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FINRA Rule 2080 Expungement

FINRA Rule 2080 allows brokers to expunge negative information reported in the Customer Complaint/Arbitration/Civil Litigation Disclosure sections on Forms U4 or U5 in their CRD record. Given information contained in the CRD record is available to the public, brokers often find themselves at the mercy of FINRA’s searchable public records system. In some cases, which the vast amount of information available to consumers serves its goal of allowing investors to make an informed choice when choosing a broker, however, in other cases, it contains information that can be misleading and has little regulatory value.

FINRA’s disclosure requirements obligate brokers to disclose “investment-related” complaints lodged by clients alleging “sales practice violations” resulting in damages of $5,000 or more. The disclosure events will appear in the registered representative’s CRD report regardless of the disposition unless it is “expunged” from the system. Given the broad scope of CRD records, complaints that were on their face without merit are included in this record. In this case, brokers will be required to seek expungement to clear their record.

FINRA Rule 2080 outlines three narrow grounds on which an expungement may be granted, one of these grounds rest on the broker successfully asserting that the customer claim against them appearing in the CRD is factually impossible or clearly erroneous.

Expunging “Factually Impossible or Clearly Erroneous” Claims

The “factually impossible or clearly erroneous” standard involves either of two components being present. The first, factual impossibility implies that the factual basis of the complaint against the broker could not have occurred because the misconduct at issue would have been impossible to be completed as alleged. For example, a complaint involving a broker who takes over an account after it had been mismanaged, yet had no hand in the previous wrongdoing is a common scenario in which expungement has been granted. Cases of factual impossibility also involve situations in which the claimant presents a version of events that purport to show misconduct which they are unable to establish through credible evidence, or are clearly contradicted by evidence presented by the respondent that misconduct did not occur.

Unlike the factually impossible standard which speaks to a narrow range of scenarios in which a respondent could not have engaged in misconduct the clearly erroneous standard is more encompassing involving situations in which a claimant’s versions of events do involve the respondent; however, they are bereft of credibility or blatantly contradicted.

For example, a recent expungement awarded by the FINRA Office of Dispute Resolution used the clearly erroneous standard to expunge a customer complaint based on allegations of a breach of contract, breach of fiduciary duty, negligent supervision, unsuitability, and violations of FINRA Rules with damages being claimed to exceed $385,000. The allegations arose by Claimants against their Wells Fargo Investment Advisor from investments made in in Municipal Unit Investment Trusts, including First Trust Insured Municipal Income Select Closed-End Portfolio, which was alleged to have been unsuitable for Claimant’s investment objectives. The claimant’s case was premised on a number of erroneous factual claims, primarily that the broker’s investment strategy was unsuitable for the client’s risk profile, by investing in unsafe municipal bonds and was not properly diversified. The panel rejected the argument that the Municipal Income Select Closed-End Portfolio was not suitable stating that “Municipal Bonds” are the safest investment after U.S. Treasury Bonds. The panel added that the closed end fund was riskier because of its leverage, but concluded that it still fell within parameters of the Claimant’s conservative investment objectives.

Further the claimant made clear misstatements in his claim in that the sales charge was 3.95% as alleged in the complaint when in fact it was 2.45%. The projected yield in the investments substantially exceeded 7.0% rather 5.3% as alleged in the complaint. Lastly, if the claimant had heeded his broker’s advice, the recommended investment would have made more than $265,000 while providing the income sought by Claimant. Given these massive factual discrepancies, the claim was dismissed, and expungement was granted. As such, one can take away from this case the lesson that expungement will likely be granted in cases in which the claimant takes material misstatements of factual allegations.

Notice to Members 04-16

For claimants who rely on the grounds for expungement outlined above, the 2004 Notice to Members 04-16 involving the NASD’s adoption of Rule 2130 regarding the expungement of CRD information provides a more streamlined process for expungement. It states that those who seek expungement in a court of competent authority are excused from the requirement that the NASD is named as an additional party in its petition when the claimant's grounds for expungement rest on the “factually impossible or clearly erroneous” standard. Therefore, those who proceed under this standard are provided some modicum of relief from the normal procedural requirements.

A broker who alleges claims for expungement under the factually impossible or clearly erroneous standard can benefit by removing marks on their record that are clearly without merit. Unfortunately, the current broad, and perhaps superfluous scope information reported in the CRD allows for meritless customer complaints involving misstated facts or clearly erroneous allegations to be reported. Fortunately, brokers can seek some relief from these marks on their record under Rule 2080.

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