Bates Research - 02-28-14

FINRA and Expungement

During its February 2014 Board Meeting, FINRA finalized a new proposed rule limiting the use of expungement in the arbitration process.  Proposed Rule 2081, which was submitted to the SEC for review, comment, and approval, would prohibit the practice of seeking claimant's guarantee not to oppose a request for expungement as part of a settlement agreement. 

Concern over an excessive expungement rate was first raised by plaintiff's group PIABA in October of 2013, when they released a study which found that from January 2007 to mid-May 2009 (when a rule change was adopted), expungement was granted in 89% of cases involving stipulated awards or settlement.  After the rule change, and through 2011, they found that the expungement rate in settled or stipulated cases rose to 97%. 

The rule change which came in Notice 09-23 (2009) amended Forms U4 and U5, which both FINRA and PIABA agree led to an increase in brokers seeking expungement because of a new uniform requirement that they report allegations of wrongdoing made by customers even if they were not named as a party in the claim. 

FINRA responded almost immediately to the study, and was quick to point out that while the findings of PIABA's study seemed high, expungements executed during that five-year period amounted to less than 5% of all filed customer disputes.  FINRA also noted that they had provided special guidance on interpreting Rule 2080, which governs expungement, to Arbitrators noting the extraordinary nature of an expungement request and asking them to directly inquire of the parties if they had conditioned settlement on an agreement not to oppose an expungement request. 

After the study was released, two U.S. Senators, Jack Reed (D-RI) and Chuck Grassley (R-IA), sent a letter of inquiry to FINRA Chairman and CEO Richard Ketchum asking him to respond to the PIABA report's conclusions, as well as to answer several other questions.  Ketchum responded to the December 2013 inquiry in January of 2014.  The number one PIABA recommendation was a rule change that prohibited the practice of including expungement in settlement conditions, which FINRA put forward approximately one month later. 

Linda Fienberg, head of FINRA's arbitration unit, had originally suggested that new rules would be forthcoming in April 2014, but the increased scrutiny that this issue has received has obviously shortened the timeline of FINRA's response. 

Two other investor-centric changes were also put forward in the same meeting.  FINRA will seek comment on its proposed change to Rule 2210, which requires that member firms include a link to BrokerCheck on their websites as well as any other online retail-client communications.  The move seeks to expand public awareness of BrokerCheck, a database allowing investors to do background research on firms and/or brokers prior to making an investment decision.

 FINRA also sent the SEC proposed changes to how public arbitrators are classified.  Panels are typically composed of a mix of public and non-public (industry) arbitrators, but FINRA has recently allowed investors to choose all-public arbitrator panels.  FINRA's definition of 'public', however, requires only that individuals who worked in industry had not done so for more than 20 years or in the last five years, and that others who represent industry firms (like attorneys and accountants) had not earned more than $50,000 (or 10% of revenue) in the last two years from industry sources.  The proposed rule change will place more restriction on who can be considered a public arbitrator.

Both of the aforementioned proposed changes to the arbitration process are now currently at the SEC, awaiting approval and adoption sometime later this year. 


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