This is the last in our series on the FINRA expungement process, and, unfortunately, the future looks grim.

Not only has FINRA made it nearly impossible (in an obvious attempt to curry favor with the public investor bar), but now it is considering some shocking additional changes to the process. Essentially, FINRA is looking to put the proverbial “final nail in the coffin” to any hope for expungement.

For example, FINRA is considering increased fees for expungement requests and a one-year limitation on requesting expungement relief. FINRA also would like to control the selection of arbitrators from the Expungement Arbitrator Roster. Additionally, FINRA is seeking to preclude subsequent expungement claims where the brokers did not request expungement in the underlying customer case, as well as formulating additional standards for recommending expungement. Finally, FINRA may require all expungement hearings must be in person or via videoconference. All of these proposals have not been adopted, but are shockingly scary.

In sum, FINRA’s expungement rules have severely limited a broker from seeking expungement. One wonders why have the process at all.

This is our second blog on the vanishing FINRA expungement process.

FINRA identifies specific grounds for expungement in FINRA Rule 2080. Rule 2080(b)(1) provided three specific grounds for expungement relief: (1)       the claim, allegation or information is factually impossible or clearly erroneous; (2) the registered person was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation, or conversion of funds; or (3) the claim, allegation or information is false.

Although FINRA Rule 2080 does not expressly require that the arbitrators determine that one of the three grounds has been met, FINRA has provided guidance that the arbitrator should find one of these three grounds to grant expungement relief. Sadly, since firms are now required to report allegations of sales practice violations despite the broker not being named a party, the expungement process has been used more often to have unmeritorious complaints expunged.

FINRA has also implemented procedures for arbitrators considering requests for expungement relief in FINRA Rule 12805. Arbitrators must consider a request for expungement relief by: (1) holding a recorded hearing session by telephone or in person; (2) review settlement documents and consider the amount of payments and conditions of the settlement; (3) provide a written explanation of the reasons for ordering expungement; and (4) assess forum fees against the parties requesting relief. FINRA, unfortunately, did not stop here. FINRA was pressured by the claimant’s bar to provide “guidance” to arbitrators. This “guidance” was a kick in the teeth to the expungement process.

FINRA now stated the importance of allowing customers to participate in expungement hearings and explicitly noted that arbitrators should: (1) allow customers (and their counsel) to attend expungement hearings; (2) allow customers to testify at expungement hearings; (3) allow customers to introduce evidence at expungement hearings; (4) allow customers to cross-examine the broker and other witnesses at expungement hearings; and (5) allow customers to present opening and closing arguments at expungement hearing.

FINRA also required that arbitrators order brokers to provide customers with a copy of the expungement request so that they are on notice of the expungement proceeding.

Prior to 1999, brokers could obtain expungement relief solely through arbitration, but, in 1999, FINRA introduced court confirmation of the expungement process. This requirement provides an additional layer of review to the expungement process, increasing the costs and time associated with the expungement process.

However, as will be discussed in our last blog, all hope seems to have vanished for any semblance of fairness in this process.

Over the past 20 years, FINRA has made it nearly impossible for brokers to expunge customer complaints and dispute information from their public records. Over the next three blogs, we will discuss the evolution of FINRA’s expungement process and how difficult expungement relief is for brokers to obtain in the future.

In 1981, the CRD system was created, and is now an online registration and licensing system for the securities industry. The CRD contains, among other things, information about every broker’s employment history, registrations, and licenses, as well as customer complaints or regulatory actions brought against the broker. The CRD system is the broker’s securities record.

Since a customer complaint is reported on a broker’s record regardless of the merit of the complaint, FINRA, grudgingly, allows brokers to seek expungement of disputed customer complaints from their records. However, what FINRA gives with one hand, it takes away with the other, making it nearly impossible to obtain expungement relief as discussed over the next blogs.

FINRA also established BrokerCheck to provide the public with information on members firms and their associated persons. BrokerCheck is an online tool for investors to research their brokers (or prospective brokers). FINRA requires firms to include a reference to BrokerCheck on each firm’s webpage and where registered persons are profiled. BrokerCheck is used to review the broker and firm records, allowing investor’s access to a broker’s complaint history.

Our next 2 blogs will discuss the expungement process and the future (or lack thereof) of it.

