California Court of Appeal Says FINRA Expungement Hearing Unfair

September 1, 2016

It may well be a legal puzzle that only a lawyer can love but, nonetheless, any serious Wall Street participant (customers and industry members alike) should take the time to read about a public customer case, which actually settled, but still managed to wind up in an appellate court. The issue for the courts was not the liability and damages but whether an expungement was properly awarded. An oddball aspect of this case is that FINRA winds up arguing that its arbitrators didn't act properly. Like I said, you may have needed to go to law school to fully appreciate the nuances of this mess but I'm guessing that lots of folks will still appreciate the ramifications of this somewhat historic ruling.

Case In Point

In a Financial Industry Regulatory Authority ("FINRA") Arbitration Statement of Claim filed in May 2013, public customer Claimant Liebhaber asserted negligence; breach of fiduciary duty; and California Securities Law Violations in connection with her investments in Ohio National Life Insurance Variable Annuity, Hartford Director M Outlook Variable Annuity, Hartford Leaders Outlook Variable Annuity, SunAmerica Annuity and Life Assurance Variable Annuity and Inland American Real Estate Trust, Inc. Claimant sought at least $325,000 in compensatory damages and interest plus costs and fees. In the Matter of the FINRA Arbitration Between Sandra L. Liebhaber, Claimant, vs. Royal Alliance Associates, Inc. , Respondent (FINRA Arbitration 13-01522, September 10, 2014).

Respondent Royal Alliance generally denied the allegation and requested an expungement of the arbitration from the Central Registration Depository record ("CRD") of Kathleen Tarr and Richard McCollam.


In May 2014, the arbitration settled and Respondent Royal Alliance requested that the FINRA Arbitration Panel keep the case open to permit an expungement hearing. As set forth in the FINRA Arbitration Decision:

[C]laimant's counsel advised that he will not be filing a pre-hearing brief regarding Respondent's Request for Expungement, but planned to call Claimant and non-party Kathleen Tarr as witnesses at the expungement hearing.

Expungement Hearing

Although Respondent had requested an expungement for Richard McCollam in its Answer, Royal Alliance did not thereafter reiterate that request and the FINRA Arbitration Panel made no determination on that matter.

The Decision offers the following commentary about the Tarr expungement hearing:

The Panel conducted a recorded telephonic hearing on August 12, 2014 regarding the appropriateness of expungement of customer dispute information from the CRD system as requested by non-party Kathleen Tarr. The request for expungement was opposed by Claimant. After oral statements and arguments by non-party Kathleen Tarr, Respondent, and Claimant, the Panel held its deliberations immediately after the hearing.

The Panel offered the following rationale, in pertinent part, for recommending the requested relief

The claim, allegation, or information is factually impossible or clearly erroneous; and
The claim, allegation, or information is false.

The Panel has made the above Rule 2080 findings based on the following reasons:

a. Claimant requested compensatory damages in the sum of $325,000.00, and laimant agreed to accept $30,000.00 in settlement of her claim. The argument of Respondent was that the decision to offer Claimant $30,000.00 to settle her claim reflected a business decision regarding the continuing costs of defending the case through a full-panel evidentiary hearing. Claimant argued that the $30,000.00 settlement reflected Claimant's net out of pocket losses ("NOP").

Paragraph 4 of the Settlement Agreement states in pertinent part: "The Parties are entering into this Agreement solely for the purpose of avoiding the burdens, inconvenience, and expenses of further litigation. This Agreement does not constitute, and shall not be construed as ... an admission ... of any wrongdoing, liability, or culpability."

There was no information presented which disputed this portion of the Settlement Agreement. Therefore, as required under Rule 12805(b), the Panel has found that with respect to the amount of payment made pursuant to the Settlement Agreement, the argument of Respondent is more persuasive and is factually correct.

. . .

Finally, Claimant did, in fact, oppose expungement, was present during the telephonic hearing, provided the Panel with opposing documents and gave a full argument to the Panel requesting that expungement relief not be awarded.

c. In late 2007, Claimant opened an Individual Retirement Account with Respondent with an initial deposit of $315,000.00. Claimant was approximately 47 years of age. Non-party Kathleen Tarr was her broker of record. Stating that her investment objectives were long-term growth and income, with a moderate investment risk. Claimant purchased four separate variable annuities and a real estate investment trust ("REIT") paying over 6% per annum. Almost 15% of her investable monies remained in cash.

Claimant stated in her Statement of Claim that these investments were not suitable for her. The statement of non-party Kathleen Tarr was that the annuities were invested in a broad-based portfolio which matched Claimant's investment objectives and risk tolerance. This information was not disputed by Claimant.

