Bill Singer Analyzes FINRA Expungement Rules 2080 and 2081

March 27, 2017

To say that we live in a litigious age is something of an understatement. That being said, as a lawyer, who the hell am I to complain about more business? Frankly, it's an ill lawsuit that blows no good for the legal profession. On Wall Street, litigation winds often take the form of typhoons and tornadoes, whose devastation last long after their winds have died down. Whether fairly named for fraud or victimized by disgruntled customers, securities industry employees find that once customer-dispute information is entered into the Central Registration Depository, its half-life challenges that of any radioactive isotope. Customers' allegations, complaints, settlements, and verdicts literally follow associated persons to the grave.

At one time, the industry had a fairly simple grievance process, which scrubbed clean a given employee's record. The problem with that approach is that a lot of recidivists got to reinvent themselves and cause ongoing damage to unsuspecting customers. After all, a dirty-record wiped clean and an unblemished record look the same if you don't know the difference. As the horror tales mounted about scamsters with sanitized histories who went on to dupe unsuspecting consumers, pressure mounted to deprive the old National Association of Securities Dealers ("NASD") and its successor the Financial Industry Regulatory Authority ("FINRA") of the right to take a squeegee to an associated person's record.  As with so many reforms that occur as a "reaction" to perceived abuse, the result didn't necessarily produce a fair set of new rules and regulations. Understandably, investor advocates shed no tears for halting what they viewed as an outrageous anti-consumer abuse by NASD/FINRA. What is now on the books is far more protective of investors and far more onerous for industry participants.  

How then do associated persons expunge customer information from their industry records? As you may imagine from the preface to this article, it's not a simple process -- and when a regulator does not provide for a simple solution, that also means that the remedy can prove expensive and time-consuming. Welcome to the world of seeking a FINRA expungement. NOTE: This article is the first installment on the issue; more to follow.

FINRA Rule 2080

The steps necessary to expunge customer-dispute-information from the Central Registration Depository ("CRD") are set out in FINRA Rule 2080. Below find verbatim extracts from Rule 2080 with my comments indented:

FINRA Rule 2080: Obtaining an Order of Expungement of Customer Dispute Information from the Central Registration Depository (CRD) System

Bill Singer's Comment: Carefully note that FINRA Rule 2080 applies only to the expungement of a customer dispute and does not pertain to intra-industry matters. Given that the goal of the Rule 2080 expungement is to remove information from CRD, let's start with an understanding of what CRD is, as set forth on FINRA's website:

Central Registration Depository (Web CRD)

FINRA operates Web CRD(R), the central licensing and registration system for the U.S. securities industry and its regulators. The system contains the registration records of more than 3,815 registered broker-dealers, and the qualification, employment and disclosure histories of more than 635,365 active registered individuals.

Web CRD also facilitates the processing and payment of registration-related fees such as form filings, fingerprint submissions, qualification exams and continuing education sessions. Web CRD is a secure system for entitled users only. Firms must complete FINRA's entitlement process noted below to request access to use Web CRD.

It is important to distinguish between seeking the expungement of information arising from a dispute between a FINRA member firm and an associated person, and the expungement of customer-complaint information arising from a dispute between a customer and a member firm and/or associated person. As to the ambit of FINRA Rule 2080, consider this commentary in "NASD Notice to Members 99-54 / NASD Regulation Seeks Comment On Issues Relating To Arbitration-Ordered Expungements Of Information From The Central Registration Depository; Comment Period Expires July 30, 1999." ("NASD NTM 99-54") [Ed: boldface in original]:

In addition, NASD Regulation is continuing to expunge information from the CRD system based on expungement directives in arbitration awards rendered in disputes between firms and current or former associated persons, where arbitrators have awarded such relief based on the defamatory nature of the information in the CRD system. To qualify for this exception from having an award confirmed in court, the dispute must be between a firm and a current or former associated person and arbitrators must clearly state in the "Award" section of the award that they are ordering expungement relief based on the defamatory nature of the information in the CRD system.. (Arbitrators, however, are not required to state explicitly in the award that they have found that all of the elements required to satisfy a claim in defamation under governing law have been met.)

Page 352 of NASD NTM 99-54

I cannot stress enough that Rule 2080 does NOT apply to intra-industry disputes between firms and associated persons provided that no customer party is involved. As such, we are eliminating from the purview of Rule 2080 matters that typically arise in conjunction with purely workplace disputes such as lack of lack of production, attendance, insubordination, promissory notes, wrongful termination, etc. In such intra-industry disputes, FINRA may expunge defamatory information without a court order.

(a) Members or associated persons seeking to expunge information from the CRD system arising from disputes with customers must obtain an order from a court of competent jurisdiction directing such expungement or confirming an arbitration award containing expungement relief.

Bill Singer's Comment: One of the most misunderstood policies on Wall Street is that the route to obtaining an expungement of CRD information is available via two paths. Among the most pervasive of all industry myths is that a CRD expungement may only be "recommended" by a FINRA Arbitration Panel and, thereafter, confirmed by a court. In reality, those seeking expungements are not limited to the relief afforded solely through arbitration but may directly apply for a court order.

(b) Members or associated persons petitioning a court for expungement relief or seeking judicial confirmation of an arbitration award containing expungement relief must name FINRA as an additional party and serve FINRA with all appropriate documents unless this requirement is waived pursuant to subparagraph (1) or (2) below.

Bill Singer's Comment: If you opt for the Court-Order-route or you have obtained an arbitration award containing expungement relief (frankly, the Rule should more accurately denote this as a recommendation of expungement from an Arbitration Panel), you are required to name FINRA as an additional party in your petition to a court and you must further serve FINRA in its role as a party.

