Thursday, February 08, 2018

NASAA to FINRA: Reforms will help, but expungement remains broken

By John M. Jascob, J.D., LL.M.

State securities regulators have offered qualified support for a FINRA proposal to reform the process for expunging customer dispute information from a stockbroker records in the Central Registration Depository (CRD). In a comment letter regarding FINRA Regulatory Notice 17-42, NASAA President Joseph Borg wrote that FINRA has taken a necessary first step toward short-term solutions that would improve the existing expungement process. NASAA cautioned, however, that the current process remains broken and that stop-gap fixes cannot be applied indefinitely to a “fundamentally flawed” foundation.

Unanimity. As it had in a 2015 comment letter to FINRA, NASAA reiterated its position that expungement should be an extraordinary remedy that is granted solely in limited circumstances. Accordingly, NASAA supports the proposal’s requirements that all expungement recommendations be made unanimously by a three-person arbitration panel. NASAA also supports FINRA’s corresponding proposal to eliminate the option to have a single arbitrator in a simplified arbitration proceeding make an expungement recommendation.

Expungement-only arbitration panels. NASAA also supports a requirement that expungement requests that are not decided during the underlying arbitration dispute be heard by a specialized panel of arbitrators with particular expertise and training. NASAA observed that post-settlement expungement hearings often consist of a one-sided presentation of the facts because investors and their counsel have little incentive to participate after the investor’s concerns have been resolved.

NASAA also supported the proposed qualifications for arbitrators on expungement-only panels, which require public chairpersons that have completed advanced expungement training, are licensed to practice law, and have at least five years of relevant experience. NASAA encouraged FINRA, however, to consult with state regulators when developing the new “enhanced expungement training” program.

Expungement requests. NASAA also supports provisions requiring brokers named as a party in a customer-initiated arbitration to request expungement in the course of the underlying dispute. The lack of timeliness of expungement requests is a significant concern for state regulators, NASAA wrote, given the difficulties in evaluating the merits of a request as more time passes. In the event that a firm does not request expungement on behalf of a broker who is unnamed in a customer arbitration but is the “subject of” the dispute, NASAA supports a requirement that the unnamed broker bring a request for expungement within one year after the closing of the underlying customer case.

Further reforms needed. NASAA believes, however, that wholesale reform is necessary in order to truly fix the expungement process. In NASAA’s view, a workable expungement framework would be built around the following core principles:
  • substantive standards that properly limit the scope of expungement requests; 
  • a mandatory process for expungement requests designed to close loopholes; 
  • increased regulatory participation, including allowing for a regulatory determination regarding the merits of an expungement request; 
  • earlier notices to state regulators; 
  • limitations on the ability of arbitrators to “grant” expungement requests, instead only allowing factual recommendations that are not considered awards; and 
  • preservation of the requirement that a court order the expungement of records prior to the removal of any information from the CRD.

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