Introduction
FINRA recently issued a Regulatory Notice requesting comment on a proposed new expungement procedure for persons not named in a customer-initiated arbitration.1 As noted in RN 12-18, in 2009, the SEC approved amendments to Forms U4 and U5 to, among other things, require the reporting of allegations of sales practice violations made against unnamed persons. RN 12-18 further notes that specifically, Forms U4 and U5 were amended to add questions to elicit whether the applicant or registered person, though not named as a respondent or defendant in a customer-initiated arbitration, was either mentioned in or could be reasonably identified from the body of the arbitration claim as a registered person who was involved in one or more of the alleged sales practice violations.
As a result, unnamed persons who want these disclosures expunged from their CRD records must seek to expunge these “subject of” allegations by:
The proposed rule would change this procedure for the unnamed person in an arbitration who is the “subject of” allegations of sales practice violations. The proposed expungement procedure would permit persons who are the “subject of” allegations of sales practice violations made in arbitrations claims, but who are not named as parties to the arbitration (unnamed persons), to seek expungement relief by initiating In re expungement proceedings at the conclusion of the underlying customer-initiated arbitration case (“In re proceedings”).
Proposed In re Expungement Rule
In re Proceedings Procedure
Under the proposed rule, the procedure would apply to associated persons identified in a Form U4 or Form U5 as having been the subject of an investment-related customer-initiated arbitration proceeding that alleged that the associated person was involved in one or more sales practice violations, but who was not named as a respondent in the proceeding. The proposed rule does not appear to address the situation where a civil complaint has been filed against an unnamed party to the civil complaint but where the firm has identified in a Form U4 or Form U5 a disclosure is required.
FINRA would notify an unnamed person in writing when a firm reports to the CRD system that an unnamed person was the subject of an investment-related customer-initiated arbitration proceeding alleging sales practice violations. Upon notice from FINRA, the unnamed person would file a Notice of Intent to File to alert FINRA that the person is considering filing a claim for expungement relief. Importantly, the Notice of Intent to File would contain confidentiality provisions that require the unnamed person to maintain confidentiality of any documents from the underlying customer-initiated arbitration to which the person is given access before the person files an In re expungement claim. In addition, the Notice of Intent to File would require the unnamed person to abide by any confidentiality agreements or orders associated with documents or testimony produced from the underlying customer-initiated arbitration case.
At the conclusion of the underlying customer-initiated arbitration case, FINRA would notify the unnamed person who filed the Notice of Intent to File that it has closed the underlying case. If an unnamed person determines to seek expungement relief, the person would then file a statement of claim and an In re Submission Agreement, which would allow FINRA to arbitrate these types of cases.
Under the proposed rule, there are certain limitations regarding In re proceedings. For example:
RN 12-18 also provides that In re proceedings would not apply not apply if the unnamed person decides to pursue other claims in addition to a claim to expunge a “subject of” allegation. By way of example, RN 12-18 states that if the unnamed person has a defamation claim against a firm and a claim to expunge a “subject of” allegation, the unnamed person may file both claims in one arbitration proceeding against the firm under current Code rules.
Notably, a party to an underlying arbitration may still request expungement relief on behalf of an unnamed person.
FINRA Notification and Unnamed Parties’ Obligation To File Notice Of Intent With FINRA
Under the proposed rule, when a member firm reports to CRD that the person was the “subject of” a customer-initiated arbitration claim alleging sales practice violations, FINRA would issue a notice to the unnamed person, and provide a copy of the Statement of Claim in the underlying customer-initiated arbitration. Importantly, FINRA would send the notice and copy of the Statement of Claim to the unnamed person’s residential address, as reflected in the CRD system. Therefore, it is important for a registered representative to ensure that his/her residential address is current in CRD.
Within 180 days from the date that FINRA sends the written notification, the unnamed person must notify FINRA of the intent to file for relief by submitting a signed Notice of Intent to File. Failure to file the notice of intent timely would preclude the unnamed person from seeking relief through an In re proceeding, unless the Director extends or modifies the time period for good cause. RN 12-18 does not provide any guidance on what would constitute “good cause.” As a result, it is unclear if a member firm that informs an unnamed person that it would seek expungement relief in the underlying customer-initiated arbitration but does not would be “good cause” for not filing a timely Notice of Intent to File. In RN 12-18, FINRA notes that the fact that the Notice of Intent to File is filed timely does not mean the unnamed person is required to file an In re expungement proceeding. As a result, it may be prudent to always file the Notice of Intent to File in order to preserve the unnamed person’s right to request expungement.
