In a Financial Industry Arbitration Statement of Claim filed in October 2011, registered persons Davis and Skow named public customers Stephen and Patricia Rugg as part of what I would charitably call the moronic "legal fiction" required to pursue the expungement of a registered person's Central Registration Depository records ("CRD"). According to the FINRA Arbitration Decision:
The cause of action relates to an amended complaint brought by Respondents in the United States District Court for the Western District of Louisiana on or about February 17, 2010 in which Respondents asserted, among other things, that Claimants did not re-adjust their portfolio of unspecified mutual funds as Respondents neared retirement.
The public customer Respondents notified FINRA that they did not take a position concerning the Statement of Claim and did not plan to participate in the expungement proceedings. In the Matter of the FINRA Arbitration Between Daniel A. Davis and Jerome R. Skow, Claimants, vs. Stephen H. Rugg and Patricia A. Rugg, Respondents (FINRA Arbitration 11-03913, June 11, 2012).
SIDE BAR: A respondent seeking expungement relief in an arbitration must obtain a ruling from the arbitrators in accordance with the standards set forth in FINRA Rule 2080 (formerly NASD Rule 2130).
FINRA Rule 2080. Obtaining an Order of Expungement of Customer Dispute Information from the Central Registration Depository (CRD) System
(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.
(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.
(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:
(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.
(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.
(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.
The sole FINRA Arbitrator conducted an expungement hearing and granted Claimant Davis's request. The arbitrator found that Davis had been replaced during a 2006 re-allocation of office accounts and "was not in any manner responsible for the account(s) during times relevant to the issues in the underlying customer complaint." Notwithstanding the absurdity of this matter even being on Claimant Davis's CRD, FINRA's rules require that the Arbitration expungement recommendation be presented to a civil court for confirmation and that FINRA be named as a party.
SIDE BAR: Assuming that Davis were some registered person who had been laid off by his employer because of the Great Recession or his former brokerage firm went bankrupt or his family finances are desperate, the full brunt of the costs for the anticipated court proceedings falls squarely on such an individual. Although there are many circumstances where FINRA's expungement process is warranted and makes sense, in a situation such as this where the registered person was wrongly named and had no meaningful role in any alleged misconduct, this process is punitive and unreasonable. As with all such bureaucratic rules and regulations, this one is inflexible. I trust that my thoughts on this topic are clear?
The FINRA arbitrator denied Claimant Skow's expungement request. Because the arbitrator's rationale is thoughtful and provides valuable guidance to other registered representatives similarly situated, I offer his observations:
While the Arbitrator believes that Claimant Skow may have prevailed in his defenses should the underlying matter have been taken to a hearing on the merits of that dispute, that did not occur, and, in fact, a substantial settlement was reached with the Rugg claimants to settle their claims (noting payment was not made by the individual relationship officers, but they were included in the parties to the release, and the confidentiality requirements of the documents did seem to inhibit the Ruggs' participation in this expungement process). It is undisputed that Claimant Skow was the "relationship officer" assigned to Respondents' account(s) from 2006-2010, the dates relevant to the dispute in the underlying customer complaint. While the precise duties and responsibilities of a "relationship officer" may have been in dispute in that case, this Arbitrator cannot find that the allegations against Claimant Skow fall within the very narrow window of opportunity to grant an expungement - i.e., factually impossible, clearly erroneous, registered person not involved in the alleged investment-related sales practice, or that the claims/allegations were false. The strict requirements of FINRA Rule 2080 ("expungement occurs only when the arbitrators find and document one of the narrow grounds specified….") and 12805 are designed for customer protection and record integrity, and place a high burden of affirmative proof on anyone requesting alteration of those records via expungement. Therefore, the expungement request of Claimant Skow is hereby denied.
A review of FINRA online regulatory records for Claimants Davis and Skow disclose that on October 29, 2009, Fidelity Brokerage Services LLC characterized the customers' complaint as follows:
THE CUSTOMERS ALLEGE THAT THE REGISTERED REPRESENTATIVE FAILED TO FOLLOW INSTRUCTIONS TO CHANGE THE ASSET ALLOCATION OF THEIR MANAGED ACCOUNT
Online FINRA records disclose that the original claim was for $1,383,000, but, on March 4, 2011, the matter settled for $150,000.
Claimant Davis's online FINRA record provides an additional response not similarly presented in Claimant Skow's online report:
THE FIRM CONCLUDED THAT THE REPRESENTATIVE DID NOT ENGAGE IN ANY WRONGDOING AND ACCORDINGLY DID NOT ASK THE REPRESNTATIVE TO CONTRIBUTE TO THE SETTLEMENT
Although a six-figure settlement is nothing to sneeze at and the sole Arbitrator correctly characterizes the payment as a "substantial settlement," the reality is that Claimants settled for about 12% of their alleged damages - not exactly an amount that suggests a strong case but certainly an amount that suggests some legitimate issues were conceded. All these considered, the brokerage firm may have concluded that for "business reasons" it would be cheaper and more expedient to settle such a case rather than embark upon a costly defense - one whose legal fees may well have equaled or exceeded the $150,000 settlement.
A takeaway for many registered persons who find themselves trapped in a similar customer complaint is to carefully weight the Arbitrator's admonition that Claimant Skow may have prevailed in a hearing on the merits of the allegations against him. Although the Arbitrator acknowledged that Skow did not contribute to the settlement and was a party to the release, that was not persuasive enough to prompt a recommendation for expungement.
An interesting reservation expressed by the Arbitrator concerned the confidentiality imposed by the terms of the settlement that he mused seemed to ‘ inhibit the Ruggs' participation in this expungement process." I would note that the public customers informed the Arbitrator that they took no position on the request and would not participate - clearly, they could have indicated their robust support or tenacious opposition but chose to take the settlement dollars and be done with the entire process. The customers' disinclination to become further involved with the FINRA arbitration/expungement process could just as easily be ascribed to their disappointment with the relatively small settlement and a lack of desire to continue fighting with the respondents - rather than a decision prompted by some inhibition in the settlement agreement. Similarly, if these customers felt passionate about their case as some do, they could have participated in the expungement hearing, even if they requested to do so telephonically rather than in person.
There are times when you really need to lace ‘em up and climb into the ring. Just because your firm or another broker may settle a case, doesn't mean that you should simply go along with a settlement. Even in the circumstance of anunnamed industry respondent who is, nonetheless, required to disclose the allegations because of his or her "involvement" in the underlying matters, there are times when passive resistance is ill-advised and a separate Statement of Claim filed against the customers might be appropriate. Still, the conventional wisdom espoused by most industry defense lawyers is that it's often best to leave well enough alone and not go hammer and tong after customers (particularly those with loses on your watch) - generally, I concur with that view but not always. As Respondent Skow learned, even if you don't contribute a penny to any settlement, that's not necessarily going to deliver you from the evils of having disclosable information on your Form U5 or on FINRA's BrokerCheck online database.
The expungement of customer complaint information is not an esoteric issue but one that arises with frequency. In recent months, I have reported about such issues involving registered persons at Citigroup, Wells Fargo, Merrill Lynch, Morgan Stanely, UBS, as well as regional/indie firms. See this additional "Street Sweeper" columns on the FINRA expungement process: