Changes to Expungement Rule Seek to Better Protect Customers' and Regulators' Right to Access Complaint Information

By James Eccleston

ecently, the Securities and Exchange Commission (SEC) approved rule changes that the Financial Industry Regulatory Authority (FINRA) had proposed to better protect customers and regulators ability to access complaint records of financial advisers. Let's examine these important rule changes.

As background, FINRA operates the Central Registration Depository (CRD) pursuant to policies and procedures developed jointly with the SEC, state securities regulators and other members of the regulatory community. The CRD contains, among other things, the employment, regulatory and customer dispute histories of all registered financial advisers and their firms. While the goal of the CRD is to be "accurate and complete", according to the SEC, the regulators have developed policies and procedures that permit certain customer dispute information to be "expunged" - or removed - from the CRD.

The original expungement rule was adopted in 2003 and is known as Rule 2130 of the NASD (National Association of Securities Dealers, predecessor to FINRA). That rule requires financial advisers and their firms seeking expungement of customer dispute information from the CRD to obtain an order from a court of competent jurisdiction directing expungement of information or confirming an arbitration award that contained expungement relief. Rule 2130 also requires financial advisers and their firms to name FINRA as an additional party in any such court proceeding, though FINRA has the right to waive the requirement that it be named under certain circumstances. Those circumstances are designed to be extremely limited; for example, based upon an affirmative judicial or arbitral finding that: (1) the claim, allegation or information is factually impossible or clearly erroneous; (2) the financial adviser was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation, or conversion of funds; and (3) the claim, allegation, or information is false.

Despite these procedural safeguards, the practices that developed became disconcerting. According to FINRA, more often than not expungement occurred at the request of a party to facilitate settlement of a customer dispute. In other words, in connection with financial advisers and their firms settling claims with their customers, firms would insist that the customer consent to (or not oppose) the request to expunge his or her complaint from the CRD. While FINRA expected arbitrators to maintain a watchful eye for abuses, arbitrators often did not even inquire into the terms of the settlement agreements, and instead simply rubber-stamped purportedly joint requests for expungement relief. At least two reviewing courts expressed concern regarding the entire expungement procedure. FINRA itself issued a warning to financial services firms and advisers not to abuse the expungement process.

Since then, FINRA has worked on improving the expungement rules. In March, 2008, FINRA filed its proposed rule changes with the SEC. Comments as well as FINRA's responses were submitted to the SEC. On October 30, 2008, the SEC approved FINRA's expungement rule changes.

Under the new rules, in order to grant expungement of customer dispute information under Rule 2130, arbitrators must: (1) hold a recorded hearing session by telephone or in person regarding the appropriateness of expungement, even if the customer does not request a hearing on the merits of his or her underlying complaint; (2) for cases involving settlements, review the settlement documents to examine the settlement amount and any other terms and conditions that may raise concerns about the financial adviser's involvement in the alleged misconduct before awarding expungement; (3) indicate in the arbitration award the grounds for expungement and provide a brief written explanation of the reasons supporting those grounds; and (4) assess forum fees for hearing sessions against the parties requesting expungement if the sole purpose of the hearing session(s) was to determine the appropriateness of expungement.

This new procedure incorporates sorely needed protections to ensure, as both FINRA and the SEC put it, that expungement be an "extraordinary remedy". The SEC emphasizes that expungement should be "used only when the expunged information has no meaningful regulatory or investor protection value."

In approving the proposed revisions to the rule, the SEC notes that FINRA has made the expungement process "more transparent". The SEC states that "[t]he additional procedures, such as required review of settlement documents, and the written explanation of the regulatory basis and reason for granting expungement, in the proposed rule are designed to help assure that the expungement process is not abused."

Let's hope so. Customers and regulators have a legitimate interest in having access to customer dispute information appearing on the CRD!

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About the Author:
James J. Eccleston is the president of Eccleston Law Offices, P.C. The Chicago-based firm represents investors and advisers nationwide in securities and employment matters. 312-332-0000 www.EcclestonLaw.com.