FINRA maybe in the process of allowing its examiners to punish member firms for rules’ infractions.  See  https://www.law360.com/assetmanagement/articles/1143015/finra-wants-to-let-examiners-lower-the-boom-on-brokers?nl_pk=5882ca7d-b76e-42a1-a1fe-eb96fcbcf60f&utm_source=newsletter&utm_medium=email&utm_campaign=assetmanagement.  There is no proposed rule as of today.  However, such a rule would be a game changer in the sense that examiners, who, generally, do not have the authority to enforce FINRA’s rules would now be in the proverbial “driver’s seat” without any of the ordinary checks FINRA usually provides in the enforcement process.  In any event, this is definitely one to keep an eye on.

Although songs and Broadway musicals routinely call upon “memories” as inspiration, it usually is not the province for decisions in FINRA arbitrations.  However, we were treated to a memory lesson in what, at first blush, seemed to be a run of the mill expungement case. See Evans v. Merrill Lynch Pierce Fenner & Smith Inc., FINRA Office of Dispute Resolution Case No.: 18-00845.

As many know, registered persons may move to expunge certain information from their FINRA Central Registration Depository (“CRD”) records. The burden is quite high, and, unfortunately for many, the results are not always good.  However, for the Evans claimant, luck and a good memory appeared to be on her side.

In Evans, the FINRA panel found that the customer “became a client of Respondent [but] had no recollection of any contact with [customer], making any recommendations to [customer], speaking to [customer] or making any trades on behalf of [customer].”  The broker had stated she believed the customer’s account “had been transferred from another broker to her, without her knowledge or notice.”  The Arbitration Panel was persuaded.

Here is the rub, it was her “memory” that saved the broker– no need to break into song just yet!  The broker told the Arbitration Panel “that she was a practitioner of memory techniques, and that she taught the techniques in one of her son’s classes and would have remembered dealing with [customer].”  The Arbitration Panel went onto reason that she “had an ability to recall details, and she testified that she had no contact with [customer].”  Finally, the Arbitration Panel determined that, as a result of the broker’s memory, “the claim of customer was determined to be factually impossible, and expunged.”

In short, it seems that memories (or lack thereof) are valid for more than just carrying a tune.  You can now start singing to yourselves!

Way back in 2017, the SEC obtained an emergency asset freeze against an internet-based ICO involving certain Canadian residents, who had raised over $15 million on a variety of social media sites through an alleged fraudulent scheme. http://www.sec.gov/litigation/complaints/2017/comp-pr2017-219.pdf.

At the time, it made major news and helped launch the SEC’s Cybersecurity Unit.  Of course, there have been many other actions since that time, but this action demonstrates that, with technology, it is impossible to ignore the potential for cross-border fraud.  Essentially, do you know who you are dealing with on the other screen?  Is it someone in Canada, Lithuania, Malta, Spain, Thailand, Hong Kong or China, among many others?  No one can ever be certain, and this leads to the tremendous risk of hacking or potential for fraud demonstrated by this SEC filing.

In sum, cryptocurrencies and ICOs are not going away, but we must be reminded to be ever vigilant since you may never know who your trading partner is or where they may be– on the other side of your floor or the other side of the world.

 

Over the last several months, there has been an increase in questions from registered investment advisers relating to using hypothetical performance information.  Generally, the use of such information is fraught with danger as well as SEC scrutiny.  Not so long ago, the SEC went after a number of investment advisers and forced them to pay a total in fines, interest, and disgorgement of nearly $10 million.  See  https://www.sec.gov/litigation/admin/2017/33-10443.pdf; https://www.sec.gov/litigation/admin/2017/34-82244.pdf; and https://www.sec.gov/litigation/admin/2017/ia-4823.pdf.

The SEC complained that these advisers did not have sufficient compliance procedures to effectively conduct an adequate investigation into the performance claims.  Essentially, the firms did not test the information being used to make sure it was accurate.  Such failures led to the monetary awards discussed above. 

In short (and as much as we preach), there is simply no way around having adequate procedures that are followed and implemented accordingly— unless, of course, you have a cool $10 million sitting around that you could turn over to the SEC when it knocks on your door.

