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The Expungement Crusade

Wall Street Breathed a Sigh of Relief when Eliot Spitzer moved into the governor's mansion in Albany. Word was that Andrew Cuomo, New York's newly elected attorney general, had other fish to fry. And, sure enough, he went on to make headlines with probes into the student loan business after taking office in 2007. Well, that reprieve didn't last long. Cuomo's office has quietly launched an assault

Wall Street Breathed a Sigh of Relief when Eliot Spitzer moved into the governor's mansion in Albany. Word was that Andrew Cuomo, New York's newly elected attorney general, had other fish to fry. And, sure enough, he went on to make headlines with probes into the student loan business after taking office in 2007.

Well, that reprieve didn't last long.

Cuomo's office has quietly launched an assault on reps who wish to have their “permanent records” on the Central Registration Depository (or CRD) wiped clean of customer complaints. (The CRD and rep information is available over the Internet to all.) If Cuomo's office is successful, that could have a very real impact on the livelihoods of registered reps who are sued in arbitrations by customers and, at the end of the cases, try to get the customers' complaints removed from their U-4s. New York State Assistant Attorney General R. Verle Johnson apparently believes that retail investor complaints are too easily purged (“expunged”) from a rep's U-4. Since February, Johnson has intervened in seven court proceedings to oppose the confirmation of expungement of investor complaints as recommended by arbitrators. Johnson declined to be interviewed, but this appears to be a policy change instituted by Cuomo.

Johnson won an early victory, convincing a state judge in Buffalo to send the recommendation for expungement back for a rehearing before the arbitrators to “clarify the facts and circumstances” for their expungement recommendation. The ruling stunned lawyers who defend reps against customer complaints, and often get stipulations of expungement in negotiated settlements. These deals are then signed off by the arbitrators, and later ordered by a judge as a matter of course.

The attorney general's new policy alarmed the Securities Industry Financial Markets Association (SIFMA), Wall Street's largest lobbying group, which has filed amicus briefs in two cases pending before judges in New York City. “We wanted to get involved at an early point to lay out the arguments in defense of expungement, to stem the tide of these cases that the New York attorney general is filing,” says SIFMA's Kevin M. Carroll. “Everyone is waiting to see at least where one New York judge comes out on the issue.”

Brian Neville, a lawyer who represents brokers, and specializes in expungement cases, says the new push has made reps reluctant to go to court to get their expungement confirmed because they fear that the petition will be picked up on Verle Johnson's radar screen. At a hearing in April, a baffled Justice Edward J. Lehner asked the attorney general how he was picking and choosing which cases to oppose. Johnson told him, “We have tried to the best of our ability to intervene — to intervene in all of them.”

Not Without Our Permission

Buffalo lawyer Catherine Grantier Cooley and her client, Douglas Parker, of the brokerage firm Sage, Rutty & Co., were among the first to find themselves in Johnson's sights. A former client of Parker's, Alice C. Salzberg, made arbitration claims that Parker had pursued unsuitable investments, but she settled at the first scheduled hearing in September 2006. In that settlement, she signed a stipulated award recommending that her complaint be expunged from Parker's records in the CRD because the panel found that “the claim, allegation, or information is factually impossible or clearly erroneous.” This language tracks one of the three narrow grounds on which arbitrators can recommend expungement under NASD Rule 2130, which was adopted by the SEC in 2004.

Another broker in the same Erie County courthouse had already gotten an expungement — without the attorney general's interference — but Cooley and her client found themselves face to face with the attorney general when they went to court on April 19. “And [the attorney general's] only excuse was, ‘Well, we didn't know about the other case,’” says Cooley. “His initial argument was that arbitrators didn't have authority to direct expungement because it would constitute destruction of state records,” she says. “I have been doing this a long time; it was so early in the new administration, but there was no indication that the brokers were going to get blindsided by this kind of opposition by the attorney general. Nothing at all. It was disturbing.”

