The broker's case for a chance at a clean record

Finra's expungement process is flawed and brokers are the losers

Aug 18, 2013 @ 12:01 am

By Patrick Mahoney

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(David Vogin)

On June 11, The New York Times ran the article “A Rise in Requests From Brokers to Wipe the Slate Clean.” It highlighted a rise in requests from brokers who seek expungement of customer complaints from their publicly available BrokerCheck records. BrokerCheck is the Financial Industry Regulatory Authority Inc.'s online database that Main Street investors can search to vet their existing and prospective brokers.

The article's theme implied that records of customer complaints are too easily erased or expunged from BrokerCheck records. This, the article argues, unfairly exposes Main Street investors to “bad brokers.”

But the article's outlook on the state of stock broker record expungement failed to properly characterize both the expungement process and its shortcomings. And unfortunately, the article reflects the misguided sentiment of investor protection advocates and attorneys nationwide.

A closer look at Finra's expungement process indicates a flawed system. But the losers in this flawed system aren't the investors but rather the brokers.

To fairly assess the stock broker expungement process, one must understand how a broker's BrokerCheck record gets tarnished due to an investor complaint in the first place.

It is also important to note that the brokerage firm, and not the broker, is responsible for reporting the investor complaint on the broker's record. In short, it takes very little for a broker to have an investor complaint disclosed on his or her BrokerCheck record.

The scenarios that trigger an amendment to a broker's record typically arise after an investor files a lawsuit through Finra, thereby initiating a private arbitration. Finra arbitration is a private dispute resolution forum in which investors agree to litigate any dispute relating to the handling of their investment accounts.

A brokerage firm must report an investor complaint on a broker's record in the following situations:

1) Where the broker is named as a defendant to the investor's Finra lawsuit.

2) Where the broker isn't named but is mentioned in the body of the investor's lawsuit.

3) Where the broker is neither named nor mentioned in the lawsuit, but the brokerage firm makes a “good faith” determination that the broker was “involved” in the alleged wrongdoing.

If the brokerage firm fails to adequately amend a broker's record to reflect an investor complaint, Finra will impose a severe fine on the firm.

Context of complaint

Now, most can agree on amending a broker's record to reflect an investor complaint where the broker is actually named as a defendant to the lawsuit. Indeed, naming the broker as a defendant to an investor lawsuit unquestionably links the broker to the malfeasance alleged in the investor's complaint.

But the link between the broker and the malfeasance alleged in an investor complaint becomes blurred where the broker isn't named as a party to the investor's lawsuit.

The link becomes especially blurred where the broker is neither named nor even mentioned in the investor complaint.

The following hypothetical exposes these blurred links.

Suppose an investor brings a lawsuit naming XYZ Brokerage as the only defendant. The investor alleges that XYZ Brokerage provided the investor misleading information in XYZ Brokerage's approved marketing literature with respect to the safety of a failed proprietary mutual fund.

There is no mention of a broker anywhere in the investor's complaint. The only person “involved” in the “wrongdoing” was a single broker who placed an unsolicited transaction initiating the purchase of the questionable fund on the investor's behalf.

Surprisingly, many brokerage firms would determine that the broker in the above example was “involved” enough in the alleged wrongdoing to warrant disclosing the investor complaint on his or her record, despite the broker's merely following the investor's instructions. Decisions to report such seemingly innocuous events are the result of the constant threat of fines and unwanted regulatory scrutiny that Finra places on brokerage firms for underreporting investor complaints.

Moreover, because the broker isn't a named defendant, he or she has no say in the outcome of the dispute. In other words, the brokerage firm gets to make 100% of the strategy decisions with respect to how to handle the investor complaint.

And questions regarding whether to settle and settlement amounts, as well as whether to take the case to arbitration (similar to a trial in court), are determined exclusively by the brokerage firm. These decisions, however, are often made to the detriment of the broker, who, if named, is more inclined to fight the allegations rather than settle to preserve his or her record.

Seeking expungement

The broker's only recourse in such situations? Seeking expungement of the investor complaint through Finra.

To expunge an investor complaint from a broker's record, the broker (typically at his or her own expense) must prove to a panel of Finra arbitrators that the investor's claim was false, that the broker wasn't involved in the alleged wrongdoing or that the investor's claim was impossible or clearly erroneous.

As a practical matter, a broker can more easily prove his or her case for expungement where he or she is neither named nor mentioned in the investor's lawsuit.

Nevertheless, the standard that the broker must meet to earn expungement of an investor complaint, particularly in light of what little it takes to warrant including it on a broker's record, is extremely high. So, too, are the costs associated with seeking expungement.

Interestingly, the same investor protection attorneys who cry foul at the number of brokers who seek to have their records “erased” are the primary cause of this supposed “problem.” Indeed, most knowledgeable investor attorneys ensure that their clients don't name the underlying broker as a defendant in the investor's complaint, because doing so creates an obstacle to settlement.

As explained, when the broker is a named defendant, he or she has a right to defend against the allegations and is more inclined to fight the charges than is the deep-pocketed brokerage firm, which would often rather settle to avoid litigation costs. And when the case does settle — as is the case with more than 90% of Finra cases — investors rarely bother opposing a broker's subsequent expungement request because the investor doesn't want to incur the costs associated with bringing such an opposition.

In sum, if investor protection advocates truly think that too many “bad brokers” are getting clean slates, then those investors who choose to bring complaints should make a point to name their broker as a defendant and vehemently oppose any of their requests for expungement.

The reality, however, is that most investors don't want their complaint to tarnish their former broker's record. And those who do would rather not incur the costs required to ensure that a broker's record remains tarnished.

Patrick Mahoney is a securities attorney at an eponymous firm in Manhattan Beach, Calif.

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