On January 15, 2014, Patrick Mahoney wrote an open letter to Linda Fienberg in response to the Public Investors Arbitration Bar Association’s study concerning broker expungement (the “Study”). In short, Mr. Mahoney’s letter points out how the Study has contributed to the misperception surrounding the expungement process.
The text of the letter is included below. Or, you can click HERE to download a PDF copy of the letter.
January 15, 2014
Re: Open Letter – The State of the Expungement Process
Dear Ms. Fienberg,
I am an attorney based out of Manhattan Beach, California. I routinely represent FINRA Registered Representatives (“Reps”) in a wide range of areas, chief among them, expungement matters. I have represented dozens of Reps in this capacity. In August 2013, InvestmentNews Magazine ran an op-ed piece that I authored concerning the expungement process from the Reps’ perspective. I have enclosed a courtesy copy of that article for your review.
With that backdrop, I sincerely hope you read and consider this letter as it relates to the state of the expungement process. The public perception of expungement is severely misunderstood. This misunderstanding has spread not only the general public, but more importantly, to the arbitrators before whom I appear to advocate for my clients. Consequently, please let this letter serve as an alternative viewpoint that I hope generates objective discussion that you and others will consider as FINRA works towards revamping the expungement process.
The swell of negative sentiment resulting from the findings of the Public Investors Arbitration Bar Association’s (“PIABA”) recent study on expungement (the “Study”) inspired me to write you directly. As you are aware, the Study showed that arbitrators tend to grant a drastically disproportionate amount of expungement requests in cases that settle (roughly 90%), compared to those that are denied. A courtesy copy of the Study is enclosed.
In close proximity to the release of the Study, FINRA released its “Notice to Arbitrators and Parties on Expanded Expungement Guidance” (the “Notice”). The Notice asserted that expungement is an extraordinary remedy and further urged arbitrators to grant expungement “only when it has no meaningful investor protection or regulatory value.”
The closeness in timing between the Study’s release and FINRA’s release of the Notice, leads me to believe that the Study inspired the Notice.
The Study, coupled with the Notice, has garnered national attention from a host of investment publications. For example, on October 18, 2013, the Wall Street Journal ran the article Stockbroker Requests to Scrub Complaints Are Often Granted, and on November 7, 2013, Businessweek ran the article Investment Brokers Find it Easy to Edit their Regulatory Records. Each article highlighted the general, yet misplaced consensus that the alleged disproportionate rate of successful expungements following settlement misleads investors as to the true state of a Rep’s disciplinary record.
On June 10, 2013, the New York Times likewise ran the article A Rise in Requests from Brokers to Wipe the Slate Clean, which also highlighted this misplaced outlook on the state of expungement. The op-ed piece I have enclosed served as a response to that New York Times article.
In sum, the consensus concerning expungement is wildly misunderstood. And unfortunately, the Study has rendered flawed results that have exacerbated this misunderstanding.
II. THE BASIS FOR THE MISPLACED PERCEPTION OF THE EXUNGEMENT PROCESS.
A. The Study Fails to account for all denied expungement requests.
As a preliminary matter, the Study fails to account for all denied expungement requests, which completely undermines its conclusion that FINRA grants more than 90% expungement requests in cases that settle. PIABA generated its Study using publicly available arbitration awards where it culled all awards that involved an expungement request between 2007 and 2011. From this collection, the Study counted those awards where the panel granted expungement, and those where it denied expungement. The conclusion showed that panels grant expungement requests upwards of 90% of the time when cases settle. But in cases that are tried on the merits, arbitration panels deny expungement requests at a drastically higher rate.
1. FINRA does not always render an arbitration award for denied expungement requests.
The fundamental problem with this conclusion, however, is that FINRA does not always render an arbitration award when a panel denies an expungement request after a case settles. In my experience, this happens in the following circumstance:
1) The underlying arbitration settles;
2) The party or non-party who wishes to seeks expungement asks FINRA to “hold” the panel so that he or she may seek expungement;
3) The Panel holds a hearing on expungement and denies the request.
In this situation, FINRA, in my experience, informs the Rep by letter that the panel denied his or her expungement request—not by formal arbitration award.
2. The Study cannot account for expungement requests denied by letter rather than arbitration award, exposing a material flaw in in the Study’s statistics.
The Study cannot account for all expungement requests denied by letter because FINRA only maintains a public record of expungements denied by formal arbitration award. As such, because there are an untold amount of expungement requests denied by letter, the Study’s conclusion that 90% of expungement requests are granted in cases that settle is incorrect.
I reached out to PIABA members about this oversight but was told that FINRA’s practice of notifying Reps of their denied expungement requests by letter as opposed to preparing a formal arbitration award “no longer occurs,” and in any event was not “material to the statistics.”