In re Proceedings Only Permitted At The Conclusion Of the Underlying Customer-Initiated Arbitration Case
For unnamed persons who filed a timely Notice of Intent to File with FINRA, the proposed rule would only permit the filing of an In re proceeding “at the conclusion of the underlying customer-initiated arbitration case.” In RN 12-18, FINRA provided examples of when it deems an underlying customer-initiated arbitration case to be “concluded;” thus, triggering the ability of the unnamed person to file an In Re proceeding.
For example, FINRA does not consider the underlying customer-initiated arbitration case to be concluded if a party to the underlying customer-initiated arbitration case files a motion to vacate and it is pending in court. With respect to appeals of a court’s decision concerning a motion to vacate, FINRA does not consider the underlying customer-initiated arbitration to be concluded until the higher court decides the appeal, and under the proposed rule, the In re proceeding would not commence until the higher court decides the appeal.
On the other hand, as noted in RN 12-18, when a court grants a motion to vacate, the court may vacate the award, in whole or in part, may send the matter back to the arbitration panel (remanding the case), or may order the case to be reheard by a new panel. As a result, under the proposed rule, the In re proceeding would commence at the conclusion of this customer arbitration case.
Under the proposed rule, at the conclusion of the underlying customer case, FINRA would inform the unnamed person who provided the Notice of Intent to File and the unnamed person would then have 60 days from the date of the notification letter that the case had concluded to file an In re claim with FINRA. In RN 12-18, FINRA notes that failure to file the claim timely would preclude the filing of such claim, unless the Director extends or modifies the time period for good cause.
Filing A Claim
As noted above, at the conclusion of the customer arbitration case, FINRA would provide a notice to the unnamed person that filed the Notice of Intent to File. FINRA also would provide the unnamed person with a copy of the pleadings (including any exhibits) submitted in the underlying proceeding as well as a copy of the award, if any. In addition, if the parties settled the underlying customer-initiated arbitration case, the FINRA-registered party in that arbitration would be required to provide a copy of any settlement agreements to the unnamed person within 10 days from the date that the unnamed party requests such documents. These documents would be subject to the confidentiality agreement contained in the Notice of Intent to File.
To file an In re expungement claim, an unnamed person would be required to file a statement of claim and an In re Submission Agreement and pay a filing fee of $750 (which would cover the cost of one hearing day — any additional hearing sessions would be calculated at the rate of $450 per session).2 The In re Submission Agreement would require the associated person to, among other things, agree to arbitrate the request for expungement relief in accordance with FINRA’s rules, and to agree to be bound by FINRA’s procedures and rules.
Hearings
A. Single Arbitrator
Notably, according to the proposed rule, FINRA would appoint a single public arbitrator to hear In re proceedings, which is not the practice today. Under current expungement procedures, the entire hearing panel for the underlying customer-initiated arbitration presides over the expungement request. RN 12-18 also notes that in cases in which FINRA appointed a panel in the underlying customer arbitration case, the In re proceeding would be handled by the public chairperson of that arbitration panel. Furthermore, in all majority public panel arbitrations, if the public chairperson is unable or unwilling to serve, RN 12-18 provides that FINRA would appoint the public arbitrator from the panel to hear the In re proceeding. If the public arbitrator is unable or unwilling to serve, FINRA would appoint randomly a new public chair-qualified arbitrator to hear the In re proceeding.
In an optional all public panel arbitration, in which there are three public arbitrators, RN 12-18 provides that if the public chairperson is unable or unwilling to serve, FINRA would appoint one of the two remaining public arbitrators from the panel in the underlying customer-initiated arbitration case to hear the In re proceeding.
Under the proposed rule, an unnamed person would be permitted to consider an arbitrator’s disclosures and raise a challenge for cause based on the disclosure information, as any party has the right to do in other arbitration proceedings. Under the proposed rule, it does not appear that a party would be entitled to any preemptory challenges. Moreover, under the proposed rule, the unnamed person could not challenge arbitrators based on their rulings and decisions in the underlying customer arbitration case.
In addition, RN-12-18 does not address the standard for determining when to grant an expungement under the In re proceeding. Presumably, the unnamed party would need to prove the same bases for expungement as set forth in FINRA Rule 2080.
B. Hearing Location
According to the proposed rule, the hearing location of the In re proceeding would be determined by the availability of the public arbitrators from the underlying customer-initiated arbitration proceeding. If a public arbitrator from the underlying customer-initiated arbitration case is available to serve, then the hearing location would be in the same location as the underlying customer-initiated arbitration case. However, RN 12-18 provides that if none of the public arbitrators from the underlying customer-initiated arbitration case is available to serve, the hearing location for the In re proceeding would be the hearing location closest to where the unnamed person was employed at the time of the dispute. In this case, the arbitrator would be selected randomly from this location.
