State securities regulators have long expressed reservations about the use of the expungement remedy. Recently, we have observed a marked increase in the use of alternative efforts by states to impact the expungement process in connection with customer arbitrations. For example, state regulators have threatened to take, and in at least one instance have taken, steps to intervene in the arbitration process to oppose the awarding of expungement.
Both firms and Financial Advisors (“FAs”) may face new hurdles and strategy considerations in connection with future expungement matters. We encourage firms and FAs to account for possible regulatory complications early in the process and especially where the arbitration involves topics, products and/or FAs subject to regulatory scrutiny.
With respect to financial services professionals subject to SEC, state or FINRA oversight, an “expungement award” by an arbitration panel can result in the relevant disclosure being removed from the professional’s CRD record. It is critical to note that states treat a Form U4 filed by a person registered in the state as constituting a “state record.”
In September 2021, the Maryland Securities Commissioner, Melanie Lubin, began her tenure as the President of the North American Securities Administrators Association (NASAA) by reminding the audience that she has long been concerned with expungement. In her NASAA Presidential Address, Ms. Lubin commented that NASAA (i.e., the organization of state and provincial securities regulators) viewed expungement as an “extraordinary remedy.” As a result, we have expected increased and novel challenges to expungement where states assess that none of the elements of FINRA Rule 2080 could be satisfied.
State Efforts to Oppose Expungement
Traditionally, state regulators have initiated legal challenges to expungement only after an arbitration panel awarded expungement relief to an FA. In such cases, a state regulator would seek to intervene in the court proceeding necessary to confirm the expungement award. In such matters, the states seek to claim standing to the extent the Form U4 is considered a state record.
State regulators are now invoking alternative methods and resources within the ordinary expungement process. These efforts have included the following:
- Withholding registration approvals without FAs’ agreements to not seek expungement of a disclosure.
- Deputizing underlying customers’ counsel to oppose, on the state’s behalf, the court confirmation of an expungement award.
- Communicating directly with the FINRA Case Administrator to intervene in a pending expungement hearing and requesting a postponement of the hearing itself.
In light of the states’ well-documented disposition as to expungement, we expect the utilization of similar tools to become more common in the near term. The likelihood that a state might take such actions in any particular matter is affected by numerous factors, including, among others: the state regulator(s) involved; the residence of the customer and/or the FA; the investment at issue; the nature of the alleged violation; whether the disclosure involves a recidivist FA; and the existence of a related regulatory investigation or pending application.
It is important that firms and FAs remain cognizant of the new hurdles being raised and make informed strategic decisions early in the process – especially when the FAs or relevant investment products are being investigated by a state securities regulator.