A new rule that took effect in January stipulates that there are three reasons—and three reasons only—to grant expungement of client complaints from your U4.
As financial advisors brace themselves for the inevitable rise in customer complaints in this financial crisis, they should consider a sobering fact: A rule that took effect on January 26 will make it harder than ever for them to wipe their official records clean of those customer beefs — especially if the arbitration case settles, as they so often do.
Back in 2003, the SEC approved Rule 2130 that set to establish that “expungement” of customer complaints from a broker's record is an “extraordinary remedy,” and set three limited grounds upon which it could be granted. The rule is aimed at curbing the use of expungement as a bargaining chip in settlement talks among brokerage firms, its advisors and disgruntled customers. The defendants (the b/d and the rep) would often ask for a customer's consent to expunge the complaint in return for a monetary settlement. Arbitrators would then rubberstamp the deal.
Under the new rule, arbitrators must hold a recorded hearing about the expungement request, review settlement documents and provide a “brief written explanation” showing that one of the grounds for expungement exists. Some lawyers who represent reps are not too concerned over the new requirements. “The new rule strikes the appropriate balance between protecting investors from bad brokers and allowing good brokers to keep their records,” says Brian Neville of Lax & Neville in New York. The only problem? “The whole thing can be fairly expensive for brokers,” he says.
In the short life of the new rule, Neville has already served as an industry-representative arbitrator on a panel that ordered expungement of a customer complaint using the new procedures. He declined to talk about the specifics because the arbitration award has not been made public by FINRA. “We understood our obligation not to be a rubber stamp,” says Neville.
Neville says the most nettlesome part of the new rule may be proving that expungement should be granted at the recorded hearing: “That's the rub, that's the difficult thing.” Rule 2130 requires the arbitrator to make one of three findings: that the customer's claim was “factually impossible or clearly erroneous,” that the broker was “not involved” in the alleged violation or that the claim is “false.”
The new rule requires the panel to pen a “brief written explanation of the reason(s)” for that finding — and that is where arbitrators may find themselves in uncharted territory. Until now, arbitrators have had no obligation to explain their awards, part of the “black box” of private dispute resolution. Marshall Fishman, a partner at New York's Kramer Levin Fantails & Frankel, says the new rule will “have a chilling effect on granting expungements,” particularly due to the required written explanation. Until now, arbitrators have shied away from written explanations, “for fear they could be readily challenged in court.” A written ruling will now “open up a few more challenges,” he says.
Expungements awarded by arbitrators have been challenged — in court and out — for more than a year. The office of New York Attorney General Andrew Cuomo began challenging court approvals of expungements in February 2007, citing, among other reasons, the failure of arbitrators to conduct hearings or make any inquiry before signing off on the expungement. That September, the Public Investors Arbitration Bar Association added fuel to the fire when it released a survey of 200 cases in which arbitrators mostly rubberstamped expungement requests.
“For practical purposes, the new rule has gotten so much publicity that a lot of panels were more or less operating under it unofficially,” says Lloyd Clareman, a sole practitioner in New York, who represents brokers. A sampling of recent expungement awards does show a tendency of panels to hold a hearing about the request. But there has been little effort to craft “brief written descriptions” for their reasoning. Clareman also believes the new rule is going to make it harder than ever — “absent genuinely unusual circumstances” — to clear a broker's record. “It's not enough that a case was unjustified against the broker. Unfortunately, these standards require that something more be shown.”
There is some good news, given the tougher standards: Individual advisors are being named far less often these days when a customer files a complaint. “We typically don't name brokers,” says John Singer of Singer Deutsch of New York, a firm that both brings customer complaints and defends brokers. “There are a lot of reasons not to name the broker. A firm might have published faulty research, or pushed a product on a broker,” he says. Neville agrees about this trend, citing the recent auction-rate securities scandal as a case in point.
Jan. 19, 1999: NASD imposes moratorium on arbitrator-ordered expungements while reforms are considered.
December 16, 2003: SEC approves Rule 2130, limiting expungement of customer complaints to three narrow circumstances, over objections from the securities industry, and requiring a court of law to confirm arbitrators' awards of expungement.
February 2007: New York Attorney General's office begins to intervene in court confirmations of expungements, opposing them in “every case” on its radar screen. At least seven cases were filed.
May 30, 2007: Buffalo, N.Y., judge grants NYAG request, finding “no facts” to support expungement of a settled customer complaint.
September 24, 2007: The Public Investors Arbitration Bar Association, lawyers for investors, publishes a study of 200 settled customer complaints, showing that arbitrators granted expungements in most cases without a hearing.
March 13, 2008: FINRA files proposed procedural changes to establish that arbitrators must hold a hearing, review settlement documents and file a written explanation why expungement should be granted under Rule 2130.
October 30, 2008: SEC approves final rule change after comment period.
January 26, 2008: New rule takes effect.