The Expungement Process for FINRA Forms U-4 and U-5: Removing Customer Dispute Information from the Central Registration Depository (CRD) System

The expungement process for FINRA Forms U-4 and U-5 is an essential mechanism in the securities industry, aimed at addressing and potentially removing inaccurate or false entries from a broker's or registered person’s public record. This process plays a critical role in maintaining the accuracy and integrity of the information available to investors through FINRA's BrokerCheck system.

Expungement is the process of removing information from a broker's Central Registration Depository (CRD) record. The CRD is a database maintained by FINRA that contains comprehensive information about registered persons and brokerage firms, including their registration status, employment history, certain types of customer complaints, arbitrations, litigations, and disciplinary actions. Information from the CRD is made available to the public through the BrokerCheck system. Because of the significant impact that information in the CRD can have on a broker’s career and reputation, the expungement process aims to retain only accurate and fair information.

Criticisms of the FINRA Expungement Process

FINRA’s expungement process has faced significant criticism from various stakeholders in the securities industry. Two primary voices in this debate are the Public Investors Advocate Bar Association (PIABA), which represents the interests of individual investors, and the Securities Industry and Financial Markets Association (SIFMA), which advocates on behalf of financial professionals and firms.

PIABA has been particularly vocal about what it perceived as weaknesses in the expungement process, which it argued could undermine investor protection and the integrity of the BrokerCheck system. One of PIABA's central concerns was that the process was too lenient, allowing brokers to expunge legitimate complaints from their records, thereby depriving the investing public of critical information needed to make informed decisions. PIABA, and other investor advocacy groups, pointed out several areas of concern, including:

High Rates of Expungement: PIABA has noted that the rate of expungement requests being granted appears disproportionately high, raising questions about whether the arbitration panels are too inclined to side with brokers. They argued that this undermined the credibility of the BrokerCheck system, which investors rely on to assess a broker’s disciplinary history.

Potential Conflicts of Interest: PIABA has expressed concerns that the arbitration panels, which are typically composed of industry insiders, may have inherent biases that favor the broker seeking expungement. This potential conflict of interest, according to PIABA, could lead to decisions that are more sympathetic to brokers rather than protective of investors.

Lack of Investor Representation: Another significant issue PIABA raised was the limited opportunity for investors to participate in the expungement process. Since many expungement requests were made after the settlement of a case, the original complainants often had no formal role in the expungement hearing. This, PIABA argued, could result in decisions being made without adequate consideration of the investor's perspective.

On the other side, SIFMA and groups representing financial professionals, had their own sets of concerns regarding the expungement process, focusing on protecting brokers from what they saw as the unfair retention of erroneous or unsubstantiated claims. They pointed out the following potential shortcomings in the expungement process:

Burden on Brokers: The expungement process placed an overly heavy burden on brokers to prove that the information is false or erroneous. They contended that this could be particularly challenging in cases where the claims were settled without any admission of wrongdoing, leaving brokers with a permanent blemish on their records despite no finding of fault.

Complexity and Cost: The complexity and cost of the expungement process were also noted as points of concern. The requirement for court confirmation of expungement awards, for instance, added a layer of legal expense and time, which can be prohibitive, especially for smaller firms and individual brokers.

Impact on Broker Reputation: Professional reputations can be irreparably damaged by false allegations. Without an effective expungement process, brokers may be unfairly penalized in the marketplace, potentially losing business or employment opportunities based on inaccurate information.

The criticisms from the industry stakeholders have led to ongoing debates and proposals for reforming the expungement process. In response, FINRA has made several changes to address these concerns, including tightening the rules around expungement and increasing the scrutiny applied by arbitration panels.

The process for seeking expungement typically involves several steps. Most expungement requests are handled through the arbitration process. Brokers seeking expungement must file a claim with FINRA’s arbitration forum, where they present evidence to support their request. The arbitration panel reviews the evidence and, as noted in detail below, determines whether expungement is warranted based on the criteria established by FINRA Rule 2080.

FINRA Rule 12805 (and similarly Rule 13805 for expungement requests filed against a member firm) sets forth specific procedures and standards for arbitrators to follow when considering requests to expunge customer dispute information from a broker’s Central Registration Depository (CRD) record. The rule is critical in ensuring that expungement is not granted without careful and thorough consideration, given the significant impact such actions can have on both the broker's career and public trust in the securities industry.