Justice Diane Y. Devlin ruled on Parker's case on May 30. Her ruling did not reference Johnson's bold claim that arbitrators had no authority to recommend expungement, but she ruled that “there is not a single fact or circumstance described” to form a basis for the arbitrators' conclusion that the claims were “factually impossible or clearly erroneous.” Of course, a lack of explanation is quite common in arbitration awards; arbitrators have no obligation to explain their reasoning under the current rules.

Parker and Cooley appeared before the arbitrators again on September 17, and Cooley is awaiting a new recommendation on expungement from the arbitration panel.

Making Exceptions

In two cases pending in lower Manhattan, Johnson initially argued that arbitration panels have no power to recommend expungement under any circumstances, but he has since tempered that stance slightly. An arbitrator “does not have the power to destroy the records of the State of New York, which is not bound by an arbitration record,” Johnson told Justice Lehner at an April 27 hearing, leaving the judge baffled. “You're saying the arbitrator has no power to do what the NASD rule allows them to do? That's the argument of the attorney general?” Johnson responded, “Yes, your honor.” Lehner retorted, “No power?” And Johnson explained, “for the reason that he doesn't have the power to order the destruction of property of a non-party to the arbitration.”

At the hearing's end, Lehner urged Michael Kalmus, the lawyer for Mary Ellen Kay, the broker seeking expungement, to get amicus support, and SIFMA got involved in the case. Johnson now “concedes that arbitrators may recommend expungement in extraordinary cases,” according to an August 13 brief filed in the Mary Kay case. (Johnson declined to speak with Registered Rep., and referred calls to a spokeswoman, who eventually provided briefs filed in the cases.)

But SIFMA still opposes Johnson's wide-ranging remaining arguments, which include his assertion that expungement is against public policy as a general matter, and that arbitrators lack the power to grant expungement in any case in which the attorney general is not a party. “If the Court accepts these arguments, Rule 2130 would have no further application in New York, as courts would never confirm an arbitration award granting expungement relief,” SIFMA's brief asserts.

Kalmus was traveling in Israel when contacted by Registered Rep., but responded by email: “The attorney general's arguments have been chameleon-like. Once he raises a specious argument and it is refuted, he modifies his posture … He now claims expungement is appropriate under exceptional circumstances, but has not articulated what those circumstances are.”

In fact, Johnson's claim that a broker's CRD records are also state records is not new. In the 1990s, state securities regulators complained about expungements, asserting that state law did not allow arbitrators to destroy state records. At the time, expungements were being granted based solely on an arbitrators' award, without court approval. In 1999, the NASD imposed a moratorium on these automatic expungements while a new rule went out for comment. The result was Rule 2130, which allows a rep to seek court approval for expungement relief upon an arbitration finding that the customer claim was “factually impossible or clearly erroneous;” or that the rep “was not involved” in the alleged practice; or violation or that the claim is “false.” But critics say arbitrators are too quick to sign off on one of these purported reasons without further inquiry, rubber-stamping an expungement as part of a negotiated settlement.

Too Easy?

The Public Investors Arbitration Bar Association, a lobbying group of plaintiffs' lawyers who represent customers, released a survey on September 24 of 200 “stipulated” awards issued in 2006 — cases that were settled by the opposing parties before the arbitrators made a final ruling. The brokers requested expungement of the customer complaint in 185 of those cases, and received that remedy in 182 of them. And in 130 of those cases — a whopping 71.4 percent — arbitrators granted expungement before any hearing on the merits of the case went forward. In each of these cases, the customer's lawyer has signed off on expunging the broker's record as part of the settlement. But that, according to PIABA President Steven Caruso, a New York lawyer, is part of the problem. “It's the quid pro quo” for any settlement, he says.

In the Mary Kay case, Johnson has argued that the arbitrator “merely adopted, as fact, a fiction that was created in the settlement agreement.” Kay was a rep at Prudential Securities. In April 2004, her client, Loretta D. Abrams, a 63-year-old widow and substitute school teacher, filed a claim alleging that Kay had traded in speculative securities without her authorization, and traded excessively in one account. Abrams sought an award of $450,000.

