By David E. Robbins[1]

Since the February 23, 2023 publication in Securities Arbitration Alert of my article “FINRA’s New Expungement Rules – Balancing Interests But Adding Roadblocks,” FINRA filed amendments to those rules and the Securities and Exchange Commission (“SEC”) approved FINRA’s major “modification” to “the current process relating to the expungement of customer dispute information.”[2]   This article explains just what the SEC has approved and the implications for financial advisers seeking such “extraordinary relief."[3]

Highlights From “FINRA’s New Expungement Rules – Balancing Interests But Adding Roadblocks”

1. What’s New? Five Major Distinctions From Normal Arbitrations

• Rules of Repose - The inapplicability of the six year arbitrability rule to expungement requests.
• Agency Selection - The elimination of party selection of arbitrators for “straight-in” requests.
• Unanimous Vote -  The requirement of a unanimous arbitrator decision to grant such relief, instead of one by majority vote.
• Forfeiture - The distinct possibility of the forfeiture of an adviser’s right to expungement.
• State Regulators - The participation by an authorized state securities regulator in “straight-in” arbitrations.

2. The Applicable FINRA Rules: Both Arbitration Codes

In its April 12, 2023 approval, the SEC made this distinction between the two arbitration Codes effected:

• “The Customer Code, which comprises the series of rules governing customer arbitrations, governs expungement requests filed by firms or associated persons during customer arbitrations.”
• “In contrast, the Industry Code comprises the series of rules governing arbitrations for disputes between or among industry parties, such as between a broker-dealer and an associated person, including straight-in requests.”
• “As a result, whether an expungement request is governed by the Customer Code or Industry Code will generally depend on whether the request is filed during a customer arbitration or is a straight-in request filed separately from a customer arbitration.” (p.3)[4]

3. The Three Expungement Grounds – What They Mean

• In its Frequently Asked Questions About the Rule 2080 Expungement Grounds,[5] examples are provided by FINRA.[6]

#1 -The claim, allegation, or information is factually impossible or clearly erroneous.

• The training material states: "The 'factually impossible or clearly erroneous' standard has clear meaning to regulators and public investors. For example, if the evidence shows that the broker was not even employed by the securities firm during the relevant time period, the arbitrators could find that they were erroneously named in the arbitration claim, dismiss the claim against the individual and recommend expungement of any mention of the claim from the CRD record under this "
• The online training module adds: "An example would be if a broker was not employed at the time of issue and was therefore erroneously "

#2 - The registered person was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation, or conversion of funds.

• The training material provides: "The above standard would require an affirmative arbitral or judicial finding that the broker was not involved in any of the activities listed This list of activities is taken from Question 14 of Form U4, which specifies the types of customer complaints that registered persons must report. Therefore, if arbitrators make the required finding, no logical basis would exist for keeping the reported claim on an individual's CRD record."
• The online module states: "These are Form U-4 Reportable Complaints - investment related sales practice violation, forgery, theft, misappropriate or conversion of "[7]

#3 - The claim, allegation, or information is false.

• Here, arbitrators will assess the evidence in the case, make an affirmative finding that the claim. allegation or information is false, and. if warranted, order expungement This is the ground customer attorneys should have the greatest trouble with since it contradicts the allegations in most Statements of Claim.
• The training material states: "This basis for expungement is premised on a finding that the claim, allegation or information given was false. Arbitrators should make such a finding only after considering the merits of the allegations against the broker or securities For example, if the customer alleged that the broker made unauthorized trades and the broker provided evidence contrary to this claim, such as a document signed by the customer directing the trades, arbitrators could find that the claim or allegation was false."
• The online module adds: "Consider the merits of the allegations and evidence contradicting the "

4. Who Decides Expungement Cases? Four Questions Answered

A. What is the Composition of the Panels?

• Special Arbitrator Roster - For all straight-in expungement requests, FINRA will select three arbitrators from the Special Arbitrator Roster, but the parties will not be able to strike and rank a longer list, as they do for all other FINRA
• Regular Panels - For pending customer arbitrations, the typical customer arbitration panel will decide the expungement request unless the case settles or is withdrawn prior to the issuance of an But, in the case of either of those exceptions, three arbitrators from the Special Arbitrator Roster will decide the expungement request in a new, straight-in arbitration (except for Simplified Arbitrations).