Some of the key provisions of FINRA Rule 12805 are as follows:

Specific Findings Requirement

Arbitrators must make specific findings that one or more of the grounds for expungement under FINRA Rule 2080 are satisfied. These grounds typically include findings that: (i) the claim, allegation, or information is factually impossible or clearly erroneous; (ii) the broker was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation, or conversion of funds; or (iii) the claim, allegation, or information is false.

Detailed Written Explanation

Arbitrators must provide a detailed written explanation of the reasons for granting expungement, referencing the specific evidence that led to their decision. This requirement ensures transparency and accountability in the decision-making process.

Consideration of Settlement Agreements

If a case has been settled, arbitrators must consider the amount of the settlement and any other terms and conditions of the settlement when deciding on the expungement request. This consideration helps to evaluate whether the settlement might have been motivated by factors other than the merits of the case.

Hearing Session Requirement

Rule 12805 mandates that the arbitrators conduct a recorded hearing session (by telephone or in-person) regarding the expungement request. This session allows the arbitrators to question the broker and any other relevant parties, providing a thorough review before making a decision.

Unanimous Panel Decision

The rule requires that all arbitrators on the panel must agree to grant expungement. This unanimity requirement serves as an additional safeguard to ensure that expungement is not granted without full and collective agreement from all members of the arbitration panel.

By incorporating these rigorous standards and procedures, FINRA Rule 12805 (and 13805) ensures that the expungement process balances the need to correct false or erroneous information with the importance of maintaining public trust and transparency in the securities industry. This rule plays a critical role in safeguarding the integrity of the information available to investors while also protecting the rights of brokers to a fair and accurate record.

After receiving an arbitration award recommending expungement, the broker must seek confirmation of the award from a court of competent jurisdiction. This step is necessary because the CRD system is a public record, and court confirmation adds a layer of review to ensure the decision is justified.

Thus, according to FINRA Rule 2080, “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” and “must name FINRA as an additional party and serve FINRA with all appropriate documents unless this requirement is waived.”

FINRA may waive the obligation to be named FINRA if it determines that the expungement relief is based on affirmative judicial or arbitral findings that (i) the claim, allegation, or information is factually impossible or clearly erroneous, (ii) the broker was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation, or conversion of funds, or (iii) the claim, allegation, or information is false.

These stringent criteria are designed to protect the integrity of the information in the CRD while also allowing for the correction of errors.

Once the court confirms the arbitration award, the broker must submit the court order to FINRA. FINRA then reviews the order to ensure compliance with its rules and regulations. If everything is in order, FINRA will proceed to expunge the information from the broker’s CRD record.

The expungement process is complex and often contentious. The broker seeking expungement bears the burden of proving that the information is false, erroneous, or otherwise meets the criteria for expungement. FINRA and the courts are cautious about granting expungement to ensure that investor protection is not compromised. They aim to balance the broker’s interest in maintaining a fair and accurate record with the public’s need for transparency. Investors or other parties who filed the original complaint against the broker may oppose the expungement request, and their testimony and evidence can influence the arbitration panel's decision.

For brokers, successfully expunging false or inaccurate information can significantly improve their professional reputation and career prospects. A clean CRD record can enhance their credibility and trustworthiness in the eyes of potential employers and clients. For investors, the expungement process ensures that the information available through BrokerCheck is accurate and reliable, which is essential for making informed decisions about whom to trust with their investments.

The expungement process for FINRA Forms U-4 and U-5 is a vital aspect of maintaining the integrity and fairness of the securities industry's regulatory framework. By allowing brokers to remove false or inaccurate information from their records, the process helps ensure that the information accessible to investors is both accurate and meaningful, thereby supporting the overall goals of transparency and investor protection. This process highlights the delicate balance between safeguarding the rights of brokers and ensuring the public has access to trustworthy information in the securities market.

However, the tension between protecting investors and ensuring fairness for brokers remains a central challenge in this area. As the securities industry continues to evolve, so too will the discussions surrounding the expungement process, to find a balance that serves the interests of both investors and brokers.

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