In May 2005, Abrams and Prudential settled the claims for $155,000, and Abrams agreed to recommend that the complaints against Kay be dropped. In August 2006, an arbitrator signed a stipulated award stating that the “registered person was not involved in the alleged investment related sales practice violation, forgery, theft, misappropriation or conversion of funds,” tracking the exact language in Rule 2130. No hearing was held. Trouble is, Kay is the only Prudential broker mentioned in Abrams's complaint. “Not a single fact is alleged with respect to another natural person,” Johnson points out in his brief. Under these circumstances, Johnson asserts, judicial confirmation of the stipulated award would amount to “a meaningless rubber stamp.”

The position of SIFMA and Kay's lawyer, according to Johnson's brief, has urged Judge Lehner to adopt a “magic words” rule, demanding that the court confirm the expungement relief “so long as the arbitrator invokes one of the basis for expungement set forth in Rule 2130.” Kalmus, Kay's lawyer, disputed the notion that arbitrators merely rubber-stamp expungements at a hearing before Lehner. “I would say in 90 percent of the cases now, the applications for expungement contain some type of submission, some type of telephonic conference, some type of hearing. They are no longer rubber-stamped,” he says. And Carroll, the SIFMA lawyer, says, “There can be informal conversations and other exchanges of information — short of a full-blown hearing — to make the appropriate expungement determination.”

Kay is not a model rep: Her U-4 shows 17 complaints against her, nine that were either settled by Prudential, or resulted in arbitration awards totaling $667,499. Even so, another eight complaints resulted in no payments to the complaining investors. “Some customer complaints have no merit whatsoever,” SIFMA's amicus briefs state. Expungement is supposed to balance the goal of protecting investors from rogue reps against the inevitable harm that such complaints cause to a broker's reputation and ability to make a living.

Those following the attorney general's campaign believe that a case involving UBS Financial Services will render a ruling that Wall Street can view as a guide. The facts in UBS pose a night-and-day comparison to the Mary Kay case: Marshall D. Gibson, a UBS client, filed a February 2006 claim in arbitration against UBS and Karen A. Karrasch, a rep, alleging breach of contract, failure to supervise and suitability claims all related to a Delta Airline convertible bond. Gibson, a trusts and estates lawyer from New Haven, Conn., represented himself in the arbitration, claiming damages of $16,475. After a full-blown hearing, the arbitrator dismissed Gibson's claims, and granted Kurrasch's request for expungement, finding that the claim was “factually impossible or clearly erroneous.”

The hearing conducted in the UBS case does not sway Johnson. “The award gives no indication whether the investor lost the arbitration because he failed to carry the burden of proving his allegations by a preponderance of the evidence, or because the allegations were so frivolous or malicious that there was a basis for finding as a matter of law that the claim never should have been brought in the first place,” his brief asserts. Johnson's various arguments include his contention that expungement is not valid because the attorney general was not a party to the proceeding. He also claims that Rosenberg v. MetLife, a New York Court of Appeals decision that in March held New York-based brokerage firms have “absolute immunity” from damages claims for the statements they put on a broker's records — a case in which the appeals court acknowledged that brokers could get expungements in arbitrations — is “not pertinent” because that acknowledgement did not have direct bearing on the Rosenberg case. (UBS and FINRA declined to comment.)

Too Many Plaintiffs

While lawyers for reps wait for the next shoe to drop in courtroom dramas with the New York attorney general, PIABA is calling on FINRA (the successor to the NASD after its merger with NYSE Regulation) and the SEC to “immediately halt” recommendations of expungement by arbitrators, Caruso says, while the regulators “re-evaluate” the process.

Neville, for one, says PIABA's “quibble about there not being a record is valid,” and believes “there should be a hearing to support the expungement process.” But he adds: “You can't kill a whole process because there is a problem with part of the process. Many claims that are brought are false.” John Singer, of New York's Singer Deutsch, a lawyer who represents both brokers and customers, says most arbitrators will simply “just green light” a request for expungement when presented with a settlement. “The last thing they want to do is to do independent research rather than adhere to the wishes of the parties,” he says. He puts the blame on lawyers for investors: “Too many plaintiffs' lawyers are willing to stipulate to an [expungment] award that's not true just to get a case resolved.”

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