(1) Upon request, FINRA may waive the obligation to name FINRA as a party if FINRA determines that the expungement relief is based on affirmative judicial or arbitral findings that:

Bill Singer's Comment: Notwithstanding that Rule 2080 mandates naming FINRA as a party, a waiver process exists by which the self-regulatory organization may relieve you of the need to name-and-serve it provided that there are judicial/arbitral "findings," which are further detailed

(A) the claim, allegation or information is factually impossible or clearly erroneous; 

(B) the registered person was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation or conversion of funds; or

(C) the claim, allegation or information is false.

Bill Singer's Comment: A waiver of name/service may be predicated upon a finding that:

(A) the cited customer claim/allegation/information is factually impossible or clearly erroneous. If you are proceeding with your expungement case pro se (without a lawyer), make sure that you specifically seek a favorable ruling in which the magic words "factually impossible or clearly erroneous" are set forth.

Examples of what might be considered "factually impossible or clearly erroneous" would be if you were named as employed by member firm X in 2015 but had either never been employed by that firm or had resigned in 2011; or

(B) the petitioning registered person was not involved in the specified allegations of investment-related sales practice violation, forgery, theft, misappropriation, or conversion of funds. If you are proceeding with your expungement case pro se, make sure that you specifically seek a favorable ruling in which you are pointedly exonerated via the specific conduct set forth in the Rule.

(C) you may need to research the elements of what constitutes forgery, theft, or conversion and argue that although you did, in fact, commit the alleged acts A, B, and C, that they do not rise to the level of the crime or tort indicated. For example, you may have "signed" a customer's signature but did so with her authorization because her hand was broken at the time. Such conduct could still be a violation of your firm's written supervisory policies but would not necessarily constitute a "forgery," which usually occurs without the prior knowledge and consent of the individual whose signature is in dispute. Similarly, you may need to prove that a client gave you a gift of cash that was never intended as a loan and, consequently, you did not convert his money. Again, accepting such a gift could be a violation of industry rules and policies but might not satisfy the legal definition of conversion.

(2) If the expungement relief is based on judicial or arbitral findings other than those described above, FINRA, in its sole discretion and under extraordinary circumstances, also may waive the obligation to name FINRA as a party if it determines that:

(A) the expungement relief and accompanying findings on which it is based are meritorious; and

(B) the expungement would have no material adverse effect on investor protection, the integrity of the CRD system or regulatory requirements.

Bill Singer's Comment: Nothing like a rule that says you may obtain relief subject to a regulator's "sole discretion" and based upon what that regulator deems to be "extraordinary circumstances." Tough to imagine a more loaded set of dice. If FINRA denies your request for the waiver, it's going to be tough to appeal because Rule 2080 pretty much permits FINRA to dismiss any appeal with the rationale that its ruling is as it is "because we say so."

Regardless of the naked discretion arrogated by the self-regulator, FINRA may grant you a waiver of the name/service requirement if your relief is deemed "meritorious" and would not materially and negatively impact investor protection, the integrity of CRD, or contravene regulatory requirements.

(c) For purposes of this Rule, the terms "sales practice violation," "investment-related," and "involved" shall have the meanings set forth in the Uniform Application for Securities Industry Registration or Transfer ("Form U4") in effect at the time of issuance of the subject expungement order.

Bill Singer's Comment: Would it not have been a preferred rule-making approach to offer the definition of those three key concepts in the body of Rule 2080? Does it truly make any sense to now send readers on a scavenger hunt?

One of the most glaring problems with Rule 2080(c) is its false premise that the Form U4 provides the referenced definitions. If you examine a copy of a U4 and you will see that few, if any, italicized or other important terms are defined "in" the Form. Additionally, the "General Instructions" portion of the Form U4 do not offer any of the definition of the three terms.

There is this oddball page of information floating around in cyberspace. If you locate it, you will see that it is housed on FINRA's website and offers explanations of terms in the Forms U4, U5, BD, BDW, and BR. What you could do, is find this online FINRA page. This document is something separate and apart from the various forms and is certainly not providing "definitions" that are physically "in" the various Forms.  By way of guidance, this is what is currently provided under "Form U4 Explanation of Terms":

Sales Practice Violations: Shall include any conduct directed at or involving a customer which would constitute a violation of: any rules for which a person could be disciplined by any self-regulatory organization; any provision of the Securities Exchange Act of 1934; or any state statute prohibiting fraudulent conduct in connection with the offer,

Investment-Related: Pertains to securities, commodities, banking, insurance, or real estate (including, but not limited to, acting as or being associated with a broker-dealer, issuer, investment company, investment adviser, futures sponsor, bank, or savings association).

Involved: Means doing an act or aiding, abetting, counseling, commanding, inducing, conspiring with or failing reasonably to supervise another in doing an act.

Also READ: "FINRA Rule 2080 Frequently Asked Questions" (Finra.org)

For an excellent primer on how FINRA arbitrators are trained to handle expungement requests, read: "Expungement Training" (Finra Office of Dispute Resolution Expungement Training, October 2016 version).

FINRA Rule 2081

Now that you have a better understanding to the Rule 2080 CRD expungement process, be careful that you don't get too creative about taking short-cuts. The very next rule in FINRA's rulebook is

FINRA Rule 2081: Prohibited Conditions Relating to Expungement of Customer Dispute

No member or associated person shall condition or seek to condition settlement of a dispute with a customer on, or to otherwise compensate the customer for, the customer's agreement to consent to, or not to oppose, the member's or associated person's request to expunge such customer dispute information from the CRD system

Bill Singer's Comment: A "NO" means "NO" rule. A rare but commendable example of a concise and lucid FINRA Rule. You cannot negotiate a customer's consent or non-opposition to a future expungement request as a condition for settling a customer dispute.