On September 22, 2020, FINRA sent proposed rule changes designed to overhaul the expungement process to the SEC for approval. On Friday May 28, 2021 – the same day the SEC was slated to adopt or reject the proposal – FINRA confirmed that, in consultation with SEC staff, it has temporarily withdrawn the proposed changes from SEC consideration.1
FINRA’s proposed rule changes represented the culmination of efforts to change the expungement process that have been in development for years, dating back to the proposal set forth in Regulatory Notice 17-42 in December 2017 and FINRA’s first issuance of its Expanded Guidance on Expungement in late 2013. This proposal also came on the heels of a recent rule change mandating minimum expungement fees that became effective for cases filed on or after September 14, 2020.
Most notably, the new rules would have created time limits on when expungement can be requested, requiring a straight-in request (a request filed separate from a customer arbitration), to be filed within 2 years of the close of the underlying litigation or within 6 years of the complaint not involving litigation being reported to the Central Registration Depository (“CRD”). Additionally, the rules would have created a special roster of arbitrators that would be randomly assigned by FINRA to decide most expungement requests. They would have also required an Associated Person named as a party in a non-simplified customer arbitration to request expungement during that arbitration or forfeit the right to do so. The major aspects of FINRA’s 557-page proposal are detailed here.
After submitting the proposed rule changes to the SEC, FINRA solicited comments and feedback. FINRA received numerous responses from various parties representing individual investors and the industry. The Public Investors Advocate Bar Association (“PIABA”), a bar association whose members represent investors in disputes within the securities industry, opposed the proposed changes to the expungement process, arguing that the changes did not go far enough. PIABA cited to its own study that found 91% of expungement requests are granted 2 to support its claim that even more onerous requirements should be implemented to prevent expungements from being recommended at such a high rate. PIABA partially attributes the high success rate to the dearth of opposition to expungement requests, especially from underlying customers. PIABA argues that FINRA should create an expungement process that provides customers and regulators a meaningful opportunity to oppose expungement requests, including providing customers more advanced notice of the hearing. In addition to increasing customer participation, PIABA also requests that FINRA creates an independent investor advocate whose purpose would be to oppose expungement requests on behalf of interested parties, including investors and state regulators. Finally, while the proposed rules would create an additional notification to state securities regulators, PIABA requests state-level regulators to be incorporated into the arbitrations or oversee expungement requests independently.
According to FINRA, however, the overall success rate for expungements is only 77%, not 91%. 3 FINRA recently published additional data showing that between 2015-2020, only 4% of customer disputes entered into CRD have been expunged. Additionally, FINRA released statistics reflecting that between 2015-2020, only 0.2% of registered persons industry-wide had a disclosure expunged. Moreover, FINRA provided evidence reflecting that its newly imposed minimum filing fee rules have had a significant impact on the number of expungement filings, decreasing straight-in requests by 95% from Q3 to Q4 2020.
The Securities Industry and Financial Markets Association (“SIFMA”), the leading trade association for broker-dealers, investment banks and asset managers, also raised concerns regarding the proposed changes. In a letter to FINRA 4, SIFMA outlined the five most significant concerns it had with the proposal, which include:
- The Proposal Should Not Limit the Grounds for Granting Expungement to the Three Grounds Listed under Rule 2080(b)(1), but Should Also Allow the Grounds under Rule 2080(b)(2);
- The Proposal Should Not Preclude a Member Firm or Associated Person from Seeking Expungement Relief in Court;
- A Customer Arbitration or On-Behalf-Of Request Arbitration That Closes Other Than By Award or Award Without Hearing Should be Allowed to Use the Same Panel to Decide Expungement;
- If a Customer Arbitration or On-Behalf-Of Request Arbitration Closes Other Than by Award or Award Without Hearing, Then the Member Firm Should Not Be Required to Pay an Additional Member Surcharge and Process Fee for a Straight-in Request; and
- The Proposal Should Clarify the Timing and Type of Regulator Involvement in the Expungement Process that FINRA Contemplates.
Beyond these concerns, SIFMA noted that it “generally supports the proposal to the extent it enhances the transparency and efficiency of the current expungement regime and the qualifications and training of the arbitrators who decide expungement requests.”5
It is likely that FINRA’s withdrawal of its proposal is at least partially due to negative feedback from the interested parties. In its news release, FINRA stated that it withdrew its proposed rule changes in order to “further consider whether modifications to the filing are appropriate.”6 FINRA further confirmed that it is still committed to working with the SEC and other stakeholders in order to limit the expungement process “so that it operates as intended - as an extraordinary remedy, only appropriate in limited circumstances when the CRD information is clearly inaccurate.”7 While FINRA’s withdrawal of its rule proposal provides a temporary reprieve from additional restrictions on the expungement process, it also signals even greater limitations on expungement that would make the process more costly and burdensome for both associated persons and firms. Toward this end, FINRA announced it continues to take meaningful steps in the near-term to enhance controls while also seeking to redesign the expungement process by implementing more fundamental changes. FINRA will continue to engage stakeholders in this process. FINRA also intends to release data, statistics and a discussion paper that analyzes expungement of broker information, before convening discussion groups regarding this information. It remains unclear at this time what revisions FINRA will make to the proposal in order to better incorporate interested parties’ feedback, but it is apparent that the proposed framework was not welcomed by PIABA, SIFMA or the SEC. It also appears that FINRA will continue to take a deliberate, measured approach that incorporates stakeholder feedback before submitting updated changes to the SEC.