B. Why can’t parties select arbitrators for straight-in cases?

• "To minimize the potential for influence in the arbitrator selection process by the associated person and member firm, whose interests may be aligned, and to help ensure the development of a more complete factual record," wrote FINRA in its initial SEC filing, "the proposed rule change would require NLSS to select randomly the three public chairpersons from the Special Arbitrator Roster.”
• “FINRA believes that the higher standards that the arbitrators must meet to serve on the Special Arbitrator Roster should mitigate the impact of the absence of party input on the selection of In addition. associated persons and member firms would still be permitted to challenge any arbitrator for cause."

C. Who will be on the Special Arbitrator Roster?

• Public arbitrators who are eligible for the chairperson roster, who have successfully completed enhanced expungement training and have served as an arbitrator through Award on at least four customer arbitrations in which a hearing was

D. What does training consist of?

• "The public chairpersons must have evidenced successful completion of, and agreement with, enhanced expungement training provided by FINRA, which will be expanded for arbitrators seeking to qualify for the Special Arbitrator Roster," wrote FINRA in its initial SEC filing.
• FINRA added: "This would allow FINRA to further emphasize with the arbitrators on the Special Arbitrator Roster the unique, distinct role they play in determining whether to issue an Award containing expungement relief and that expungement should be issued in limited circumstances and only if the arbitrators unanimously find that the information to be expunged is factually impossible, clearly erroneous or false, or that the associated person was not involved in the alleged "

5. New Procedural Hoops

 A. Request or Forfeit - In a customer arbitration in which the financial adviser is a named Respondent, the request must be contained either in the Answer (within 45 days upon receiving the Statement of Claim) or by separate pleading (to be submitted no later than 60 days before the first scheduled hearing).

Warning: Failing to do this will result in an adviser’s forfeiture to request expungement.

B. On-Behalf of Requests - If the person is not a named Respondent in the customer arbitration and a party (e.g., brokerage firm) wishes to have that panel decide the request, the so-called "unnamed person" must sign a FINRA Dispute Resolution Services submission form agreeing to be part of the arbitration, along with the requesting party. The "on-behalf of" request must be filed no later than 60 days before the first scheduled

C. Caveat - The "unnamed person" is not required to take part in the customer arbitration for expungement purposes and may instead file a separate, straight-in case before a Special Arbitrator In this instance, the "unnamed person" - unlike a "named person" - would not forfeit his/her right to seek expungement.

D. What Are The Six Things That Must Be Contained In All Expungement Requests?

1. The applicable filing fee under the Code;
2. The CRD number of the party requesting expungement;
3. Each CRD "occurrence" number that is the subject of the request (and which appears on the adviser’s FINRA Professional Gateway report,[8] not found in the BrokerCheck Report[9]);
4. The case name and docket number associated with the customer dispute information;
5. An explanation of whether expungement of the same customer dispute information was previously requested and, if so, how it was decided; and,
6. Which of the three grounds for expungement apply and why.

