On December 11, 2013, WealthManagement.com ran Patrick Mahoney’s latest editorial, FINRA’S Proposed Changes to the Broker Expungement Process, as part of his periodic column, The Legal Rep. A link to the article is available HERE.
The article’s content is available below:
In April 2012, FINRA released Regulatory Notice 12-18, which features FINRA’s proposed overhaul of the broker expungement process. The overhaul applies primarily to brokers whom customers do not name as defendants to their FINRA lawsuits.
The basic components of FINRA’s proposed overhaul will involve the implementation of proposed FINRA Rule 13807, which creates an “In re Expungement” proceeding for unnamed persons
What “In re Expungement” means.
FINRA Rule 13807 would create a new mechanism for brokers whose records are adversely affected by an investor lawsuit in which the broker was not named as a defendant. In such instances, a broker could bring an “In re Expungement” action. In other words, a lawsuit that does not name any other party as a defendant meant exclusively to allow the unnamed broker an opportunity to earn expungement of the investor complaint.
How is the proposed “In re Expungement” action different and better than the current expungement process?
Under the current process, to apply for expungement, an unnamed broker must effectively file a lawsuit against either the investor who filed the complaint or the brokerage firm involved in the investor complaint. This often creates a procedural nightmare, particularly where the unnamed broker must file a lawsuit seeking expungement against an investor (who the broker may or may not still maintain as a client) who did not intend to involve the broker in the underlying complaint in the first place.
Subject to limited exceptions, the proposed “In re Expungement” rule would eliminate this unnecessary prerequisite, which would give brokers an unobstructed path to seek (but not necessarily earn) expungement.
What will bringing an “In re Expungement” action cost?
FINRA will charge brokers who seek expungement under this proposed rule an initial $750 filing fee, plus a $450 fee per FINRA hearing (there are typically two hearings held in an expungement action). Under the current system, depending on the situation and scope of the damages alleged in the investor complaint, FINRA fees required just to apply for expungement can be upwards of $5,000.
Accordingly, the “In re Expungement” action will provide unnamed brokers more predictable costs.
How will a broker initiate an “In re Expungement” action?
Under the proposed “In re Expungement” rules, when a broker has his or her record tarnished due to an investor lawsuit in which the investor does not name the broker as a party, FINRA will give the broker formal notice that their record has been affected. Once the broker receives notice that his or her record has been tarnished, the broker has 180 days to notify FINRA of his or her intent to file an expungement application.
Thereafter, when the investor lawsuit concludes, the broker will have 60 days to file a formal expungement application.
To put this proposed procedure into an example, suppose an investor files a lawsuit in FINRA naming XYZ brokerage as the only defendant. The broker, though not named as a party to the lawsuit, was “involved” in the events giving rise to the complaint such that his or her record becomes tarnished.
FINRA would notify the broker that the investor lawsuit caused a blemish on his or her record; and from that point, the broker would have 180 days to notify FINRA of his or her intent to apply for expungement of all reference to the customer complaint from his or her record. When the investor’s lawsuit concludes (either through a formal arbitration proceeding or settlement), the broker will have 60 days to file documents to support his or her expungement request.
How will the broker obtain the supporting documents necessary to earn expungement?
The broker will have access to all documents from the underlying, investor-initiated arbitration necessary to prove his or her case for expungement. The arbitrator deciding whether or not to grant expungement will determine the scope of the documents available to the broker.
What role will the investor play in the expungement proceeding, if any?
Any party to the underlying arbitration (meaning either the brokerage firm or the investor) may appear at the unnamed broker’s expungement proceeding to either support or oppose the broker’s request for expungement.
How will the proposed “In re Expungement” action affect brokers who are named as defendants to investor lawsuits?
The proposed “In re Expungement” rules would not apply to brokers who are named in investor complaints. But this does not mean FINRA will preclude named brokers from seeking expungement. Indeed, named brokers may still seek expungement, but may do so only during the investor arbitration. Meaning, if FINRA closes its file in connection with the arbitration (either because the case settled or reached a conclusion via a formal arbitration hearing), a named broker loses his or her opportunity to seek expungement.
The latter part of this rule differs from current expungement rules in that under the current rules, a broker may still seek expungement after the underlying arbitration closes, albeit at a higher cost.
When will the new “In re Expungement” rule come into effect?
Though FINRA asked for public comment on the proposed rules over a year ago, the SEC still must approve the rules. Accordingly, the time table for when this rule will come into effect depends on when FINRA receives SEC approval to implement, which could take between 6 and 12 months.
For nearly five years, unnamed brokers involved in investor complaints have been forced to endure a confusing and utterly convoluted expungement system that few understand and even fewer know how to implement. To that end, the proposed “In re Expungement” rules are long overdue, particularly insofar as they give brokers whose reputations have been tarnished a clear path to at least seek expungement.
That said, the most glaring issue the proposed rules fail to address is retroactivity. That is, how will these rules affect unnamed brokers to investor complaints that concluded more than 60 days ago? Indeed, the vast majority of brokers to whom these rules would apply had their records tarnished in connection with investor complaints that arose out of the 2008-2009 Credit Crisis. As such, most of these investor complaints have been resolved for upwards of two years.
In a similar vein, how will the new rules affect a broker named in a concluded investor lawsuit, who, under the current rules, may still seek expungement irrespective of whether the investor lawsuit is still pending?
Surely, FINRA will have to give brokers caught in such circumstance some recourse. Or will it?
For more information about this topic or related topics, please Email Attorney Patrick Mahoney.
**This article is intended for informational purposes only and does not constitute legal or investment advice. Any views expressed are those of the author only.**