes.
We represent many investment advisers, IARs, broker-dealers, registered representatives, and businesses.
Attorney Geroge C. Miller can be reached in the firm’s San Diego office at (619) 696-9500.

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