E. What are the Seven Restrictions on Filing Straight-In Expungement Requests?

1. Prior Arbitration: A panel held a hearing to consider the merits of the associated person's request for expungement of the same customer dispute information.
2. Res Judicata: A court of competent jurisdiction previously denied the associated person's request to expunge the same customer dispute information.
3. Pending Action: The customer arbitration, civil litigation or customer complaint associated with the customer dispute information is not
4. 2 Year Rule of Repose for Actions: More than two years have elapsed since the customer arbitration or civil litigation associated with the customer dispute information has closed.
5. 3 Year Rule of Repose for Complaints: There was no customer arbitration or civil litigation associated with the customer dispute information and more than three years have elapsed since the date the customer complaint was initially reported to the CRD system.
6. Forfeiture: A named person is prohibited from seeking expungement because he/she did not request it in the customer arbitration pursuant to Rule 12805(a)(l)(A).
7. Regulatory Action -  In its April 2023 amendment to the Initial Filing with the SEC, FINRA added this seventh restriction: An associated person shall not file a claim requesting expungement of customer dispute information from the CRD system against a member firm at which the person was associated at the time the customer dispute arose if the customer dispute information involves the same conduct that is the basis of a final regulatory action taken by a securities regulator or self-regulatory However, if the person is successful at appealing a final regulatory action, he/she may file a claim requesting expungement involving the same conduct that is the basis of the final regulatory action, provided that the request is not otherwise ineligible for arbitration, including time barred. ^[10]

F. An ironic twist to the time restrictions:

• Claimants can bring an arbitration as long as the arbitrators find that the six-year rule of arbitration eligibility has been complied with - as provided in Rules 12206) and
• But not straight-in expungement Claimants; they are bound by either the two-year or three-year rules of
• What happens if the financial adviser brings a successful straight-in expungement case and wins? Does that prevent the customer from thereafter bringing a case?

No, according to FINRA's Initial Filing: "As a result of this six-year eligibility rule, a customer arbitration may be filed after an associated person has filed and received an Award in connection with a customer complaint associated with the customer arbitration.

To avoid unfairly impacting a customer arbitration filed after a panel has issued an Award on a request to expunge a customer complaint associated with the customer arbitration, the proposed rule change would provide that a prior expungement Award shall not be admissible in the customer arbitration.

6. Third-Party Participants – Old Guests and a New One (Since the Old Ones Rarely Showed Up)

• Customers have always been encouraged to participate in expungement hearings, but few do - especially after they settle. The new rules make it easier for them to play an important role and provide for a new spokesperson whether they appear or not.
• For the first time in FINRA arbitration a non-party (an "authorized representative of state securities regulators") may receive all of the arbitration filings and take an active role at straight-in hearings.

A. Notification to Customers: The new rule requires the financial adviser and the Director to notify all customers whose customer arbitrations, civil litigations or customer complaints are a subject of the expungement request, of the time, date and place of any prehearing conferences and the expungement hearing. (It is hoped that the Director will also notify their counsel-of-record.)

B. Notifications to State Securities Regulators: Notification by the Director would help, in FINRA's opinion, to ensure that they are timely notified of expungement requests. In its Initial Filing, FINRA stated that, at the hearing, arbitrators should allow customers and their representatives to appear, customers to testify (telephonically, in person, or by other method), to introduce documents and evidence, to cross-examine the associated person or other witnesses called by the party seeking expungement and to make opening and closing statements.

C. What is the extent of the regulator's participation? According to FINRA's Initial SEC Filing, "The authorized representative will be permitted to: (1) introduce documentary, testimonial or other evidence; (2) cross-examine witnesses; and, (3) present opening and closing arguments if the panel allows any party to present such arguments. The other persons appearing at the expungement hearing could state objections to the authorized representative's evidence and cross­examine the authorized representative's witnesses."

D. Why is FINRA permitting such participation?

• While FINRA and the SEC expanded on this issue in subsequent filings, in its Initial Filing, FINRA gave these reasons:  "Allowing an authorized representative to attend and participate in straight-in requests may provide meaningful opposition to the expungement request, which might otherwise be unopposed, and thus help create a more complete factual record for the panel to rely upon to decide the expungement request.”
• “NASAA and state securities regulators have a shared interest with FINRA in protecting the integrity of the information contained in the CRD system, as it is a crucial tool in their registration and oversight responsibilities."
• It also will no doubt have a chilling effect on advisers seeking