 

FINRA litigants and arbitrators alike should take note of a federal court’s decision rejecting an unexplained FINRA award when it was unable to discern its basis, notwithstanding that FINRA rules did not require an “explained” decision, and later vacating the explained award once it demonstrated the panel’s manifest disregard of the law. This decision has potentially far-reaching tactical and practical implications, and suggests that arbitrators must be prepared to support their awards whether or not the parties request an explained decision.

Under FINRA dispute resolution rules, arbitrators are not required to issue an explanation of their decision unless requested by both parties. Code of Arbitration Procedure Rules 12904(g) (Customer Code), 13904(g) (Industry Code). Therefore, these “unexplained” awards are customarily devoid of any fact-based explanation, and even explained decisions need not contain legal analysis or damages calculations. Id.

This can present a problem when federal courts are called upon to either confirm or vacate arbitration awards, as was the case in Interactive Brokers LLC v. Saroop, 279 F.Supp.3d 699 (E.D. Va. 2017). There, customers initiated arbitration alleging an array of claims against their online brokerage firm. An arbitration panel entered a substantial monetary award in favor of the customers. However, because the parties had not requested an explained decision under FINRA rules, the panel included little-to-no factual application, legal authorities, or damages analysis. The brokerage moved to vacate and the customers cross-moved to confirm the award.  Although recognizing the “extreme deference” due to arbitrators, the federal court was unable to discern the basis for the panel’s damages award and remanded to the panel for an explanation, noting bluntly that “[j]udges…are not wallflowers or potted plants.” Id. at *708.

Following an unsuccessful appeal to the Fourth Circuit, the panel issued a second award, adding some further text that the federal court found “not very helpful.” Interactive Brokers LLC v. Saroop, Case No. 3:17-cv-127, E.D. Va. (Dec. 18, 2018), Dkt. 95 at 12. The additional explanation, however, showed that the panel based both its damages award and its dismissal of the brokerage’s counterclaims on the brokerage’s alleged violation of FINRA Rule 4210. However, because a violation of FINRA rules does not provide a private right of action, the court vacated the award for manifest disregard of the law, and ordered that the brokerage’s reinstated counterclaims be heard by a new panel of arbitrators. Id. at 19.

There are at least three important takeaways from Interactive Brokers.

First, whether litigants request an explained decision is usually a tactical choice.  Litigants who are concerned about the likelihood that arbitrators will appropriately apply the facts to the law sometimes request explained decisions to force arbitrators into making more reasoned decisions and to provide a basis to seek vacatur of adverse decisions. Interactive Brokers shows, however, that an unexplained decision may also lead to vacatur.

Second, for their part, arbitrators may wish to exercise their discretionary authority to issue explained decisions even where the parties do not request them. See Rules 12904(f); 13904(f). This is especially true where the issues and damages calculations are particularly complex. Issuing explained decisions will not only minimize the uncertainty around post-arbitration proceedings but will enhance the credibility of arbitrator decision-making.

Third, whether or not an explained decision is requested or issued as a matter of arbitrator discretion, an unexplained decision may conflict with the requirement that federal courts have an appropriate record on which to base their post-arbitration decisions. In Interactive Brokers, that conflict resulted in significant delay, extra expense, a new hearing, and a drastic shift in the outcome of the matter—none of which serve the purposes of arbitration, in FINRA or otherwise.

FINRA has published cybersecurity guidance for all its member firms.  See https://www.finra.org/sites/default/files/p602363%20Report%20on%20Cybersecurity%20Practices_0.pdf.

In particular, FINRA is indicating that it wants its member firms to bolster their cybersecurity regimes, and limit both internal and external threats.  The FINRA report also provides a number of resources for firms in applying this guidance.

Please make no mistake about this report.  FINRA is not doing it out of the “goodness of its heart;” instead, member firms should assume FINRA will use this report to bludgeon member firms, who have cybersecurity issues in the future.  That is, member firms should work with counsel to ensure that they have the appropriate cybersecurity policies and procedures in place before FINRA “comes a knockin!”

Ever wonder what it’s like to argue in front of the Supremes? Fox partner Ernest E. Badway will moderate a forum with two Supreme Court advocates – Robert G. Heim and Howard Meyers – that will offer a fascinating glimpse into one of the most intense experiences in the practice of law.  The program will take place on January 3, 2019, from 12 p.m. to 1 p.m. E.S.T., and focus on their recent high court argument in Lorenzo v. SEC, including the preparation and the argument itself.  Registration details will follow.