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FINRA's Troublesome Rule to Keep Clients Out of Expungement Requests

FINRA's Troublesome Rule to Keep Clients Out of Expungement Requests

Why FINRA’s proposed rule to prohibit firms from demanding clients don’t oppose broker’s records being expunged will change nothing.

On February 13, 2014 FINRA issued a press release announcing its approval of a rule that would “prohibit firms and associated person from conditioning settlements of customer disputes on, … an agreement not to oppose a request to expunge information from an associated person’s Central Registration Depository (“CRD”) record.”

The proposed rule explained:

When a customer files a lawsuit against a broker-dealer, the allegations brought by the customer are reported on the underlying broker’s CRD record, which, in turn, appears on the underlying broker’s publicly available BrokerCheck record.

Publicly available references to customer complaints, of course, negatively impact the underlying broker’s reputation. The only way for a broker to have reference to a customer complaint removed or “expunged” from their record is to go through FINRA’s formal “expungement” process. This process requires the broker to prove to a panel of FINRA arbitrators that either: (1) the customer complaint is false; (2) that the broker was not involved in alleged sales practice violation; or (3) that the claim was impossible or clearly erroneous.

Importantly, if the broker chooses to try to remove reference of the customer’s lawsuit from his or her record, the customer who filed the complaint has a right to “oppose” the broker’s expungement request. In other words, the customer may (but does not have to) argue before the FINRA arbitration panel all the reasons why the broker should not have reference to the lawsuit removed from the broker’s record.

To be sure, the broker’s chances of having his or her record cleared increase significantly if the customer does not to oppose the broker’s attempt to clear his or her record.  This gives brokers an incentive to take steps to ensure that the customer does not hamstring that effort.

One way to ensure that the customer will not obstruct a broker’s attempt to have the customer complaint removed from their record is to condition settlement of the customer complaint on the customer’s promise not to oppose the broker’s effort to earn expungement. For instance, suppose a customer files a lawsuit alleging that the broker-dealer made an unsuitable investment recommendation. The broker-dealer offers to settle the case for $100,000, but only if the customer promises not to oppose or obstruct the broker’s attempt to have reference to the lawsuit removed from his record.

FINRA’s suggested rule would prohibit such conditions.

Why the rule is inconsequential:

Though the rule gives the impression that FINRA is taking yet another hardline on the expungement process, from a practical standpoint, the rule is form over substance and will change nothing.

In my experience representing both firms and brokers in customer-initiated FINRA arbitrations, I have never conditioned a settlement on an agreement from an investor not to obstruct a broker’s attempt to clear his or her record.  That’s not to imply that the practice does not occur (though I bet it happens rarely). And I admit that such a condition benefits the broker subject to it because it guarantees that no one will try to sabotage their attempt to have their record cleared.

But FINRA’s press release proposing the rule gives the perception that firms unjustly “force” investors into agreeing not to oppose their broker’s effort to absolve his or her record, thus clearing the way for financial advisors, otherwise underserving of expungement, to easily wipe their slates clean 

Reality, however, presents a small problem.  By and large, investors could not care less whether or not the underlying broker to their lawsuit moves to have his or her record cleared after the investor has agreed to settle and dismiss their complaint.  And no rule will change that attitude.  Condition or no condition, investors who settle their lawsuits before formal arbitration (similar to a trial in court) almost never oppose expungement requests in first place, and the reasons behind this attitude are purely financial. 

First, when a case settles, the investor generally receives a check from the firm as compensation for both their alleged losses and dismissal of their complaint.  So, from the investor’s perspective, as long as they receive monetary compensation from the firm to settle their lawsuit, it generally makes no difference whether or not the broker later tries to remove reference to the lawsuit from their record.  Why would it?  The investor has been compensated.  What the broker does next is of no consequence.

Second, opposing broker expungement requests costs investors time, money and legal resources.  Why then, under any scenario, would an investor choose to spend their time and resources opposing a broker’s attempt to clear their record when the firm has already compensated the investor for their alleged losses? They wouldn’t, and don’t.

Third, the firms have no incentive to condition settlement on a promise not to oppose expungement because to do so would undermine the firm’s priorities.  The firm’s goal is to resolve underlying customer complaints in a manner that fits the firm’s best interests.  This includes ensuring the case is handled as efficiently and cheaply as possible.  This objective almost always comes at the expense of the underlying broker’s record. 

Consider the following hypothetical.  An investor agrees to settle a lawsuit she initiated against XYZ firm for $100,000.  The firm budgeted $400,000 to settle the case.  Disclosure of the lawsuit appears on John Doe Broker’s CRD record.  Do you think the firm, who is footing the bill to defend and settle the lawsuit [which is almost always the case], is going to pass up settling for 25% of what it budgeted because of concerns about whether the investor will oppose John Doe Broker’s later attempt to expunge the lawsuit from his CRD record?  No chance.  Similarly, do you think that if the firm cuts the investor a check for $100,000 that the investor will later use that money to pay her lawyer to oppose John Doe Broker’s later attempt to clear his record?  Of course not.  

Conditioning settlement on non-opposition of broker’s expungement request is a valueless bargaining chip.  It’s like offering to give someone a free car with the condition that the recipient promises not to slash its tires.  Nevertheless, FINRA endeavors to create a rule to prevent the practice.  And while the rule will change nothing in a practical sense, the spirit with which FINRA wrote it again sends the message that it will stop at nothing (including passing a futile rule) to maintain its hardline stance on the expungement process.

**This article is intended for informational purposes only and does not constitute legal or investment advice. Any views expressed are those of the author only.**


Patrick Mahoney is an attorney based out of Manhattan Beach, California.  His practice focuses on representation of financial professionals in connection with a wide range of matters including: expungement of customer and employment related disputes from Central Registration Depository (“CRD”) records; litigation arising out of employment and customer disputes; and representation in connection with inquiries from state, federal, and self-regulatory bodies.

Patrick is admitted to practice law in all state and federal courts in California, including the Ninth Circuit Court of Appeals.

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