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«NOTE WHAT YOU DO NOT KNOW CAN HURT YOU: HOW THE FINRA EXPUNGEMENT PROCESS IS ENDANGERING FUTURE INVESTORS THROUGH A LACK OF INFORMATION I. ...»

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Curtailing the current use of settlement negotiations to secure expungement is a critical first step in fixing the process.27 Further, modifying the current Rule 12805 in order to institute greater FINRA participation, along with more strict and defined arbitrator requirements, is necessary as well.28 Finally, ensuring a further level of customer participation than is currently required in FINRA Rule 2080 is important in correcting the current process and ensuring that expungement awards do not remain the frequent occurrence they currently are.29 Part II of this Note will explain the history of FINRA, and the source of its power.30 Also in Part II, the general arbitration process and its procedures, along with the establishment of the CRD and (discussing the misuse of settlement negotiations); Notice to Members 04-43, Members’ Use of Affidavits in Connection with Stipulated Awards and Settlements to Obtain Expungement of Customer Dispute Information Under Rule 2130 (June 2004), at 554, [hereinafter Notice to Members 04-43], available at http://www.finra.org/web/groups/ industry/@ip/@reg/@notice/documents/notices/p003015.pdf (acknowledging the settlement problem). FINRA has made another attempt to fix the settlement issue in 2014—the Board of Governors approved a rule proposal to prohibit the conditioning of settlements on expungement awards, although the proposal still requires SEC approval. See News Release, FINRA, FINRA Board Approves Rule Prohibiting Conditioning Settlements of Customer Disputes on a Customer’s Agreement Not to Oppose Expungement (Feb. 13, 2014) [hereinafter FINRA Board Approves Rule Prohibiting Conditioning Settlements], available at http://www.finra.org/Newsroom/ NewsReleases/2014/P445251.

25. Jean Eaglesham & Rob Barry, Brokers Able to Hide Some Disputes, WALL ST. J., Oct. 17, 2013, at C1 (“[FINRA’s] attempts to mandate narrow grounds for granting expungement relief... have failed.”).

26. PIABA Study, supra note 12, at 2 (quoting Rachel Weintraub, legislative director and senior counsel, Consumer Federation of America).

27. See Caruso, supra note 24, at 4-5 (outlining the current issues facing investors’ attorneys);

Mason, supra note 24, at 96-97 (discussing the consequences if an attorney agrees to expunge a claim he knows is not false); see also FINRA Board Approves Rule Prohibiting Conditioning Settlements, supra note 24 (approving a rule to attempt to deter the settlement issue).

28. See FINRA MANUAL R. 12805 (2011).

29. See FINRA MANUAL R. 2080 (2011); infra Part III.A.1 (showing expungement awards have become common).

30. See infra Part II.A.

1232 HOFSTRA LAW REVIEW [Vol. 42:1227 BrokerCheck will be explained.31 Finally, and most importantly, Part II will describe the evolution of the expungement process since the inception of the CRD in 1981, the ramifications and industry sentiment towards the moratorium in 1999, and the new rule changes in 2004 and 2009.32 Part III will examine the current legal challenges faced by the securities industry as a result of the expungement process.33 The ability of broker dealers to abuse settlement negotiations by offering a customer a lump sum in exchange for expungement is damaging the CRD, and resulting in a lack of faith in the expungement process. 34 Moreover, the incentive for a customer’s attorney to accept such a settlement offer, in order to secure some type of monetary award for their client, presents legal and ethical issues for that attorney.35 Along with the settlement issues that currently exist, Part III will also examine the issues surrounding the rest of the expungement guidelines, most notably the lack of input that they solicit from the customer.36 Part IV will explore the scope and obligation of FINRA to alleviate the current expungement issues outlined in Part III.37 The current Rule 2080 will be used as a framework but will be modified to take into account the need to eliminate the settlement issues, while also requiring more extensive participation from FINRA.38 Also, the need for stricter and more expansive arbitrator guidelines, along with adjustments to secure further customer participation, will be presented as modifications to Rule 12805.39 Part IV will conclude with a brief overview of the potential benefits that updated arbitrator training could provide.40 This Note concludes that changes to the current FINRA expungement process are imminently necessary.41 The current process is providing diligent investors with incomplete information and

31. See infra Part II.B–C.

32. See Elisofon, supra note 20, at 2 (stating that the CRD was created in 1981); NASD Notice to Members 99-09, NASD Regulation Imposes Moratorium on Arbitrator-Ordered Expungements of Information from the Central Registration Depository (Feb. 1999), at 47 [hereinafter Notice to Members 99-09], available at http://www.finra.org/web/groups/ industry/@ip/@reg/@notice/documents/notices/p004582.pdf (introducing the moratorium on arbitrator awarded expungements); Notice to Members 04-16, supra note 15, at 213-14 (explaining the new rule change in 2004); infra Part II.D–E.

