FINRA Releases Arbitration Disbarment Reform Proposal

FINRA’s latest proposal to remove client complaints from broker-dealer records sets up a rule-making debate that is likely to be long and contentious.

FINRA filed its latest rule proposal a year ago under the criticism that the reforms did not go far enough to resolve issues with so-called expungement cases in FINRA arbitration. After releasing a white paper earlier this year signaling its intention to move forward with a potential rule assigning cases to a specially trained group of arbitrators, the regulator Posted a formal proposal on July 29 seeking SEC approval.

The plan raises some concerns in the industry and among lawyers who represent brokers, while drawing widespread praise from customer advocates and state regulators.

“A number of recommendations will improve the process,” said Nicole Iannarone, an assistant professor at Drexel University’s Thomas R. Kline School of Law, who teaches courses on commercial arbitration. She noted that FINRA had included many of the same elements from its previous proposal and said they could have already “reformed the system significantly” last year.

Iannarone and others have called on FINRA to enact more reforms than the latest plan by taking cases out of arbitration and into an administrative process overseen by regulators. Reformers view disbarment cases very differently from financial advisers and wealth managers who argue that the existing system provides brokers with the means to ensure the accuracy of disclosures on BrokerCheck and to remove false claims from their records.

“The proposed changes not only appear to be extremely punitive to the ability of associated individuals to clear their names, but they also appear to subvert the neutrality and autonomy of arbitrators’ ability to determine whether the criteria for disbarment are met,” Doc said. Kennedy, an attorney who represents the councillors. through his firm AdvisorLaw, wrote in an Aug. 9 letter to FINRA that may be the first formal comment filed with the regulator about the 300-page proposal.

What’s in the proposal
FINRA’s latest plan calls for the appointment of arbitrators from a randomly selected group who have received enhanced training on expungement cases, but it would also add a few other major changes to the mix.

In a plan long sought by Reformers, FINRA would bring state regulators into the expungement arbitration process in a formal way by alerting them to cases and allowing them to participate in hearings. The rule would also “impose strict time limits,” such as statutes of limitations, for broker disbarment cases of three years after customer complaints surface on BrokerCheck or two years after any decision in a related arbitration claim. . In addition, it would codify the best practices of existing FINRA guidelines, require arbitrators to unanimously agree to grant any disbarment, and mandate that at least three hear broker cases.

For “many years” FINRA has tried “to balance the interests of securities regulators in having accurate and relevant information to fulfill their regulatory responsibilities; the interests of investors in having access to accurate and meaningful information about associated persons with whom they can entrust their money; the interests of brokerage firms in having accurate information to use in making informed employment decisions; and the interests of the brokerage community in having a fair process to address inaccurate customer dispute information,” according to the proposed rule.

“FINRA is concerned, however, that the current debarment process is not working as intended — as a remedy that is appropriate only in limited circumstances under the narrow standards of FINRA rules,” the regulator said.

Reformers and supporters of the existing system each cite statistics that explain their positions. FINRA’s latest new delisting rule in September 2020 increased the price for brokers to file a claim and led to a substantial drop in the number of cases, according to the regulator. Proponents point out that arbitrators only redacted 4% of 35,000 customer complaints between 2015 and 2020.

On the other hand, the regulator’s statistics show the different success rates in cases involving the full participation of customers, as they are part of a customer’s arbitration case, versus claims by brokers who file their own cases for debarment. These latter “direct” requests resulted in expungements in 84% of cases between 2016 and 2021, compared to 58% in customer arbitration requests, according to figures included in the proposed rule.

Industry stakeholders
State regulators have become one of the most vocal critics of the current system. Alabama Securities Commissioner Joe Borg’s agency filed a lawsuit in Florida state court against FINRA over a bid cancel the write-off of a client complaint from a broker’s file. While their advocacy group, the North American Securities Administrators Association, has expressed support for aspects of FINRA’s latest proposal, its October 2020 commentary letter called the plan mere “procedural improvements that do not address the central problem of the delisting process.”