On the contrary, this oversight is material to the statistics. For example, the Study indicates that in 2011, FINRA only denied three expungement requests where the parties stipulated to an award or settled. To put this figure into context, if the Study only accounted for my own experience with expungements denied by letter, the 2011 denied expungement statistics for settled cases would increase 100%.
Accordingly, neither FINRA, nor the court of public opinion can, in good faith, rely on the Study as the basis for, or even as a contributing factor to any determination on the effect expungement has on investor protection without first accounting for this unknown quantity of denied expungement requests. The results of the Study should likewise not be used to draw the conclusion that arbitration panels simply “rubber stamp” all expungement requests in cases that settle.
B. Claimants’ current litigation strategy is also attribibutable to any rise in granted expungement requests.
1. Claimants intentionally refrain from naming involved Reps as parties to their lawsuits.
Even assuming the statistics from the Study accounted for expungements denied by letter, it failed to acknowledge one of the largest contributing factors to approved expungement requests. That is, Claimants often intentionally refrain from naming the underlying broker of record as a respondent to the actions they bring, which works to facilitate the unnamed Rep’s ability to subsequently earn an expungement award.
(a) Claimants have an interest in not naming Reps as parties to their FINRA lawsuits because Reps are viewed as a hindrance to settlement.
Fundamentally, cases are more easily settled if there is only one respondent. This holds true particularly where the only respondent a deep-pocketed broker-dealer who would more often prefer to settle a case rather than incur the litigation costs associated with trying the case.
The involved but unnamed Rep, on the other hand, who would be more inclined to fight the allegations because his or her reputation is at stake (vis-à-vis his or her amended CRD record), is excluded almost entirely from the litigation with no standing to defend against the customer’s allegations. But as further expanded upon below, the Rep’s CRD record nevertheless becomes tarnished irrespective of whether or not he or she is a named respondent.
Accordingly, eliminating the Rep from the litigation removes one of the most significant hurdles to settlement, but notably increases the Rep’s chances of subsequently earning expungement if pursued.
(b) The data from the Study shows an exponential increase in FINRA cases where Claimants fail to name to a Rep as a respondent.
The data from the Study backs up this trend of intentionally failing to name the underlying Rep in a customer-initiated FINRA action.
According to the Study, in 2007 (the first year of data that the Study collected), out of 152 cases, all but 4 named a Rep as a respondent. Put differently, claimants failed to name a Rep as a party to their lawsuits less than 3% of the time.
But a change in strategy emerged that coincided with a 2009 FINRA rule change concerning CRD record reporting. Before 2009, a customer complaint only appeared on a Rep’s CRD record if the customer named the Rep as a respondent to a FINRA matter. But following FINRA’s release of Regulatory Notice 09-23 (“RN 09-23”), FINRA required CRD record disclosure of customer complaints even if the customer did not name the Rep as a party to a FINRA action.
The rule change enabled claimants to FINRA actions to avoid naming the broker of record to their lawsuits—bypassing a significant settlement obstacle. At the same time, the rule change ensured that the lawsuit nevertheless would be reflected on the underlying broker’s CRD record.
The Study’s data clearly displays this abrupt strategy change. In 2009 there was a marked increase in cases where claimants refrained from naming the underlying broker. Out of roughly 525 cases the Study examined in 2009, claimants refrained from naming a broker as a respondent 142 times. Indeed, in two years, the percent of cases where brokers were not named as parties increased from 3% to roughly 27%.
The trend continued through 2011. Out of 261 cases that the Study reviewed during that year, the claimant refrained from naming a broker in 116 cases. In other words, claimants did not name a Rep as a party to their lawsuits in 44% of cases in 2011—another 17% increase from two years earlier. Though the Study did not perform any analysis for 2012 or 2013, it stands to reason that this trend of intentionally not naming a Rep as a party to FINRA lawsuits continues.
From the brokers’ perspective, cases that previously had no effect on their CRD record, suddenly were disclosed. The same standard to earn expungement (outlined in FINRA Rule 2080) applied irrespective of whether or not the broker was a named party to the lawsuit. And again, from a practical standpoint, the odds that a Rep earns an expungement recommendations increases when he or she is not a named party to the action.
Accordingly, if Claimants wish to use the Study as a mechanism to support the conclusion that Reps are too easily earning expungement awards, Claimants should do more to ensure that Reps’ records stay tarnished by either naming Reps as parties to FINRA lawsuits, or by opposing their subsequent expungement requests. But as further outlined below, absent some incentive to use their time and resources to oppose expungement requests or name the Reps involved with their claims, claimants likely will not change this practice
2. Claimants’ should assert unambiguous allegations directed against the Reps involved in their FINRA lawsuits.
Additionally, if Claimants’ have an interest in decreasing expungement awards in cases that settle, they should assert clear allegations of wrongdoing against the Reps involved in their complaints.
As RN 09-23 note 7 points out, broker-dealers must disclose any customer complaint on a Rep’s CRD record if it makes a good faith (though, totally subjective) determination that the Rep was “involved” in the alleged sales practice violation. This requirement applies even where the customer complaint neither names nor mentions the Rep. (RN 09-23, n. 7.)
