Inside the Litigation Lion

FINRA Hits The Rep While He is Down

Going down for the count is never a good thing in any confrontation.  But being hit while you are down is far worse.  That is precisely what FINRA is attempting to do to its members with the approval of its new rule that prohibits conditioning settlements of customer disputes upon the customer’s agreement not to challenge or oppose an expungement. 

For a bit of history, in March of 2004 – over ten years ago -- I wrote an article in Registered Rep magazine entitled “Sunset for Settlements” in which I explained how FINRA (at the time the NASD), was harming its own members, the registered representatives, by stripping the broker of his ability to expunge the record of an arbitration.  As everyone reading this article already knows, any allegation against a rep, regardless of merit, results in a “ding” to the rep’s Form U-4.  That is, a rep’s Form U-4 is marked with an allegation of wrongdoing before any court or arbitration panel has ruled on the validity of the accusation.  Before the 2004 rule change, a broker was able to cleanse his or her record if the panel sitting on the arbitration recommended that the matter be expunged from that broker’s records.  If the case settled before a hearing, pre-2004, as many did, expungement of the U-4 black mark was often negotiated between the customer and the broker before being submitted to the arbitration panel for approval. 

In 2004, the NASD decided – in its infinite wisdom – to allow for a CRD expungement only in cases where the broker can demonstrate, through competent evidence at a hearing, that the claim was either factually impossible or clearly erroneous.  That decision by the NASD led to fewer settled resolutions of disputes because brokers were more willing to fight to save their reported regulatory history.  Under that rule change, a broker’s record could be eligible for expungement only if: (a) the claim brought in arbitration was “factually impossible or clearly erroneous;” (b) the registered rep was not involved in the alleged violation; or (c) the claim is false. Further, from the 2004 rule change, a broker who wanted the court to approve an expungement then had to name the NASD as a party to the court proceeding, something never before required under the rules.  As I predicted in “Sunset for Settlements” in 2004, the rule harmed consumers and brokers alike by removing the brokers’ incentive to settle cases expeditiously because settling the case would result in either a permanent U-4 blemish or an expungement process with an unfairly high standard.  Post 2004, one way that firms and associated persons decided to eliminate this chilling effect on settlements was to have the customer agree that, for settling the matter, he or she would not oppose the new, drawn out attempt by the broker to eliminate that “ding” from his or her CRD.

Now fast forward.  After creating a road block to the settlement process ten years ago, FINRA has done it again.  Just this month it announced that it approved a rule proposal that would prohibit brokers or firms from conditioning settlements of customer disputes on the customer’s agreement that it will not oppose the (already difficult) expungement proceeding.  This new rule, which FINRA touts as designed to “help ensure that the CRD system continues to contain information that is critical to investor protection,” hits the broker when he is down.

In reality, however, the rule change serves no legitimate purpose.  The 2004 rule change already made it exceedingly difficult to obtain expungement, thus furthering FINRA’s stated goal of “investor protection.”  Unlike the 2004 rule change, however, the new proposal quite literally forces brokers and customers to continue to fight.  Not only does a broker who wish to settle a case have to meet the already high burden of proving one of the three standards in the 2004 rule, but the broker must now be willing to take the risk that after paying out a settlement, the jilted (and often times, wrong) customer will not actually appear at the expungement hearing for the purpose of intentionally destroying any hope of removing the matter from the broker’s CRD.

The “About Us” page on the FINRA website boasts that FINRA “is dedicated to investor protection and market integrity through effective and efficient regulation of the securities industry.”  I get that.  I also understand the fact that FINRA wants transparency and the ability to allow a customer to learn the regulatory history of his or her broker.  But the effect of these rule changes swings the pendulum way too far.  This new rule proposal not only firmly stacks the cards in favor of a customer upon commencing arbitration, it essentially declares that the broker is guilty until proven innocent, and proving your innocence may now be virtually impossible.   

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An inside view of trends in SEC/FINRA regulatory and compliance issues and how it affects individual financial advisors and their firms.

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Richard Roth

Richard Roth is the founder and president of The Roth Law Firm, PLLC, a boutique litigation firm that concentrates in litigating securities arbitrations and SEC/FINRA enforcement actions. He...
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