If a proposed new FINRA rule is adopted by the SEC, reps may find it harder to get potentially frivolous customer complaints wiped clean from their U4s. Not so long ago, when a customer arbitration dispute was settled, their complaint was expunged from the rep's U4, which was then rubber-stamped by arbitrators, and rubber-stamped yet again by the judge who confirmed the award. The reasons for settlement and expungement were not required to be made public. The alleged violation would simply be flushed from a rep's permanent record (the so-called Central Registration Depository or CRD, maintained for inspection by the investing public on FINRA's website).
But, last spring, the New York attorney general's office (perhaps inspired by Eliot Spitzer) began butting in, challenging expungement confirmations in the name of protecting investors. While the Attorney General (AG) has been having mixed results in court, Andrew Cuomo's office has a few new allies: FINRA and (surprise!) SIFMA, the brokerage industry's largest lobby. FINRA has proposed a new rule that would require arbitrators to hold a separate hearing to make a finding that expungement is appropriate-and to make the logic for the expungement public.
FINRA's board of governors approved the new rule last December, and the formal rule was finally released for public comment March 27 (the public vetting was scheduled to close on April 24). It is all but certain to become final because SIFMA does not plan to oppose it. "SIFMA broadly supports FINRA's efforts to make public the reasoning behind an expungement of a broker's record," said SIFMA spokesman Travis Larson. The upshot: Registered reps best put money aside to fight customer complaints they deem to be untrue or without merit.
This "victory" for Cuomo and the AG's office in setting a new expungement standard, weirdly, arose out of a defeat-the case of Mary Ellen Kay v. Loretta Abrams. Loretta Abrams, a 63-year old widow, and a customer of Kay while she was a rep at Prudential Securities, filed a $450,000 arbitration claim alleging that Kay had traded without her authorization in speculative, aggressive equities.
In May 2005, the case was settled for $155,000-if Abrams agreed to drop her complaints from Kay's CRD. A single arbitrator signed off on the expungment without holding a hearing. Business as usual. Well, it would have seemed so. After all, New York State Supreme Court Justice Edward H. Lehner denied the AG's motion to intervene to challenge the expungement, calling it "moot," citing an appellate court precedent limiting his authority on arbitration results. Even so, Lehner observed that he had "reservations about the existing law," and quoted from the FINRA press release on the new rule proposal, declaring that such a rule "would clearly be in the public interest, and be in accord with many of the objections with respect to the expungement procedure raised by the attorney general."
Not Business As Usual
The proposed FINRA rule would change current practice-which renders arbitrations a virtual black box in which the arbitrators need not explain how they decide a case. If the SEC accepts FINRA's proposed rule to grant an expungement, arbitrators would be required to hold a recorded hearing in person or by phone in every instance, and to review settlement documents. And arbitrators would be required to, "provide a brief written explanation of the reason(s) for its finding" that one of the three limited grounds for expungement existed.
FINRA, in proposing the new rule, admits that the current system is not working: The proposal says arbitrators have "often" ordered "expungement at the request of a party to facilitate the settlement of a dispute." Steven Caruso of Maddox Hargett & Caruso, the president of the Public Investors Arbitration Bar Association (PIABA), called for a moratorium on expungements last fall based on a PIABA study finding that FINRA arbitration panels were too quick to approve requests to wipe clean a broker's record. "The new rule will go a long way to eliminating the abuses that have been allowed to exist," says CarusoTK.
And the New York AG is not alone in marching into court to challenge expungements. PIABA has filed an amicus brief in a pending federal appeals court case involving Joseph R. Karsner IV, a Maryland broker, who, according to PIABA's survey, received 18 expungements from arbitrators in 2006 alone. Kaiser has 12 cases pending before the federal district court in Washington, D.C. to confirm those expungements.
Last April, U.S. District Judge Richard J. Leon denied the Maryland attorney general's motion to intervene in Karsner's case, and confirmed his expungement. The Maryland AG appealed, and, since then, Karsner's 11 other bids to confirm the cleaning of his record have been stayed. Karsner's lawyer, Richard J. Magid of Whiteford Taylor Preston in Baltimore, did not return calls for comment.
"He's the poster boy," Caruso says of the current system. "Arbitrators were just signing off on these things. This rule will put an end to the rubber-stamping process." Kay, the winner of Lehner's decision, and now a broker with Aegis Capital Corp., had a lengthy record of complaints as well: The New York AG pointed out that there were 17 customer complaints against her, nine of which were settled or resulted in an award by arbitrators, and eight that didn't result in payments to the complaining investors.