Consequently, disclosure of customer complaints must appear on Reps’ CRD records even if the customer complaint did not make a single allegation of wrongdoing against the Rep. In such cases, the Rep understandably has a significantly higher likelihood of earning expungement if he or she spends the time and money to pursue it.
Indeed, FINRA rule 2080(b)(1)(B) allows expungement relief if the Rep can show that he or she “was not involved in the alleged investment-related sales practice violation, forgery theft, misappropriation or conversion of funds.” Accordingly, if the customer complaint makes no allegation of wrongdoing against the Rep, the Rep can argue that fact to support the contention that he or she was “not involved [in any] alleged investment related sales practice violation.”
Put differently, how can a Rep be “involved” in an investment related sales practice violation if the customer does not allege that the Rep did anything wrong, and further does nothing to oppose a Reps’ subsequent expungement request?
Arbitrators tend to agree with this argument and often ask during the course of an expungement hearing how and why the customer complaint was disclosed on the Rep’s CRD record in the first place, when there is no allegation of wrongdoing on the Rep’s part. This question is particularly prevalent in cases where the claimant does not so much as mention the Rep in their lawsuit.
Thus, if Claimants asserted clear allegations directed at an individual Rep, this lack of involvement argument would become significantly more difficult to prove.
3. Claimants have no incentive to oppose a Rep’s subsequent attempt to seek expungement; as such, the notion that Respondents improperly condition settlement upon non-opposition of future expungement requests is a red herring.
The Study calls for a “rule change” that would prevent respondents from “conditioning a settlement upon an investor’s agreement to not oppose expungement…” (the Study at 3.)
This proposed rule change and the context used to promote it, however, draws the improper conclusion that respondents use this settlement condition to coerce claimants into agreeing not to oppose expungement, which, in turn, facilitates the Reps’ path to a clean record. It further infers that but for this condition not to oppose expungement requests, claimants would have actually spent their time and resources preparing expungement opposition papers even after receiving a settlement check.
This conclusion is disingenuous. In the overwhelming majority of cases, it makes no difference to claimants whether or not the Rep involved seeks expungement, especially in cases where the Rep is not even a named party. And again, claimants have no motivation to use their time and resources to oppose expungement efforts when they have already received settlement funds. So, even absent this condition, the claimant in all likelihood would not have opposed expungement in any event.
Thus, the suggestion that respondents use such conditions as a backdoor strategy to facilitate expungement recommendations is incorrect. And even if FINRA created a rule that prohibited this practice, it would do nothing to motivate claimants to spend the money it would take to oppose an expungement request on the heels of receiving a monetary settlement.
Finally, the Study and the media attention it has received has improperly created the perception arbitrators will “rubber stamp” the expungement request of any unsavory, dishonest Rep to the detriment of would-be investors, irrespective of the merits of the underlying case.
As the foregoing showed, however, this perception is wrong. As an initial matter, the Study’s statistic that arbitration panels grant expungement in 90% of cases that settle is categorically flawed. But more fundamentally, claimants, for self-serving purposes, (1) routinely fail to name Reps as respondents to their underlying arbitrations, (2) fail to make any specific allegations as to a Rep’s misconduct, and (3) fail to oppose Reps’ subsequent expungement requests. This litigation strategy, which has become the rule rather than exception, has created an environment that leaves arbitrators no choice but to grant the expungement request of brokers who fall victim to this approach.
Accordingly, any rise in expungement recommendations (flawed statistics notwithstanding) is not necessarily a function of arbitrators who fail to understand how to apply FINRA rule 2080, nor “bad” Reps who exploit loopholes in the system. Rather, any increase is equally, if not more attributable to a combination of FINRA’s CRD record reporting requirements, the standards set forth in FINRA Rule 2080, and the strategies employed by claimants who want short, inexpensive paths to settlement; who further lack any incentive to use their resources to oppose expungement requests.
I sincerely hope FINRA considers this alternative viewpoint as it finalizes its changes to the expungement process. And while investor protection is the ultimate priority, Reps nevertheless deserve a fair opportunity to defend against any allegation that could impact his or her ability to successfully operate in the financial services industry.
Please feel free to contact me with any questions or concerns.
Patrick R. Mahoney
Mahoney, Patrick, The Brokers Case for a Chance at a Clean Record, InvestmentNews Magazine, Vol. 17, No. 31, (August 19-23. 2013).
PIABA Study, Stockbroker Arbitration slates Wiped Clean 9 out of 10 times when “Expungement” Sought in Settled Cases, (October 16, 2013).
 It is unclear why the Study did not include arbitration awards from 2012 or 2013.
 It should also be noted that in my experience defending broker-dealers in FINRA litigation, my clients never conditioned settlement on a claimant’s agreement not to oppose a later expungement.