SEC Says No Second Bite of FINRA Expungement Apple

May 9, 2023

FINRA's expungement process is a flawed mess. Scraping customer complaints and allegations of employment-related misconduct from public, published records often impedes public investors engaged in due diligence before opening brokerage accounts. Similarly, FINRA's expungement process is often too expensive and too prolonged for associated persons who have truly been victimized by false allegations. A recent FINRA expungement matter took four years to work its way on appeal to the SEC. That's a disservice to the public and the industry. 

FINRA Denies Arbitration Forum for Expungement

In 2019, after a FINRA Arbitration Panel hearing a customer case denied his request for an expungement, FINRA associated person Pearce filed an intra-industry arbitration expungement claim. That relief was deemed ineligible for arbitration by FINRA. In response, Pearce filed an appeal with the SEC. In Pearce's "Application for Review" (June 28, 2019), he asserted in part that:

[O]n June 27, 2019, Mr. Pearce received notice that the Director of FINRA Office of Dispute Resolution ("the Director") denied FINRA forum for arbitration, claiming that the Director determined that Mr. Pearce's request for expungement of the Occurrence "is not eligible for arbitration," citing Industry Code Rule 13203(a).1

. . .

Counsel believes that the Director's arbitrary decision to deny forum may be based on the fact that there was a prior adverse award related to the underlying customer dispute disclosure. Seeing as Mr. Pearce's counsel has represented other associated persons in FINRA arbitration for expungement of disclosures after a prior adverse award and has succeeded on the merits, it would further reiterate the point that the Director's denial of forum in this case is unwarranted and inconsistently applied.  . . .

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Footnote 1:  Industry Code Rule 13203(a) states that: "The Director may decline to permit the use of the FINRA arbitration forum if the Director determines that, given the purposes of FINRA and the intent of the Code, the subject matter of the dispute is inappropriate, or that accepting the matter would pose a risk to the health or safety of arbitrators, staff, or parties or their representatives. Only the Director may exercise the authority under this Rule." 

The SEC Has Some Questions

In the Matter of the Application of Kent Vincent Pearce for Review of Action taken by FINRA (Order Requesting Additional Briefing, '34 Act Rel. No. 92967; Admin. Proc. File No. 3-19228 / September 13, 2021), the SEC requested additional briefing, in part, on the following issues [Ed: footnotes 2 and 4 omitted]:

  • During the underlying customer arbitration proceeding, did Pearce seek expungement of the information about the underlying arbitration from his Central Registration Depository record, and did the arbitration panel deny that request?

  • How does the underlying customer arbitration panel's apparent denial of Pearce's request for expungement bear on whether Pearce accessed FINRA's arbitration service, or was prohibited or limited in his access to that service? What is the relevance, if any, of Dustin Tylor Aiguier and John Boone Kincaid III?

  • For the purposes of Exchange Act Section 19(d)(1), is arbitrating an expungement claim during a customer arbitration a  "service" and, if so, is it different than the "service" of arbitrating an expungement claim during an intra-industry arbitration? Or is the relevant "service" the same, regardless of whether an expungement claim is made in a customer arbitration or an intra-industry arbitration? In answering these questions, the parties should address the similarities and differences between seeking expungement in customer arbitration and intra-industry arbitration and should consider citing particular FINRA arbitration rules and practices.

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Footnote 3: Dustin Tylor Aiguier, Exchange Act Release No. 88953, 2020 WL 2743938, at *2-3 (May 26, 2020) (holding that FINRA's action denying applicant's request to reopen an earlier arbitration hearing did not limit his access to FINRA's arbitration service, and thus there was no jurisdiction under Section 19(d), because applicant had accessed FINRA's arbitration forum); John Boone Kincaid III, Exchange Act Release No. 87384, 2019 WL 5445514, at *3-5 (Oct. 22, 2019) (concluding that FINRA action giving effect to arbitrator's award was not a limitation of access to arbitration, and thus there was no jurisdiction under Section 19(d), where the applicant received a ruling from the arbitrator denying the requested relief and sought to challenge the ruling as an erroneous application of FINRA's rules).

Two Bites of Same Arbitration Apple

The SEC dismissed Pearce's Application for Review. In the Matter of the Application of Kent Vincent Pearce for Review of Action taken by FINRA (Opinion, '34 Act Rel. No. 97451; Admin. Proc. File No. 3-19228 / March 8, 2023) As the SEC characterized Pearce's matter [Ed: footnotes omitted]:

[H]aving received an adverse final award on that first expungement claim, Pearce is thus asking FINRA to allow him to access its arbitration service again, so that he can argue for a second time that he is entitled to expungement because there was no merit to the customer allegations. But Pearce has not established that FINRA offers the service of repeated access to its arbitration forum to bring an expungement claim for which a final award has been issued. To the extent that Pearce suggests that FINRA should allow for separate intra-industry arbitration of an expungement claim that has already been denied during a customer arbitration, we also lack authority under Exchange Act Section 19(d) to review FINRA’s failure to offer this service. 

at Pages 5 - 6 of the SEC Opinion

As the SEC summarized its response to the Petition, Pearce was seeking a second bite of the expungement apple by posturing a previously denied application in a customer arbitration as a separate application in an intra-industry arbitration. In offering its rationale for denying the second bite, the SEC asserts in part that [Ed: footnotes omitted]:

[W]here, like here, FINRA has already provided access to its arbitration service to seek expungement, we have consistently held that we cannot exercise review because FINRA has not in fact prohibited (or limited) access to its service. Because Pearce has not shown that FINRA prohibited or limited his access to a service it offers, we thus lack authority over Pearce’s application for review. 

at Page 6 of the SEC Opinion

In further hammering that last nail into Pearce's expungement coffin, the SEC doubles down [Ed: footnotes omitted]:

[I]t was thus Pearce’s choice to bring his expungement claim during the initial underlying customer arbitration or take the risk that an adverse outcome in the customer arbitration could result in his losing access to any arbitral forum to seek expungement. That Pearce now believes it may have been better strategically for him to bring his expungement claim in a subsequent intra-industry arbitration proceeding does not change that he already received a final arbitration award on the merits of the very expungement request for which he now claims FINRA denied him access.

Bill Singer's Comment

FINRA's expungement process is a flawed mess.

As I have long and often noted in this blog and in media comments, I do not believe that expungements should be entertained by a panel of arbitrators but, in contradistinction, by a regulatory body as a regulatory proceeding. Ultimately, FINRA's dubious approach has turned expungements into a cottage industry for the self-regulatory-organization that yields filing fees, forum fees, and attendant costs. Making matters worse, the scraping of customer complaints and allegations of employment-related misconduct may work to the detriment of investors who pursue meaningful due diligence of FINRA member firms and their registered representatives. Similarly, FINRA's expungement process is often too expensive and too prolonged for associated persons who have truly been victimized by false allegations.

Perhaps there is no more damning proof of the unfairness of FINRA's expungement construct than to note that it took four years for Pearce to obtain the SEC's denial of his appeal of a 2019 FINRA determination that his expungement claims were ineligible for presentation to that forum. Notably, the merits of his claims were never much of an issue on appeal. The sole focus was whether FINRA had the right to bar the door to its forum. The SEC affirmed the self-regulatory-organization's conduct. Why that took four years is both a mystery and a shame. Neither the investing public nor the industry is best served by such delayed justice.