SEC Approves Sweeping FINRA Rule Changes That Will Make Expungement More Difficult for Broker-Dealers and Associated Persons

By Seth M. Rosenstein

It is the rare FINRA-registered professional who does not face a customer complaint at some point in their career, and it is rarer still to find one who would not prefer to have customer dispute information expunged from the Central Registration Depository (“CRD”). But on April 12, 2023, the SEC approved changes to the FINRA rules regarding expungements and expungement hearings that will significantly alter how and when negative marks on professionals’ records are removed from the CRD and BrokerCheck.

The substantive and procedural changes were largely due to pressure put on FINRA by customer advocates and state securities regulators to make it more difficult to obtain an expungement. A 2021 PIABA study, for example, revealed that FINRA arbitrators approved 90% of the expungement requests they received.

Concerns About Straight-in-Requests in Particular

While some updates relate to all requests for expungement of customer dispute information, others only apply to each of the two types of hearings through which expungements can be obtained. This includes specific procedural changes to “straight-in-request” arbitration hearings, which are commenced by an associated person separate from a customer-initiated arbitration (as opposed to “on-behalf-of-requests” that are filed at the conclusion of an investment-related customer-initiated arbitration).

FINRA was particularly concerned about issues with straight-in-request arbitration proceedings, which often involve complaints brought and resolved many years before the expungement request. As FINRA expressed in an April 2022 discussion paper, the rule changes sought to address four shortcomings it identified with such hearings:

• The unavailability of documents or information relating to disputes that occurred years prior. FINRA noted that two-thirds of straight-in-requests filed between 2016-2021 were filed more than six years after the customer dispute was initially reported.
• The lack of customer participation in straight-in-requests leading to only one side presenting evidence and testimony.
• The firm named in a straight-in request may have no relevant documents pertaining to the customer dispute because the event occurred while the associated person was employed at a different firm.
• “Arbitrator shopping” by associated persons who make repeated attempts to seek expungement of the same customer dispute.

Changes That Apply to All Expungement Arbitration Hearings

These updates apply to both straight-in-request (FINRA Rule 13805) and on-behalf-of-request (FINRA Rule 12805) expungement hearings:

• Arbitration panels can only issue expungement relief if they unanimously find that:
  • the claim or allegation is factually impossible or clearly erroneous;
  • the associated person was not involved in the alleged conduct; or
  • the claim or allegation is false.
• FINRA must notify state securities regulators of all expungement requests.
• The associated person requesting expungement must appear at the hearing in person or by video conference.
• FINRA must notify involved customers of the time, date, and place of any prehearing conferences and the expungement hearing, advise them that they may attend and participate in those proceedings, and provide access to all relevant documents filed in the matter.
• Panels are authorized to request any evidence the panel members consider relevant from the broker-dealer firm or associated person.
• Panels must explain their rationale in sufficient detail when granting expungement relief.
• Associated persons may not request expungement if a panel previously considered the merits of, or a court previously denied, an expungement request involving the same customer dispute information.
• An associated person who withdraws an expungement request cannot subsequently re-file the request.

Changes to Straight-In-Request Hearings Under FINRA Rule 13805

To address the concerns above about straight-in-request hearings, FINRA made the following rule changes for such proceedings:

• FINRA will not consider expungement requests filed:
  • more than three years after the date the customer complaint was initially reported in the CRD; or
  • more than two years after the customer-initiated arbitration or litigation involving the customer dispute information is fully adjudicated.
• Straight-in requests must be filed against the broker-dealer firm at which the associated person was associated at the time of the events underlying the dispute.
• An authorized representative of a state securities regulator may attend and participate as a non-party in the proceedings to the same extent that a customer could.
• All straight-in requests must be decided by a three-person panel composed of randomly selected arbitrators pulled from a roster of experienced public arbitrators with enhanced expungement training and no significant ties to the industry. Parties cannot:
  • agree to fewer than three arbitrators;
  • strike any of the selected arbitrators;
  • agree to an arbitrator’s removal; or
  • agree to use arbitrators they pre-select.

Conclusion

The SEC’s 158-page notice approving FINRAs proposed rule changes contains several other modifications that impact an associated person’s ability to obtain an expungement, and FINRA has not yet announced an effective date for these changes. We will provide an update when they do. But given that the additional modifications generally make expungement more challenging, industry professionals contemplating an expungement request may wish to proceed sooner than later.

If you have questions about these updates, please contact Seth Rosenstein at Ansell, Grimm & Aaron.