NASAA is reviewing the new proposal and plans to express its views in a comment letter to FINRA, Chair Melanie Senter Lubin said in an email.

“NASAA’s view is, and has been, that the deletion of customer complaint information is an extraordinary remedy and that, for far too long, the existing deletion process has allowed deletion to occur in ways routine and not extraordinary,” Senter Lubin, who is Maryland’s Securities Commissioner, also said. “Tightening the procedures surrounding erasure requests is essential to ending the continuing threat to the integrity of documents containing critical information investors need to decide whom to entrust with their financial investments and financial well-being. “

Brokerage firms and their industry trade groups are likely to push back against any provisions of the rule that they see as limiting BrokerCheck’s ability to suppress erroneous complaints. An advocacy group for independent brokers, the Financial Services Institute, has pledged to be open to some reform in the past, with caveats. In a comment from 2018 letter Regarding an earlier regulatory notice from FINRA on delisting, FSI asked BrokerCheck to continue to show valid customer complaints, but not false ones. Like NASAA, the FSI is reviewing the potential new rule and has not yet taken an official position.

“We support reasonable and unambiguous restrictions on the removal of truthful and accurate information that is crucial for investor protection, but to be effective they must also provide a means of removing misleading, meaningless or irrelevant information. having no regulatory or investor protection value,” Robin Traxler, FSI’s deputy general counsel, said in a statement.

A matter of time
In some respects, the interests of brokerage firms diverge from those of their registered representatives. The potential time restrictions in FINRA’s latest proposal ignore the fact that many brokers can ignore client complaints for years if a case is settled before arbitration or if they retire or go into a new venture, according to Jenice Malecki, an attorney who represents advisers in disbarment cases. A statute of limitations could take away the right to seek disbarment from some brokers this way, she said.

“Individuals likely to leave the industry don’t necessarily check BrokerCheck daily, weekly or monthly and don’t think about updating their address with a registration system or a former employer they are no longer a part of,” Malecki said. . “The ‘contact’ with brokers is abysmal. Companies want to do what they want to do, having little incentive to notify brokers in cases where brokers are no longer with the business.”

For reformers, however, this time limit will end practices such as brokers repeatedly trying to withdraw the same complaint over and over or searching for it so far down the road that it will not be possible to locate clients. living who might wish to weigh in on the radiation. According to Christine Lazaro, director of the Securities Arbitration Clinic at St. John’s University School of Law, other provisions “codify what is currently only guidance” on the degree to which clients should receive notice and participate in hearings. . “When it’s in the rules, it’s easier for the referees and the parties to find,” she said.

Next steps
Other reformers also applauded the new proposal, with some reservations. The proposal “addresses some of the issues,” but doesn’t address “the big issue, which is whether the expungement is up to arbitration,” said Michael Edmiston, an attorney at Jonathan W. Evans & Associates and current chairman of the client lawyer. organization the Public Investors Advocate Bar Association.

“Long term, this is a regulatory issue that should be addressed from the regulatory side, not from the arbitration side,” he said. “I certainly support this as good progressive steps to eliminate some of the existing abuses in the process, but everyone, including FINRA in its white paper earlier this year, recognizes that there is still work to be done.”

Advisors can play a direct role in these efforts by making their views known to FINRA, which reviews public comments on the proposal for any potential adjustments before the regulator submits the rule to the SEC for approval, said Kennedy, the broker’s attorney. From his point of view, any false allegation is simply “false – it doesn’t matter if it’s 10 minutes old or if it’s two centuries old”, he said. Kennedy’s letter criticizes every element of the proposal.

FINRA “just created way too much complexity and nuance,” for the write-off, Kennedy said. “They tried to make it so heavy in order to discourage it. I think they should do the opposite by making it simpler and more reliable.”