«NOTE WHAT YOU DO NOT KNOW CAN HURT YOU: HOW THE FINRA EXPUNGEMENT PROCESS IS ENDANGERING FUTURE INVESTORS THROUGH A LACK OF INFORMATION I. ...»
WHAT YOU DO NOT KNOW CAN HURT YOU:
HOW THE FINRA EXPUNGEMENT PROCESS IS
ENDANGERING FUTURE INVESTORS THROUGH
A LACK OF INFORMATION
It is often said, what you do not know can not hurt you.
Unfortunately, in the high stakes world of securities investment, what investors do not know can indeed hurt them. 1 When investors did not know that the head of a small California investment firm had a previous claim brought against him for operating a $1.75 million Ponzi scheme, they believed in his reputability, which led to another $125 million Ponzi scheme over a seven-year stretch.2 A deal cut in a previous settlement led to the lack of information on the broker’s Central Registration Depository (“CRD”) record.3 More recently, in May 2013, a Wells Fargo broker—who despite nine client disputes on her record, and Wells Fargo agreeing to pay a $125,000 settlement because of a complaint related to the broker—received an expungement award on some of the disputes on her record after an arbitrator determined they were “suitable and safe” for expungement (alternatively “expungement process” or “process”).4 Just a few months prior, in February of 2013, a former
1. See Rich Smith, Investing Basics: What You Don’t Know Is Hurting You, DAILY FINANCE (Apr. 22, 2013, 10:30 AM), http://www.dailyfinance.com/2013/04/22/investing-basics-what-youdont-know-is-hurting-you (discussing how brokers depend on the ignorance of investors).
2. Michael Freedman, The X-ed Out Files, FORBES (Dec. 25, 2000, 12:00 AM), http://www.forbes.com/forbes/2000/1225/6616280a.html (expunging a previous customer dispute through settlement allowed Carl Martellaro to continue his fraudulent practices without investors becoming aware, leading to the $125 million Ponzi scheme).
3. See id. The CRD is an online registration system that houses administrative and disclosure information about brokerage firms and associated persons. See Central Registration Depository, FINRA, http://www.finra.org/Industry/Compliance/Registration/CRD (last visited July 20, 2014).
For a further discussion about the CRD, including its reporting requirements and changes made to the system over time, see Scott Ilgenfritz, Expungement Study of the Public Investors Arbitration Bar Association, 20 PIABA B. J. 339, 340-43 (2013).
4. Susan Antilla, A Rise in Requests From Brokers to Wipe the Slate Clean, N.Y. TIMES, 1228 HOFSTRA LAW REVIEW [Vol. 42:1227 Charles Schwab executive, who personally ran a fund which led to investors losing hundreds of millions of dollars, was able to secure an expungement award as well.5 Despite agreeing with the Securities and Exchange Commission (“SEC”) to pay a fine of $325,000 and be barred from the business, the expungement award was the former executive’s eighth award since August 2012.6 These examples are all illustrative of the negative aspects of the expungement process in the securities industry.7 However, it would be misleading to suggest that such examples make up the complete expungement picture.8 There are certainly desirable expungements, such as where an implicated broker was not actually in control of a customer’s account and had no part in the wrongdoing.9 In such a situation, the use of expungement is reasonable and desirable, as it does not jeopardize the overriding intention of the expungement guidelines— for example, investor protection—and it ensures that a broker is not inaccurately labeled as fraudulent.10 June 11, 2013, at B1 (stating the recommended deletion of the complaint from the broker’s record came after a hearing where only the broker was present, as the client did not attend, and the broker went as far as to request expungement of two unrelated incidents on her record).
6. Id. (denying any wrongdoing, despite the sanctions levied against him, the Charles Schwab executive will be allowed to reapply for FINRA membership in 2015).
7. See Snyder v. City of Alexandria, 870 F. Supp. 672, 683 n.28 (E.D. Va. 1994) (citing BLACK’S LAW DICTIONARY 522 (5th ed. 1979)) (defining expungement of information as “[t]he act of physically destroying information... in files, computers, or other depositories”); Examples of Expungement Orders, FINRA, http://www.finra.org/ArbitrationAndMediation/Arbitration/ SpecialProcedures/Expungement/P126302 (last visited July 20, 2014) (providing examples of expungement orders); Notice to Arbitrators and Parties on Expanded Expungement Guidance, FINRA, http://www.finra.org/ArbitrationAndMediation/Arbitration/SpecialProcedures/ Expungement (last visited July 20, 2014) [hereinafter Notice to Arbitrators] (expunging information permanently deletes that information from the CRD system).