C. Parties Who Can Attend In re Proceedings
Under the proposed ruled, all parties to the underlying customer-initiated arbitration proceeding would be permitted to attend the In re proceeding and elect to appear and testify either in-person or by telephone. According to the proposed rule, the absence of a party at the In re proceeding would not create a presumption that the absent party either consents to or opposes the expungement request. Notably, under the proposed rule, all parties from the underlying customer-initiated arbitration case would have the right to representation at the In re proceeding.
D. Documents and Subpoenas
Unnamed persons would be subject to any confidentiality agreements or orders associated with the documents or testimony produced in the underlying customer-initiated arbitration case. The proposed rule essentially leaves it up to the arbitrators to determine whether an unnamed person may receive documents in an In re proceeding. Indeed, the proposed rule limits document requests by unnamed persons to only those documents needed to establish the grounds for expungement under FINRA Rule 2080. Under the proposed rule, an unnamed person would be required to demonstrate that the requested documents have a substantial and direct relationship to the request for expungement. A standard that appears to be much harder to prove than would be in the course of a customer-initiated arbitration. Notably, a party from the underlying customer-initiated arbitration case would be allowed to object to producing such documents within 10 days of the unnamed person’s request. According to RN 12-18, if a party objects to the additional document request, the objection must be in writing and served on the unnamed person and arbitrator at the same time and in the same manner. Indeed, the arbitrator would rule on objections to additional document requests and the unnamed person requesting the production of documents would pay the costs of production.
Under the proposed rule, subpoena requests are limited to witnesses needed to establish the grounds for expungement under Rule 2080 and the unnamed person would need to demonstrate that the requested witnesses have a substantial and direct relationship to the request for expungement. Importantly, the proposed rule further limits the scope of the subpoena request to prohibit an unnamed person from seeking to subpoena a customer in the underlying customer-initiated arbitration case, unless the unnamed person demonstrates that the customer’s testimony is not available from tape, digital or other recording or transcript, and that no other approach or method exists to introduce the relevant documents or information. This aspect of the proposed rule could be considered inherently unfair when the In re proceeding arbitrator is not one of the arbitrators in the underlying customer-initiated arbitration. The proposed rule permits a party to the underlying customer-initiated arbitration case to object to the scope or propriety of the subpoena by filing such objection with the Director (a copy to the arbitrator), and served upon the unnamed party.
Expungement Awards
Under FINRA Rule 2080, registered persons must obtain a court order directing expungement or confirming an arbitration award containing an expungement directive. In addition, Rule 2080 requires that FINRA be named as a party to the court proceedings and be served with all appropriate documents, unless FINRA waives that requirement. In RN 12-18, FINRA notes that the proposed rule incorporates this requirement of Rule 2080 by mandating that an unnamed person name FINRA as a party to any court proceedings in which the unnamed person seeks to vacate an In re award. Moreover, RN 12-18 notes that a request to vacate an In re award is likely only when the arbitrator denies the expungement request. Since there would be no other party to object to the motion to vacate, the proposed rule would require the unnamed person to name FINRA as a party to any court proceedings, to allow FINRA to oppose the motion if appropriate under Rule 2080.3
Conclusion
While FINRA is interested in receiving comments on all aspects of proposed FINRA Rules, FINRA seeks specific comment as to whether the 180-day notice requirement in proposed Rule 13807(c) for the unnamed person to notify FINRA of the intent to file for expungement relief after FINRA sends its notice of an alleged sales practice violation would provide an unnamed person with sufficient time to determine whether to pursue an In re expungement claim; and whether FINRA should either automatically provide documents, defined as tapes, digital or other recordings or transcripts in proposed Rule 13807(l)(1)(A)(i), to an unnamed person or alternatively require the unnamed person to subpoena FINRA for these documents, rather than permit the unnamed person to request documents as provided in proposed Rule 13807(l)(1)(A)(i).
The comment period expires May 21, 2012.
*This alert was co-authored by W. Hardy Callcott, David Boch and Paul Tyrrell.
Contacts
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
Boch-David1 Expungement Procedures, FINRA Regulatory Notice 12-18 (April 2012) http://www.finra.org/Industry/Regulation/Notices/2012/P125948 (hereinafter “RN 12-18”).
2 Under the proposed rule, the Director could defer or waive payment of all or part of the filing or hearing session fees upon a showing of financial hardship. Moreover, in RN 12-18, FINRA notes that it would not assess member surcharge fees in these cases.
3 FINRA notes that other rules of the Industry Code would apply to the In re proceedings, and, is therefore, proposing to list them as Supplementary Material. However, since In re proceedings would not involve adverse parties, FINRA proposes to exclude from the list those rules that presume the existence of adverse parties.
This article was originally published by Bingham McCutchen LLP.