More On Legal & Compliancefrom The Advisor's Professional Library
- Disaster Recovery Plans and Succession Planning RIAs owe a fiduciary duty to clients to prepare for disasters and other contingencies. If an RIA does not have a disaster recovery plan, clients financial well-being may be jeopardized. RIAs should also engage in succession planning, ensuring a smooth transaction if an owner or principal leaves.
- Books and Records Rule Thorough and complete books and records enable RIAs to demonstrate that they have fulfilled their fiduciary obligations to clients and complied with applicable rules and regulations.
A study of more than 1,600 arbitration cases over the past five years shows an “alarmingly high” rate of brokers who were able to get their arbitration histories wiped clean, leaving investors vulnerable to potential fraud and abuse, according to a just-released report by the Public Investors Arbitration Bar Association (PIABA).
In reviewing all securities arbitration awards in cases filed between Jan. 1, 2007, and Dec. 31, 2011, in which the word “expungement” appears, the report by PIABA, which is an association of lawyers who represent aggrieved investors, found:
- An “alarmingly” high percentage of arbitration cases resolved by settlement or stipulated awards where expungement relief has been granted. For the time period Jan. 1, 2007 through mid-May 2009, expungement was granted in 89% of the cases resolved by stipulated awards or settlement. (The May 2009 end date reflects a change in reporting requirements mandating more information about arbitration cases.)
- For mid-May 2009 through the end of 2011, expungement relief was granted in nearly every instance: 96.9% of the cases resolved by settlements or stipulated awards.
- Some stockbrokers have taken a particularly aggressive approach to wiping their slate clean. One individual associated with a brokerage firm requested expungement 40 times, and arbitration panels granted such relief to that individual 35 times.
“To say that ‘expungement’ of customer claims from broker records is a major investor protection problem is an understatement,” said Scott Ilgenfritz, outgoing president of PIABA, and author of the expungement study, during a Wednesday conference call to announce the study’s findings. “What is supposed to be an extraordinary relief measure is now being sought and granted in roughly nine out of the 10 settled cases that we studied.”
Such a high percentage of expungements “clearly indicates that the current expungement procedures are seriously flawed. Regulators need to step in and crack down on the granting of expungements, particularly in settled cases.”
FINRA responded in a statement that the recent increase in expungement requests, as PIABA noted, is largely attributable to the 2009 change to the Forms U4 and U5 that increased the number of customer claims reported against brokers, and consequently in an increase in brokers pursuing expungement relief. "While still significant, the number of arbitrator-recommended expungements executed by FINRA following a court order during the five-year period (838 orders) covered by the study is less than 5% of the total number of customer disputes filed (17,635)."
FINRA maintains the qualification, employment and disclosure histories of 5,100 broker-dealers and approximately 660,000 of their securities employees in the electronic CRD system. FINRA and the North American Securities Administrators Association (NASAA) established the CRD system in 1981.
“PIABA’s study makes many valid points. Expungement is and should continue to be an extraordinary remedy," says Andrea Seidt, NASAA president and Ohio securities commissioner. "We share PIABA’s concerns that there be robust oversight of the process to ensure that expungement is not easily granted. Such oversight helps to ensure the integrity of the CRD system that regulators, investors and industry rely upon for information about the background of stockbrokers."
Seidt says that NASAA continues to work with FINRA "to address these concerns and looks forward to working constructively with all interested parties to ensure that the expungement process requires a thorough and thoughtful analysis of each request.”
FINRA responded in its comment the same day that it shares PIABA's concerns with respect to the expungement process. As a result of these concerns, FINRA said it "recently provided expanded guidance to assist arbitrators in the proper performance of their responsibilities with respect to expungement, and is enhancing arbitrator training with added emphasis on the importance of the integrity of the information in the CRD system." In addition to the steps FINRA is taking to provide additional guidance and training to arbitrators, the self-regulator said that it is "reviewing its rules and interpretations, and will consider changes to provide clarity as to what actions in connection with conditions on settlements violate conduct rules."
Specifically, the PIABA report recommends the following: “FINRA needs to propose a rule change with respect to respondents and their counsel bargaining for in settlement negotiations or conditioning a settlement upon an investor’s agreement to not oppose expungement or an agreement to expungement.”
Incoming PIABA president Jason Doss said on the call that FINRA also needs to provide “more and better training for arbitrators.” The training required by FINRA for arbitrators to be able to rule upon a motion seeking expungement relief “is limited,” he said. As it stands now, he said, arbitrators are only required to take an online training course, which takes approximately one hour, and pass a test concerning the materials included in the online training course.
Doss said the issue is "systemic," and shows a "dramatic increase" in the number of brokers asking for expungement and getting it.
The report also notes that FINRA should take the following steps:
- For FINRA to fulfill its mission of investor protection, the procedures applicable to motions for expungement relief need to be changed. FINRA needs to play a more active role in arbitrators’ rulings on motions for expungement relief.
- FINRA needs to review and critically assess all motions for expungement relief, particularly those made in cases resolved by settlement.
- FINRA also needs to review and critically assess settlement agreements. A proposed rule change should include the requirement that the hearing on any motion for expungement relief be scheduled no sooner than 60 days after service of the motion on the customer and FINRA. In cases resolved by settlement, FINRA should require respondents to provide to FINRA the settlement agreement along with the motion for expungement relief.
Check out 5 SEC Exam Red Flags: Tom Giachetti on ThinkAdvisor.