Claimant did not add any additional monies to her IRA. Claimant regularly received or took distributions from her IRA. Claimant sold one variable annuity in December 2011.
At the time of the expungement hearing, non-party KathleenTarr stated that it was her understanding and belief that Claimant still owns the same three variable annuities as well as the REIT. This information was not disputed by Claimant.

No other evidence or information regarding suitability was offered by Claimant.

d. Respondent argued that any losses incurred by Claimant were "paper" losses due to the economic downturn of 2008 - 2009. By continuing to hold her assets. Respondent argued that Claimant no longer has incurred losses, and, to the contrary, has benefited from the upturn in the economy. This argument was not disputed by Claimant.

e. The Panel finds that the statements offered by non-party Kathleen Tarr during the telephonic hearing were credible. The Panel finds that the investments were suitable for Claimant, and that the claim or allegation of unsuitability is clearly erroneous.

f. The Panel finds that based upon the documents described above, the statements and other information presented at the telephonic hearing, and the Settlement Agreement, Claimant's argument that the $30,000.00 payment reflected NOP losses is not true. In addition, there is no documentation or other evidence to support a claim that Claimant suffered losses as a result of non-party Kathleen Tarr's actions, or Respondent's actions or inactions.

To The Courts

For reasons that may now have come back to haunt Royal Alliance (but, in fairness to the company, the move made perfect legal sense), the company petitioned the Superior Court of California to confirm the arbitration award. Additionally, Liebhaber moved to vacate the award. FINRA appeared and argued in support of Liebhaber. Royal Alliance Associates Inc., v. Sandra L. Liebhaber et al. (Superior Court of California, County of Los Angeles, BS151127 / May 18, 2015).

In denying the petition to confirm and in granting the motion to vacate, the Court found that:

[L]iebhaber's rights were substantially prejudiced by misconduct of the arbitrators, the arbitrators exceeded their powers, and Liebhaber's rights were substantially prejudiced by refusal of the arbitrators to hear evidence material to the controversy. Specifically , the arbitrators violated FINRA Rule 2080 governing expungement of the CRD records of Kathleen Tarr by allowing Ms. Tarr to provide an unsworn statement in support of expungement while also preventing Liebhaber's attorney from cross-examining Ms. Tarr in order to determine if the requirements of Rule 2080 were met . . .

Court of Appeal

After the Superior Court vacated the expungement, on appeal by Royal Alliance, the California Court of Appeal affirmed the judgment and found that the FINRA Expungement hearing was conducted in an unfair manner. Royal Alliance Associates, Inc., Plaintiff / Appellant, v. Sandra L. Liebhaber et al., Defendants / Respondents (Opinion, Court of Appeal of the State of California, Second Appellate District; B264619 / August 30, 2016). As set forth in the Opinion's preamble:

Appellant Royal Alliance Associates, Inc., a securities brokerage firm, petitioned to confirm an arbitration award recommending expungement of an allegation of misconduct from the record of one of its employees, Kathleen J. Tarr. The individual who made the allegation of misconduct, Sandra Liebhaber, petitioned to vacate the same arbitration award. Liebhaber argued that the arbitrators violated the rules applicable to the arbitration and refused to hear evidence she sought to introduce and cross examination she sought to elicit. The Financial Industry Regulatory Authority, Inc. (FINRA), under whose auspices and rules the arbitration at issue was performed, also petitioned to vacate the award on similar grounds.

The trial court denied Royal Alliance's petition to confirm the award and granted Liebhaber's and FINRA's petitions to vacate, ruling that the arbitrators exceeded their powers and that Liebhaber's rights were substantially prejudiced by the arbitrators misconduct and refusal to hear material evidence. Royal Alliance appealed, and we affirm. The arbitrators denied Liebhaber a full and fair opportunity to introduce and challenge evidence material to the expungement proceedings to which she was a party. The arbitrators' refusal to hear Liebhaber's evidence and cross-examination deprived Liebhaber of a fair hearing and substantially prejudiced her rights within the meaning of Code of Civil Procedure section 1286.2.

