By Harry A. Jacobowitz, Esq.*
In a timely move, the Alabama Securities Commission (“ASC”) raises serious questions about the procedure employed in a recent FINRA expungement proceeding, giving the forum some more to consider as it begins focusing on reform of the procedure for excising customer dispute information from brokers’ registration records.
As we reported in SAA 2022-03 (Jan. 27), FINRA President and CEO Robert Cook last January said the SRO would be focusing this year on expungement. More recently, we discussed in SAA 2022-17 (May 5) a 26-page Discussion Paper – Expungement of Customer Dispute Information that FINRA issued on April 28. The Discussion Paper recommended a dual-track approach of adopting expungement reforms contained in SR-FINRA-2020-030, a rule change proposal to reform expungement procedures that FINRA temporarily withdrew in May 2021 (see SAA 2021-22 (Jun. 3)), while at the same time considering new ideas. As if on cue comes word of the ASC’s own interest in the expungement process, news of which we teased in SAA 2022-18 (May 12), while promising a more though review in this issue. Through the good offices of ASC Commissioner Joseph Borg, the Alert has obtained copies of the pleadings. Our discussion here will focus on the ASC’s petition to vacate and what it suggests about deficiencies in the existing process.
The ASC Intervenes in an Expungement Confirmation Proceeding
In Kent Kirby v. UBS Financial Services Inc., FINRA ID No. 21-01152 (Nashville, TN, Sep. 17, 2021), Arbitrator Harvey R. Linder recommended the expungement of five customer dispute occurrences from broker Kirby’s Central Registration Depository (CRD) records. After Kirby filed a petition to confirm the Award in the Circuit Court for Palm Beach County, Florida, the ASC filed a petition to intervene in the confirmation proceeding and an accompanying petition to vacate the Award on February 22, 2022. In the petition to intervene, the ASC argued that it is charged with protecting investors and regulating the securities industry in Alabama, that Kirby is registered to do business as a securities dealer in Alabama, that the integrity of the ASC is critical to protecting investors, and that the ASC therefore has an interest in maintaining that integrity. In addition, the ASC argued that Florida had the same interest. The parties did not oppose the intervention.
A Customer’s Objections
In essence, the ASC seeks to vacate the Award because, in its view, Arbitrator Linder violated the procedural rights of Kenneth Lehman, the only customer to appear at the arbitration hearing and oppose granting expungement relief to Kirby. According to the ASC, based on an affidavit by Lehmann which the ASC attached to the petition to vacate: Lehmann complained that in 2008, when Kirby worked for Merrill Lynch Pierce Fenner & Smith, Inc. (Merrill Lynch), he overconcentrated Kirby’s account in 23 alternative investments, including two Alesco collateralized debt obligations (CDOs). In 2011, Kirby filed an arbitration against Merrill Lynch only, because his attorney advised him that Merrill Lynch was liable for Kirby’s actions. Merrill Lynch settled with Lehmann for $125,000. According to Kirby’s Statement of Claim (as well as his BrokerCheck Report), however, the claim involved only the two CDOs. Lehmann received notice of the telephonic expungement hearing, refamiliarized himself with his case against Kirby, and appeared pro se at the hearing to object.
The Expungement Hearing
The ASC, citing the hearing transcript (also attached to the petition), as well as Kirby’s affidavit, alleged several problems with the hearing, including the following: 1) No one else appeared at the hearing to contest Kirby’s request; 2) Kirby’s attorney mischaracterized Lehmann’s arbitration as involving only the two Alesco CDOs and as not involving Kirby; 3) Before allowing Lehmann to make an opening statement, “Arbitrator Linder falsely stated that Linder was not permitted by “guidance and rules and procedures’ to allow Lehmann to reargue the facts underlying his Merrill Lynch arbitration in Kirby’s expungement hearing,” although “FINRA’s guidance, rules and procedures require arbitrators to consider evidence about the underlying customer complaint;” 4) After allowing Lehmann to give an opening statement and Kirby’s attorney to cross-examine him, the Arbitrator dismissed the customer from the hearing; 5) The Arbitrator allowed Kirby to give unrebutted testimony concerning the merits of Lehmann’s complaint; 6) Kirby perjured himself; 7) The Arbitrator did not allow Lehmann to introduce documents that supported Lehmann’s and contradicted Kirby’s testimony; and 8) “After Kirby concluded his testimony, Arbitrator Linder had only one question for Kirby – why was Lehmann ‘so vehement about your expungement’ and ‘What do you think turned him so much against you?’”