33. See infra Part III.A–B.

34. See Ilgenfritz, supra note 3, at 360-61.

35. See Caruso, supra note 24, at 4.

36. See infra Part III.B.

37. See infra Parts III.A–B, IV.A–B.





38. See FINRA MANUAL R. 2080 (2011); infra Part IV.A.

39. See FINRA MANUAL R. 12805 (2011); infra Part IV.B.

40. See infra Part IV.C.

41. See infra Part V.

2014] FINRA EXPUNGEMENT PROCESS 1233 endangering their decision-making process.42 Proposing rule changes to the SEC will put FINRA on the path to accomplishing its desired goal of making expungement an extraordinary remedy, instead of expungement’s current state as an ordinary occurrence.43

II. FINRA’S POWER AND ATTEMPTS TO FIX THE EXPUNGEMENT

PROBLEM

Since 1981, FINRA has proposed, and the SEC has passed, numerous rules and regulations in attempting to improve the expungement guidelines and better serve FINRA’s intended purpose— investor protection.44 With each new rule or regulation that was passed, industry sentiment continued to grow; yet, the process was still not where it needed to be in order to prevent unnecessary expungements.45 In order to gain a better understanding of the rules that FINRA has developed, it is helpful to look at the historical context behind the power granted to FINRA by the SEC, and why it was so empowered, which Subpart A will do.46 Subpart B will explore the arbitration process and the guidelines surrounding that process, which allow for investors to bring claims against broker dealers.47 Next, Subpart C will discuss the CRD’s history and relation to the birth and subsequent growth of BrokerCheck.48 Finally, Subparts D and E will look at the history of the expungement process, dating back to 1981, and will finish with an outline of where the expungement process stands today.49 A. The Power to Regulate the Securities Industry In 1934, the SEC was established after the passing of the Securities Exchange Act.50 Congress passed the Securities Exchange Act in 1934 because it recognized that “[m]onitoring the securities industry

42. See infra Part III.A–B.

43. See infra Part III.A.1.

44. See infra Part II.D–E. Examples of passed regulations include: FINRA MANUAL R. 2080 (2011); FINRA MANUAL R. 12805 (2011); NASD MANUAL R. 2130 (2004).

45. See Caruso, supra note 24, at 4-5 (arguing settlement issues created a number of concerns for both investors and their attorneys). See generally Lipner, supra note 12 (advocating for change in the expungement process regarding the use of settlements); Mason, supra note 24 (outlining issues with the entire expungement process).

46. See infra Part II.A.

47. See infra Part II.B.

48. See infra Part II.C.

49. See infra Part II.D–E.

50. See generally 15 U.S.C. § 78d (2006) (providing the SEC with the power to act as the regulatory agency for the U.S. securities industry).

1234 HOFSTRA LAW REVIEW [Vol. 42:1227 require[d] a highly coordinated effort.”51 Congress’s primary goals in monitoring the securities industry were to protect investors, as well as to have an agency to enforce the then-newly passed securities laws.52 Four years after the Exchange Act was passed, Congress passed an amendment to the act which allowed for the creation of Self Regulating Organizations (“SRO”) to be formed underneath the supervision of the SEC.53 The amendment “gave legislative approval to the formation of national securities associations designed to supervise their members’ conduct under the general oversight of the Securities Exchange Commission.”54 Although there was no maximum number of organizations that could apply to the SEC for SRO status, only one organization applied after the 1938 amendment, the National Association of Securities Dealers (“NASD”).55After applying to the SEC for recognition, the NASD was approved in 1939.56 Years later, the NASD merged with the New York Stock Exchange Regulation to form FINRA in 2008.57 FINRA subsequently made its mission both investor protection and market integrity.58

51. Onnig H. Dombalagian, Demythologizing the Stock Exchange: Reconciling SelfRegulation and the National Market System, 39 U. RICH. L. REV. 1069, 1074-75 (2005) (concerning practices of stock exchange, members and manipulative practices were part of Congress’s rationale for the Exchange Act); The Investor’s Advocate: How the SEC Protects Investors, Maintains Market Integrity, and Facilitates Capital Formation, U.S. SEC. & EXCHANGE COMM’N, http://www.sec.gov/about/whatwedo.shtml (last visited July 20, 2014) [hereinafter The Investor’s Advocate].