The Opinion offers us much-needed content and context to understand the nature of the disputed conduct of the expungement hearing:

The three-member panel of arbitrators held a telephonic arbitration proceeding on August 12, 2014. Liebhaber and her counsel, Robert S. Banks, Jr., were on the call, as were Royal Alliance and its counsel, Kasumi L. Takahashi. Takahashi informed the arbitrators that Tarr was on the line as well; "[s]he's here to offer any additional testimony and answer any questions that the panel may have of her . . . ." Takahashi argued that expungement was warranted because Liebhaber's allegations against Tarr were false. She contended that the investments Tarr recommended were suitable for Liebhaber, and Liebhaber's alleged net losses could be attributed to her large withdrawals from her retirement account and "the 2008 market crash." Takahashi also noted that a complaint similar to Liebhaber's previously had been expunged from Tarr's record.

At the conclusion of her argument, Takahashi informed the arbitrators that Tarr had "a couple things [sic] that she would like to say to the panel before we kick it over to the claimant's counsel." The presiding arbitrator said that Tarr could speak, and Liebhaber's counsel did not object. No oath was administered to Tarr, who presented a lengthy narrative description of her interactions with and advice to Liebhaber. Tarr also noted that she was "the daughter and granddaughter of ministers" and emphasized the "vigorous" nature of her opposition to Liebhaber's allegations. No one interrupted Tarr with questions or objections. When Tarr concluded her remarks, Takahashi informed the panel that Royal Alliance had nothing further to present.

In his response argument, Banks contended that Royal Alliance failed to show that Liebhaber's complaints against Tarr were false or factually impossible. He also emphasized the importance of making complete (i.e., not expunged) CRD and BrokerCheck records available to brokerage firms and the general public.At the conclusion of his argument, Banks told the arbitrators, "I guess I would like to ask some questions of Ms. Tarr and I would also like to ask some questions of Ms. Liebhaber so that you can have a little bit more information before you make the decision that they're asking you to make." Takahashi objected to "counsel's proposed procedure for this hearing." She argued, "This is a hearing on a request for expungement, it's not a hearing on the merits of the case. The underlying case was settled. The only question before the panel right now is whether or not the claim should be expunged based on the falsity of allegations, so I would request that we not hear from the claimant at this time and that we have a chance to rebut the opposition."

The presiding arbitrator commented, "I believe Ms. Tarr didn't say anything substantive that is not already on the record on her behalf with respect to the declaration. I listened carefully to Mr. Banks and I think he, based on the documents that I've seen, has covered all the important points. [¶] I don't see that any testimony as such is necessary, setting aside whether it's proper and has not been in effect perhaps prepared for by everybody here, so I'm inclined to think that we should leave it at that, unless Mr. Banks has further argument by himself and go from there." He then asked for input from his fellow panel members. One of them commented that she would like to hear from Liebhaber and Tarr. She thought it was "important to hear the questioning," and commented that "the guidelines are pretty clear that we're supposed to be looking at everything because this was a settled case, and that the more information we have, the easier it is for us to make what I would consider to be a fair and well reasoned decision regarding expungement."1 She then added, "[t]hat's just my thought as long as we're not going to be here for another two hours."

The presiding arbitrator responded, "Well, how can we make sure we're not going to be here for another two hours? That's the problem. [¶] I appreciate your comments and I think that's in the best of all possible worlds how it should be." The third arbitrator then commented that she agreed with the presiding arbitrator. "[W]ith the greatest respect, I think that allowing claimant's counsel to question Ms. Tarr is out of order, and . . . I do think that that's not the purpose of this hearing, and if it is and the panel needs to be corrected on that, because some of the -- this is kind of a new process that has not been well defined, then we can be corrected on that, but I would be very comfortable with the information, and I'm comfortable with us asking Ms. Tarr questions, but I am uncomfortable with claimant's counsel cross-examining her in any way." The second arbitrator stated that she was "good with that." The presiding arbitrator then denied Banks's "request to take testimony from the claimant and to allow questioning by counsel of the respondent."

Pages 4 - 6 of the Opinion

In defining the task before it, the Court of Appeal explained that:

Accordingly, we find it unnecessary in this case to resolve the parties' substantial disagreements regarding the scope of (and degree of arbitrator compliance with) the FINRA rules. The pertinent question for us is not what the FINRA rules provided or whether the arbitrators adhered to them; it is whether the trial court correctly concluded that the arbitrators prevented a party from fairly presenting its case and prejudiced her rights as a result. . .

Page 16 of the Opinion

In reaching its determination, the Court of Appeal offered this damning perspective:

Simply put, the hearing was not fair. The arbitrators gave Royal Alliance an unfettered opportunity to bolster the written record but denied Liebhaber even a limited chance to do the same. Liebhaber's rights as a party to the arbitration proceedings were substantially prejudiced within the meaning of section 1286.2, subdivision (a)(5), and the arbitration order properly was vacated as a result.