The ASC’s Grounds for Vacatur
It is not for us to judge the credibility of the witnesses, the merits of the expungement recommendation itself or whether vacatur ought to be granted on any ground; in fact, it is worth noting that Lehmann’s losses occurred during the 2008 market crash, which might account for losses in Lehmann’s account regardless of how suitable his securities were. The ASC, though, sought to vacate the resulting Award on the following grounds: 1) The Arbitrator refused to hear relevant evidence by removing Lehmann from the hearing prematurely and not allowing him to introduce documents to supplement his testimony; 2) The Award was procured by fraud, because “Arbitrator Linder reinforced misleading and inaccurate statements made by Kirby’s attorney in opening remarks about the scope and purpose of the expungement proceeding” and Kirby gave perjured testimony; 3) The Arbitrator displayed evident partiality or corruption by allowing Kirby’s attorney to cross-examine Lehmann but denying Lehmann the right to cross-examine Kirby and refusing to question Kirby about Lehmann’s specific allegations himself; 4) The Arbitrator overstepped his authority by misrepresenting and not following FINRA’s guidance to arbitrators; and 5) The Award was in manifest disregard of the law because the Arbitrator “imposed his own brand of ‘industrial justice’ in granting expungement.”
Is Expungement Guidance Enough?
FINRA’s Expanded Expungement Guidance provides, in part:
“In making these determinations, arbitrators should consider the importance of maintaining the integrity of the information in the CRD system…. Given this significant role, arbitrators should ensure that they have all of the information necessary to make an informed and appropriate recommendation on expungement. Thus, arbitrators should request any documentary or other evidence they believe is relevant to the expungement request, particularly in cases that settle before an evidentiary hearing or in cases where only the requesting party participates in the expungement hearing.… It is important to allow customers and their counsel to participate in the expungement hearing in settled cases if they wish to. Specifically, arbitrators should:… 3. Allow counsel for the customer or a pro se customer to introduce documents and evidence at the expungement hearing; 4. Allow counsel for the customer or a pro se customer to cross-examine the broker and other witnesses called by the party seeking expungement; and 5. Allow counsel for the customer or a pro se customer to present opening and closing arguments if the panel allows any party to present such arguments.”
ASC asserts that Arbitrator Linder did not follow some of these instructions, at least by limiting Lehmann’s involvement and arguably by not asking more questions of Kirby to ensure he had “all of the information necessary,” but we point out that such “Guidance,” in its current form, is not mandatory.
Other Lessons Learned
This case raises two other concerns that FINRA should consider addressing. First, Kirby’s BrokerCheck Report makes no mention of the other 21 alternative investments of which Lehmann complained, raising questions about the completeness of FINRA’s CRD records even without expungement and, therefore, whether arbitrators are necessarily getting a complete and accurate account of the customer complaints they are expunging. Secondly, the overwhelming majority of expungement proceedings (about 95% in the last three years by our estimate) are entirely uncontested; yet, it is likely that none of these concerns would have come to light in this case but for Lehmann’s objections and the ASC’s intervention.
(ed: *This Squib was prepared by Harry A. Jacobowitz, President of HAJ Research and Writing LLC. Mr. Jacobowitz, a member of the Pennsylvania bar, and his firm perform legal research and writing for attorneys and handle substantive searches of SAC’s Award database. He can be contacted at firstname.lastname@example.org. **We will keep our readers informed of any further developments in this case of which we learn. ***Among the reforms included in the withdrawn rule were to require “straight-in requests” (i.e., those filed by brokers in arbitrations independent of customer complaints) to be decided by three-member panels composed of randomly chosen arbitrators with enhanced expungement training and to give customers or their representatives the right to cross-examine the broker and opposing witnesses. ****Regardless of the particular merits of its petition to vacate, kudos to the ASC for taking an interest in the integrity of the expungement process.)