7. The Unanimous Award and What Happens Next

• Other Cases - FINRA Awards are decided by majority vote by Customer Code Rule 12904 and Industry Code Rule 13904. All FINRA disciplinary decisions are also so enforceable by Rule 9268. Until the new rules, that was the rule for all expungement requests.
• Outlier – Now, however, arbitrators may not grant expungement requests by majority vote; they must be unanimous. Nor can the granting of the request just cite one or more of the three grounds for expungement; more is required.
• How Come? According to its Initial SEC Filing, "FINRA believes that this change would help protect the integrity of the information in the CRD system and help ensure that the expungement process operates as intended - as a remedy that is appropriate only in limited circumstances in accordance with the narrow standards in FINRA " In addition, "The panel's explanation must be complete and not solely a recitation of one of the FINRA Rule 2080(b)(1) grounds or language provided in the expungement request. The panel's explanation should identify any specific documentary, testimonial or other evidence on which the panel relied in awarding expungement relief."
• The SEC Speaks – The SEC added this justification for approving the unanimous vote rule: “Requiring a unanimous decision will help enhance the integrity of the information in the CRD system by helping ensure expungement will only be awarded when there is no disagreement among the arbitrators that the factual record supports it. The importance of the CRD system extends to all aspects of regulation of broker-dealers and registered … For these reasons, the importance of the integrity of information in the CRD system militates against awarding expungement in circumstances where there may be disagreement about the merits of a claim.” (pp. 126 – 127 of the SEC’s Approval)

 

• After the Request is Granted

In its April 2022 Discussion Paper on Expungement (see endnote 2), FINRA dealt with the expungement process after a favorable Award is issued. "FINRA will not expunge customer dispute information from the CRD system based on an arbitration Award unless that Award is confirmed by a court of competent jurisdiction."

When such an Award is received by FINRA and before seeking its confirmation in a court of law as a judgment, FINRA should be requested by the financial adviser to waive participation in the court Effective March 16, 2023, FINRA will no longer accept Rule 2080 waiver requests via email.  All waiver requests and supporting documentation must be submitted via an online form that can be accessed through the Rule 2080 FAQ page.[11] Refer to the FAQs, specifically Question 7, for more information and tips on submission and for logging into the new system.

 

Key Take Aways From FINRA’s Second SEC Filing and the SEC’s Approval Release 

1. FINRA’s April 3, 2023 19-Page Letter and 49-Page SEC Filing

A.    Support – “PIABA and PIABA Foundation stated their support for the Proposal and recommended that the SEC approve the Proposal. NASAA generally supported the Proposal, but also suggested one modification [that was thereafter contained in the amended filing]” (p. 3 of Letter)

B.     No Compulsion – “FINRA does not believe customers should be compelled to attend or participate in a separate proceeding to decide an expungement request after the customer has resolved their arbitration claim or civil litigation.” (p. 6 of Letter)

C.     No Intervention – “If the associated person is neither a party to the arbitration nor the subject of an on-behalf-of request by another party to the arbitration, FINRA continues to believe that the associated person should not be able to intervene in the customer's arbitration to request expungement” (p. 8 of Letter)

D. Making Sure The Financial Adviser Knows of Customer Arbitrations and Complaints

Arbitrations

• “There could be instances when associated persons may not be aware that a customer arbitration has closed, and that the two-year time limit for requesting expungement of customer dispute information has begun to run.”
• “Accordingly, FINRA will update the cover letter that is provided by Dispute Resolution Services (DRS) to Respondents once a Statement of Claim has been filed ("cover letter") to explain that:

(a) an associated person is prohibited from filing a straight-in request while a customer arbitration or civil litigation associated with the customer dispute information that is the subject of the straight­in request is pending;

(b) an associated person is permitted to file a straight-in request within two years of the close of a customer arbitration or a civil litigation associated with the customer dispute information, unless such request is barred under the Industry Code; and,