8. See Bill Singer, PNC Broker Exonerated in FINRA Customer Dispute But Saddled with Expungement Ordeal, FORBES (July 6, 2012, 9:07 AM), http://www.forbes.com/ sites/billsinger/2012/07/06/pnc-broker-exonerated-in-finra-customer-dispute-but-saddled-withexpungement-ordeal (granting expungement to a broker not named in the claim and who attempted to deter the claimaint from investing so heavily).
9. See id.; see also Jisook Lee, A Closer Look at Expungement: Asking the Right Questions, THE NEUTRAL CORNER (FINRA, New York, N.Y.), 2013, at 2, 3 (taking no part in the alleged action should result in expungement); Suzanne Barlyn, COMPLY-Merrill Broker Files John Doe Case to Clear Record Quietly, REUTERS (Sept. 19, 2013), http://www.reuters.com/article/ 2013/09/19/finra-johndoe-idUSL2N0HE19220130919 (looking favorably on requests to expunge where customers filed claims, but ultimately did not pursue them).
10. See About FINRA, FINRA, http://www.finra.org/AboutFINRA (last visited July 20, 2014) (outlining how FINRA accomplishes its mission of investor protection); Suzanne Barlyn, Wall Street Watchdog to Review Tactic for Cleaning Broker Records, REUTERS (Aug. 2, 2013, 12:46 PM), http://www.reuters.com/article/2013/08/02/us-finra-expungementidUSBRE9710WA20130802 (presenting industry argument that “brokers’ records should not have to carry black marks from cases in which investors have not proven their claims”). Patricia Cowart, 2014] FINRA EXPUNGEMENT PROCESS 1229 Brokers’ desire for expungement stems from the fact that dispute information is made publicly available through the online tool BrokerCheck.11 While investors are encouraged to research broker dealers through this online tool in order to determine whom they can trust, industry sentiment suggests that the current expungement process is depleting the amount of valuable information available to investors and putting them in danger.12 These growing concerns with the process come from the frequency with which investors are relying on BrokerCheck to educate themselves with accurate information regarding broker dealers; as industry professional Seth Lipner describes it, “[p]eople are starting to use BrokerCheck the way they use TripAdvisor.”13 The Financial Industry Regulatory Authority (“FINRA”) is primarily responsible for self-regulating the securities industry and ensuring investor protection above all else.14 Part of FINRA’s responsibility in regulating the securities industry is to acquire and maintain registered broker dealer reporting information, which is then housed in the CRD.15 Included in the required reporting information is customer dispute information, maintained in BrokerCheck’s online database.16 Through BrokerCheck, investors are able to investigate a a lawyer for Wells Fargo & Co., stated: “The importance of having an accurate and fair record will affect (a broker’s) livelihood.” Id.
11. See FINRA BrokerCheck - Research Brokers, Brokerage Firms, Investment Adviser Representatives and Investment Adviser Firms, FINRA, http://www.finra.org/Investors/ ToolsCalculators/BrokerCheck (last visited July 20, 2014) [hereinafter FINRA BrokerCheck].
12. Id. (encouraging investors to make BrokerCheck the first resource they utilize when making investment decisions). While discussing investor concerns, the President of the Public Investors Arbitration Bar Association (“PIABA”), Scott Ilgenfritz, elaborated: “To say that ‘expungement’ of customer claims from broker records is a major investor protection problem is an understatement.... [I]nvestors who are diligent enough to seek out information about brokers may be getting a woefully incomplete picture....” PIABA Study: Stockbroker Arbitrations Slates Wiped Clean 9 Out of 10 Times When “Expungement” Sought in Settled Cases, PUB.
INVESTORS ARB. BAR ASS’N 1-2 (Oct. 16, 2013), http://piaba.org/system/files/pdfs/ PIABA%20Expungement%20Study.pdf [hereinafter PIABA Study]; see Seth E. Lipner, The Expungement of Customer Complaint CRD Information Following the Settlement of a FINRA Arbitration, 19 FORDHAM J. CORP. & FIN. L. 57, 102 (2013) (arguing that the current expungement process does not work and is harming investors); Antilla, supra note 4, (erasing records of bad brokers is happening too often according to attorneys representing investors).
