A couple of years ago, I complained about PIABA’s effort to make expungement even more difficult to obtain. Well, fast forward to June 1, and, as Chris Seps explains here, the SEC has approved the first proposed expungement rule change from FINRA, one that appears to serve no purpose other than to generate money for poor FINRA. – Alan
As many of you know, FINRA has recently proposed many rule changes for the expungement process that are still pending. FINRA proposed those rules changes back in 2017 in order to try to make the process of removing erroneous customer complaints from a broker’s CRD record more difficult. Many of the proposed rule changes will indeed make it more difficult to obtain expungement: there will be stricter rules about when and how a broker can request expungement, including new time limitations; they will have to convince three arbitrators of their case instead of one; and they will be required to testify in person or via videoconference rather than by telephone. But the only rule change that has made it to the SEC – and which the SEC recently approved in an order published in the Federal Register on June 1 – is a change that simply makes it more expensive for the broker to obtain expungement. The rule change literally serves no other purpose than to put more money in FINRA’s pocket. We will talk about that in a minute, but first, let’s talk about the old rule and how it changed.
FINRA charges certain fees to anyone who is seeking expungement – an initial filing fee, a fee for each pre-hearing session, and a hearing fee. Certain fees are charged to the broker-dealer named as the respondent as well. Historically, these fees fall on a graduated scale. The higher the damages sought, the higher the fees. In cases where non-monetary relief is sought – such as expungement cases – the fees and surcharges are in the thousands of dollars, in total. However, experienced counsel usually add a nominal request for $1 in damages, which means the fee charged falls on the smallest end of the graduated scale. The filing fee would be only $50, the hearing session fees would be $50 per session, and the member surcharge charged to the broker-dealer named as the respondent would be $150. This was frequently known as the “$1 trick.” It wasn’t illegal; it wasn’t immoral; it was just a loophole that saved dozens of brokers thousands of dollars each as they attempted to remove erroneous complaints from their permanent records.
FINRA’s new rule eliminates the “$1 trick.” Under the new rule, which was just approved by the SEC and will probably take effect later this summer, all requests for expungement will fall into the non-monetary relief category of the graduate scales, regardless of any damages that are sought. So, the filing fee will be $1,575. The hearing session fees would also be charged at the non-monetary relief level for a hearing with three arbitrators: $1,125 per session. The broker-dealer named as the respondent in the expungement case will be charged the member surcharge for non-monetary relief: $1,900. And the broker-dealer that is named as the respondent would be charged a processing fee for non-monetary relief claims: $3,750. If the broker decides to name the customer as the respondent instead of the broker-dealer, it doesn’t matter; FINRA will still charge the $1,900 member surcharge and $3,750 processing fee to the broker-dealer where the broker was registered at the time the customer made the complaint at issue. So, in other words, the expungement fees will go from $300 to $9,475, most of which will be charged to the broker-dealer.
Unlike the other expungement rule changes that have not been approved yet, this one is purely about money, not customer protection. But you have to give FINRA credit – they admit it is all about money. After FINRA proposed this rule, they made it known that from 2017 to 2019 approximately 75% of expungement-only arbitrations used this $1 trick, costing FINRA approximately $7.3 million. FINRA was not happy about that, even though it had an operating budget of $1.053 billion in 2019 – the highest in the past three years, despite having the lowest number of broker-dealers and the second lowest number of registered reps in the past 16 years. As a result, representatives of both sides of the aisle – the plaintiff’s bar PIABA, which files complaints on behalf of customers, and the defense bar which defends brokers and broker-dealers – are unhappy with the rule change. In fact, as reported by Investment News, a co-author of a recent PIABA expungement study called the rule change out for what it is: “a money grab” by FINRA. That is quite an admission from PIABA, which routinely pushes FINRA to enact rules that make expungement more difficult to get.
Now, let’s be clear for a minute: closing a loophole and clarifying the rules regarding fees so that they are implemented the way that FINRA probably initially intended is fine. Close the loophole and charge everyone the same for expungement requests. And that’s what the SEC’s order routinely falls back on to justify the rule change – it claims that it is just making things fair by charging everyone the same fees in expungement cases, regardless of whether you slyly tack on a request for some nominal monetary damages. But the real problem – and the one commentators take issue with – is the excessive fees charged not to the broker who is making the expungement request, but to the broker-dealer who has no dog in the fight whatsoever. Just so we are all clear, a broker making an expungement request has to name someone as a respondent – either a broker-dealer or the customer who complained. In either instance, under FINRA’s rule change, the broker-dealer is going to get socked with thousands of dollars in fees for having done absolutely nothing and having no role in the expungement request. In fact, many broker-dealers do not even participate in expungement hearings because they have nothing to gain or lose if brokers gets their records cleaned up. But the broker-dealer has no choice but to pay the fees to FINRA, even if it has no interest in participating and does not object to the expungement request.
FINRA knows its members are being stuck with huge fees, and in fact that was its goal. On the one hand, according to the SEC Order, “FINRA believes the Proposal will help ensure that the fees for expungement requests are assessed, and that the costs borne by the forum to administer expungement requests are allocated, as intended, to those requesting expungement under the Codes.” If that were true, then the brokers requesting expungement of these erroneous customer complaints their records would be charged with the majority of the fees, not the broker-dealer who has no involvement in the request. In fact, the SEC Order also states, “FINRA also noted that … it believes that member firms, rather than associated persons or customers, should continue to bear the larger share of the costs of expungement.” Not only are those two statements completely inconsistent, but FINRA really provides no reason for charging the bulk of the fees to the broker-dealer, except that someone has to pay the administrative costs of these hearings.
If FINRA really wants to be fair about the fees associated with expungement requests, here is what it should do: charge the expungement fees to the broker and broker-dealer if the panel rejects that expungement request, but charge them to the customer who made the complaint that is being expunged if the panel grants the expungement request. This will help further the goals of both the plaintiff and defense bars. On the defense side, brokers would be happy because their fees would be covered if they prevail in the expungement. But more importantly, this might prevent completely bogus claims from being filed in the first place. Right now, there is nothing preventing an investor who lost money to take 30 minutes, throw together a few sentences about how they were never told of the risks of their investments, and sit around waiting for a settlement check. If a threat existed, however small, that their claim might be outed by an expungement panel as not just lacking merit, but as clearly erroneous, and they would be charged with the $9,475 in FINRA fees, then maybe customers would reconsider filing a claims that they completely fabricated. I know what you are thinking, and no, this will not have a “chilling effect” on customers who may want to file a complaint. Is a customer with a claim for a million dollars, or even $100,000, going to be scared away from trying to recover all that money by the prospect of having to pay a $9,000 expungement fee? Probably not. But customers who make up a story in order to recover some losses might be dissuaded from filing – which is a good thing.
The other upside to making the expungement fees contingent on the outcome of the expungement request is that it will encourage customers to actually participate in the expungement hearings. PIABA and FINRA have lamented for years that once customers settle cases, the vast majority of the time they don’t participate in the expungement hearing because they have nothing to gain at that point. As a result, according to FINRA, panels only hear one side of the story and frequently grant expungement in instances that they might not have if they had heard from the customer. Accordingly, if customers face the prospect of being charged the $9,475 in fees if their claims are found to be erroneous in the expungement hearing, I would bet that many of them would actually show up and testify in the expungement hearing. FINRA would be happy about that, and about a potential secondary effect – brokers might think twice about filing questionable expungement requests if they know a customer will show up to contest their side of the story. This simple change to the expungement fee allocation might finally bring balance to the expungement process. Then again, that’s probably why it will never happen.