(c) associated persons may remain apprised of the status of the customer arbitration, including case closure, by contacting the parties to the arbitration or DRS.^”

• “FINRA will publish guidance on its website about the changes to the Codes that will include information about how associated persons can remain apprised of the status of a customer arbitration, including through contacting DRS.” (pp. 9 – 10 of Letter)

Customer Complaints

• “As a result of the three-year time limitation, an associated person may be prevented from filing a request for expungement of customer dispute information because the member firm's investigation of the customer complaint has not concluded and, therefore, the customer complaint associated with the customer dispute information has not closed.”
• “FINRA believes that the three-year time limitation would generally provide sufficient time for firms to complete their investigation of the complaint, and for associated persons to develop a sense of whether the complaint may evolve into an arbitration or civil litigation and to gather the necessary resources and determine whether to request ”
• “In the event that an associated person is prevented from filing a request for expungement of customer dispute information in the DRS arbitration forum because of the three­year time limitation, the associated person could seek a court order directing expungement of the customer dispute information. (pp. 10 – 11 of the Letter)

E. The Added Restriction On Filing – NASAA’s Request

• An associated person will not be permitted to file a claim requesting expungement of customer dispute information from the CRD system “if the customer dispute information involves the same conduct that is the basis of a final regulatory action taken by a securities regulator or self-regulatory ”
• “However, if an associated person is successful at appealing a final regulatory action, the associated person may file a claim requesting expungement of the customer dispute information involving the same conduct that is the basis of the final regulatory action, provided that the request is not otherwise ineligible for arbitration, including time barred.” (p. 12 of Letter)

2. An Intriguing Coda

The SEC’s approval of these new rules will not end FINRA’s desire to adapt the process to what it may see as problematic developments.  In the letter’s conclusion, FINRA made this intriguing statement:

• FINRA will continue to evaluate whether there are other ways to further strengthen the current expungement process, including:

1. whether a panel from the Special Arbitrator Roster should be required to decide an expungement request in simplified arbitrations,
2. whether to allow state securities regulators to attend and participate in separate expungement-only hearings in simplified arbitrations and
3. whether to require that a panel find that the evidence presented in support of an expungement request meets a clear and convincing standard of proof in order to issue an award containing expungement relief.” (pp. 18 – 19 of Letter)

2. The SEC’s April 12, 2023 158 Page Approval

A. No Intervening in Customer Arbitrations to Request Expungement

• The rule change provides “that if an associated person is not a party to a customer arbitration (i.e., they are an unnamed person), and no party to the customer arbitration requests expungement on their behalf, the unnamed person would be prohibited from intervening in the customer arbitration to request expungement.”
• “Instead, the unnamed person would be able to file the request as a new claim against the member firm at which the person was associated at the time the customer dispute arose under proposed Rule 13805 under the Industry Code, and a panel from the Special Arbitrator Roster would decide the request.” (p. 19 of Approval)

B. Notifications to State Securities Regulators

• FINRA will be required “to notify state securities regulators, in the manner determined by the Director in collaboration with state securities regulators, of an expungement request within 15 days of receiving an expungement FINRA stated that the notification requirement would help ensure that state securities regulators are timely notified of expungement requests.” (p. 45 of Approval)