13. Antilla, supra note 4.
14. About FINRA, supra note 10.
15. See Notice to Members 04-16, NASD Adopts Rule 2130 Regarding Expungement of Customer Dispute Information from the Central Registration Depository (Mar. 2004), at 212 [hereinafter Notice to Members 04-16], available at http://www.finra.org/web/groups/industry/@ip/ @reg/@notice/documents/notices/p003235.pdf (noting that the CRD contains administrative information, which includes broker dealer information, as well as disclosure information, such as customer dispute and disciplinary information).
16. See FINRA BrokerCheck, supra note 11.
1230 HOFSTRA LAW REVIEW [Vol. 42:1227 broker dealer’s dispute and arbitration history prior to entering into a relationship.17 Some investors are likely unaware that broker dealers can “expunge” information from their CRD records, permanently erasing the particular incident as if it never happened.18 Expungement is intended to balance the goal of protecting investors from fraudulent brokers, while also protecting brokers against harmful reputations resulting from meritless claims.19 The expungement process, which began in 1981, is currently governed under FINRA Rule 2080 and companion Rules 12805 and 13805.20 The expungement process has frequently been described by FINRA as an “extraordinary remedy,” only to be used when the information would have no investor protection value if it were left on the respective CRD record.21 Despite this objective, expungement has become something other than extraordinary—it has become ordinary.22 Expungement requests were granted in post-settlement agreement claims 96.9% of the time from 2009 through 2011, and 91.5% of the time in
2013.23 The use of settlements to obtain expungement agreements has been viewed in the industry as a large part of the current problem.24
17. See id.; see also Christine Lazaro, Ethical Concerns When Settlement Includes an Agreement About Expungement, PIABA 22ND ANNUAL MEETING MATERIALS, 2013, at 90, 90 (using BrokerCheck to determine whether they will invest with a particular broker is an industry known use).
18. See Freedman, supra note 2 (investing public was unaware that information had been expunged from Martellaro’s record); Notice to Arbitrators, supra note 7 (describing expungement as an extraordinary remedy granted only in certain instances).
19. See Karen Donovan, The Expungement Crusade, REGISTERED REP., at 3 (Nov. 1, 2007) (bringing claims without merit leads to erroneous entries on a broker’s CRD).
20. See Howard R. Elisofon & Grant R. Cornehls, The Road to Expungement Grows Longer, SEC. ARB. COMMENTATOR, Sept. 2010, at 1, 2. See generally FINRA MANUAL R. 2080 (2011) (pertaining to the process for obtaining an expungement order); FINRA MANUAL R. 12805 (2011) (pertaining to customer disputes); FINRA MANUAL R. 13805 (2011) (pertaining to industry disputes). Rule 13805 will not be discussed further as this Note deals exclusively with customer disputes.
21. See Lee, supra note 9, at 6; NASD Notice to Members 01-65—Request for Comment, NASD Seeks Comment on Proposed Rules and Policies Relating to Expungement of Information from the Central Registration Depository (Oct. 2001), at 565 [hereinafter Notice to Members 01-65], available at http://www.finra.org/web/groups/ industry/@ip/@reg/@notice/documents/notices/p003745.pdf; Notice to Arbitrators, supra note 7.
22. See infra Part III.A.1.
23. Ilgenfritz, supra note 3, at 360; FINRA Dispute Resolution Arbitration Award Review 2013 from Steven B. Caruso (Jan. 2014) (on file with the Hofstra Law Review).
24. See Steven B. Caruso, Expungement Requests in Settlement Negotiations: Consequences If You Don’t Just Say No, PIABA B.J., Summer 2007, at 3, 4 (explaining potential consequences attorneys may face because of settlement issues); Lipner, supra note 12, at 103-04 (advocating for change of the way the current process handles settlement agreements); C. Thomas Mason, III, CRD Expungement: Law, Proposed NASD Rules, and Lawyer Ethics, PIABA B.J., Winter 2002, at 76, 96 2014] FINRA EXPUNGEMENT PROCESS 1231 Despite a number of rule changes over the past fourteen years, FINRA’s expungement process still has flaws.25 A member in the securities industry from the Consumer Federation of America, which works to ensure investors receive complete and accurate information,
characterized the current expungement process as:
[T]oo easy for brokers to get complaints expunged from their records, investors who attempt to do the right thing and check out the broker’s disciplinary record may end up making their decision based on incomplete information. Worse, they may be led to believe that a broker has a clean disciplinary record....