52. The Investor’s Advocate, supra note 51; see also John E. Tracy & Alfred Brunson MacChesney, Securities Exchange Act of 1934, 32 MICH. L. REV. 1025, 1037-39 (1934) (creating the SEC for regulation of industry).

53. 15 U.S.C. § 78o–3 (2006) (amending the Securities Exchange Act, the Maloney Act of 1938 allowed for the creation of SRO).

54. Rebecca Curnin, Note, The NASD’s Fair Sales Practice Rules: An Argument for Their Application to Government Securities Transactions, and for the Consideration of Some New Rules in the Mortgage Market, 1993 COLUM. BUS. L. REV. 191, 193 (1993).

55. See Tamar Hed-Hofmann, The Maloney Act Experiment, 6. B.C. INDUS. & COM. L. REV.

187, 205-06 (1965); Onnig, supra note 51, at 1076-77 (describing the 1938 amendment and the incentives provided to individuals who became members of the NASD); Marianne K. Smythe,

Government Supervised Self-Regulation in the Securities Industry and the Antitrust Laws:

Suggestions for an Accommodation, 62 N.C. L. REV. 475, 485 (1984) (allowing for creation of additional SROs but only the NASD was formed after passage of act).

56. See Hed-Hofmann, supra note 55, at 188 (celebrating its twentieth anniversary in 1959).

57. See Order Approving Proposed Rule Change to Amend the By-Laws of NASD to Implement Governance and Related Changes to Accommodate the Consolidation of the Member Firm Regulatory Functions of NASD and NYSE Regulation, Inc., 73 Fed. Reg. 32377, 32377 (June 6, 2008); Press Release, FINRA, NASD and NYSE Member Regulation Combine to Form the Financial Industry Regulatory Authority – FINRA (July 30, 2007) (on file with the Hofstra Law Review) [hereinafter FINRA, NASD] (announcing the commenced operations of FINRA).

58. About FINRA, supra note 10; FINRA, NASD, supra note 57; see also What We Do, FINRA, http://www.finra.org/AboutFINRA/WhatWeDo (last visited July 20, 2014) (outlining the five ways that FINRA achieves its purpose).

2014] FINRA EXPUNGEMENT PROCESS 1235 B. An Overview of the FINRA Arbitration Process “Arbitration is an alternative to litigation or mediation,” with a panel composed of one or three arbitrators.59 The award issued by the arbitration panel is universally binding, requiring all parties to abide by the decision unless it is successfully challenged in court.60 “Arbitration, [which] is generally confidential,”61 begins when a party files a claim requesting a specific remedy, and the respondent subsequently answers such a claim.62 The selection of the arbitration panel depends on the amount of money in controversy.63 Following arbitrator selection, the parties will have a telephonic prehearing conference, participate in discovery, and have a hearing in front of the arbitration panel,64 where after the panel will make a decision and potentially grant awards.65

59. Arbitration Overview, FINRA, http://www.finra.org/ArbitrationAndMediation/ Arbitration/Overview (last visited July 20, 2014). Arbitration became an entrenched aspect of the securities industry after the landmark decision Shearson/Am. Express Inc. v. McMahon. See generally 482 U.S. 220 (1987). The Shearson court found that claims brought under § 10(b) of the Securities Exchange Act could utilize arbitration under pre-dispute agreements. Id. at 238. As a result of the holding in Shearson, resolving securities disputes via arbitration has become the industry norm. See Constantine N. Katsoris, Securities Arbitration After McMahon, 16 FORDHAM URB. L.J. 361, 368-69 (1987) (reasoning just a year after the decision that arbitration would become the primary forum); Antilla, supra note 4, (noting that arbitration resulted in firms insisting that customers give up the right to sue in court).

60. Arbitration Overview, supra note 59.

61. Id. However, disciplinary decisions and the subsequent disciplinary action documents are available and can be obtained through FINRA’s website. See 2013 OHO Disciplinary Decisions, FINRA, http://www.finra.org/Industry/Enforcement/Adjudication/OHO/DisciplinaryDecisions/2013 (last visited July 20, 2014) (providing past years’ decisions, but not yet 2014 decisions); FINRA Disciplinary Actions Online Database, FINRA, http://www.finra.org/Industry/Enforcement/ DisciplinaryActions/FDAS (last visited July 20, 2014).

62. Arbitration Process, FINRA, http://www.finra.org/ArbitrationAndMediation/ Arbitration/Process (last visited July 20, 2014) (following the filing of a claim is the selection of the arbitration panel).



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