C. Attendance and Participation of an Authorized Representative in Straight-in Requests

• “The rule change would provide a mechanism for an authorized representative of a state securities regulator to provide [his/her] position or positions on an expungement request in writing or by attending and participating in the expungement hearing in person or by video The rule change would limit attendance and participation by an authorized representative to straight-in requests.”  (pp. 45 – 46 of Approval)
• “If the Director receives notification from an authorized representative no later than 30 days after the last answer is due that the authorized representative intends to attend and participate in the expungement hearing, the proposed rule change would require the Director to notify the authorized representative of the time, date and place of any prehearing conferences and the expungement ” (p. 46 of Approval)
• “FINRA acknowledged that in person attendance and participation by an authorized state representative may be limited given state resource constraints. FINRA pointed out that the proposed rule change provides low-cost options to help facilitate state participation; specifically, that it would permit the authorized representative to attend and participate via video conference or submit a state’s position in writing.^”
• “The Commission believes that permitting attendance and participation by state securities regulators in straight-in expungement proceedings, which have a higher likelihood of proceeding unopposed, and providing state regulators low-cost options to do so, will enhance the straight-in expungement Specifically, including state securities regulators and providing them with access to documents relevant to the expungement request provides them the opportunity to fulfill their own regulatory obligations, while at the same time increasing the likelihood that the panel in an expungement proceeding will hear evidence from multiple viewpoints, thus allowing the panel to make more informed decisions.” (pp. 91 – 92 of Approval)

Conclusion

In its approval of these important procedural changes to the expungement process, the Securities and Exchange Commission stated it best:

• “After careful review of the proposed rule change, the comment letters, and FINRA’s responses to the comments, the Commission finds that the proposed rule change is consistent with the requirements of the Exchange Act and the rules and regulations thereunder that are applicable to a national securities association.” (p. 55 of Approval)
• “The Commission finds good cause to approve the proposed rule change.” (p. 156 of Approval)

While it has been said that FINRA Dispute Resolution Services would prefer not to be involved in “the expungement business,” with these new rules, it has nevertheless done so in a carefully considered, clearly articulated and fair manner.

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ENDNOTES

[1] © 2023 David E. Robbins. of Kaufmann Gildin & Robbins LLP [www.securitieslosses.com] is a long time member of the board of this publication. He represents investors, brokers and firms and is the author of Securities Arbitration Procedure Manual and the Securities Arbitration Practice Commentary for McKinney's Consolidated Laws of New York.

[2] FINRA’s April 3, 2023 Rule Filing With the SEC: https://www.finra.org/sites/default/files/2023-04/sr-finra-2022-024-partial-amendment-2.pdf ; FINRA’s  April 3, 2023 Comment Letter to the SEC: https://www.sec.gov/comments/sr-finra-2022-024/srfinra2022024-20163319-333785.pdf ; and, SEC’s April 12, 2023 Approval of Rule Changes  - https://www.sec.gov/rules/sro/finra/2023/34-97294.pdf . FINRA’s 2022  Discussion Paper on Expungement can be found at https://www.finra.org/sites/default/files/2022-04/Expungement_Discussion_Paper.pdf

[3] See April 3, 2023 letter from FINRA to SEC [endnote 2: “FINRA is concerned that the current expungement process is not working as intended as a remedy that is appropriate only in extraordinary circumstances in accordance with the narrow standards in FINRA rules.” (p. 3)

[4] See: Customer Code - Rule 12805: Requirements arbitrators must meet to issue an expungement Award containing expungement of customer dispute information; Industry Code - Rule 13805: "Straight-In Request" requirements.; and, Customer Code - Rule 12800(d) - Expungement requests in "simplified customer arbitrations." https://www.finra.org/arbitration-mediation/arbitration-rules . Also see: FINRA Rule 2080:- Obtaining an Order of Expungement of customer dispute information from the Central Registration Depository ("CRD"). https://www.finra.org/rules-guidance/rulebooks/finra-rules/2080

[5] https://www.finra.org/registration-exams-ce/classic-crd/faq/finra-rule-2080-frequently-asked-questions

[6] https://www.finra.org/rules-guidance/rulebooks/finra-rules/2080

[7] https://www.finra.org/sites/default/fi1es/form-u4.pdf

[8] FINPRO: https://www.finra.org/registration-exams-ce/finpro

[9] https://brokercheck.finra.org/

[10] See p. 12 of FINRA’s amended filing of April 3, 2023 [endnote 2].

[11] https://www.finra.org/registration-exams-ce/classic-crd/faq/finra-rule-2080-frequently-asked-questions