The Links between FINRA’s High Risk Rep Program and Expungement


Finra released a video interview on 1/10/18 with Mike Rufino,  Executive Vice President and Head of FINRA Member Regulation—Sales Practice, about FINRA’s High-Risk Registered Representative Program. Mr. Rufino discussed some of the criteria and the methodology FINRA uses to identify and monitor High Risk Registered Representatives. He listed the following criteria as inputs into the High Risk Representative algorithm/model:

Model Criteria

  1. Association with Firms, especially highly disciplined Firms
  2. Length of time a Rep has been at a “problem” Firm
  3. How many problem Firms a Rep has been associated with (see WSJ story on Rep “cockroaching“)
  4. Licensing exams- test failures and expired licenses
  5. Investor Harm Disclosures
    1. Age of Disclosure
    2. Number of Disclosures
    3. Types of Disclosures- arbitrations, customer complaints, U4 and U5 filings
  6. Prior FINRA exam/review of the Rep

 

Mr. Rufino stated that FINRA uses a three-pronged approach to High Risk Brokers. The first prong is the “predictive model” using the above weighted criteria to come up with a “numeric score for all our brokers” which is then subject to a qualitative review by staff. Secondly, Mr. Rufino said that FINRA looks at the “sheer number of disclosures that an individual may have” in order to determine if there is a pattern or issue FINRA should be concerned with. Mr. Rufino acknowledged that there is “an age decay” and that more recent disclosures are weighted more heavily. The final prong, is “individuals who are appealing a bar” who are able to work in the industry during the appeal process.

 

Greater Consequence of Complaints Drive Expungement Surge

 

Commentators have suggested that FINRA’s requirement to link to BrokerCheck has caused some Representatives to seek expungement for old customer disputes. Financial Advisor reports that before a change in 2010, “complaints that had not been adjudicated or settled for nuisance amounts would be archived and not shown on BrokerCheck after two years.” According to Financial Advisor Magazine the number of stand alone expungement arbitrations more than doubled 2017.

Dynamic Securities Analytics suggests that FINRA’s use of algorithms that incorporate “Investor Harm Disclosures” and the “sheer number of disclosures” to identify High Risk Brokers also spurs Reps to expunge disputes.  One way to reduce a Rep’s chances of ending up on FINRA’s High Risk Broker list is to reduce the number of disclosures in BrokerCheck.

Firm’s may also have an incentive to refund Reps the cost of cleaning up their individual histories because Firms employing a large number of Reps with disclosures are identified by FINRA as “High Risk Firms.” FINRA’s 2018 Exam Priorities state that it will “focus on firms’ hiring and supervisory practices for high-risk brokers” and reminds Firms of their “existing obligation to adopt and implement tailored heightened supervisory procedures under FINRA Rule 3110 (Supervision) for high-risk individuals.” Firms may decide it is more cost effective to finance Representatives’ customer dispute expungements than it is to supervise high-risk individuals.1

 

Proposed Changes to Expungement Process

 

FINRA published proposed changes to the expungement process in December 2017. Advisor Hub reported on the proposed changes:

Chief among the concerns of lawyers representing brokers whose records are tarred by complaints is an expungement time limitation that Finra proposed on Wednesday as part of amendments to its codes of arbitration procedure. Brokers currently can make expungement requests at any time, no matter how old the complaint they seek to remove from their records.

The revised code would limit brokers to seek expungement of complaints that have been settled or withdrawn within a year of the day that their firms report a complaint to the Central Registration Depository, which holds licensing and registration data for the securities industry.

There appears to be a disjoint between Mr. Rufino’s statement that old disclosures suffer from “age decay” (i.e. are valued less heavily) while the expungement proposals would disallow expunging old complaints. If the proposal goes through, Reps will be impelled to immediately file for expungement for the new disclosures with many likely being removed, while the old disclosures (which are valued less by FINRA) would remain in the BrokerCheck. FINRA will need to rework their algorithm if this is how the changes play out.

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1- The proposed changes will also significantly raise expungement filing fees in for about 20% of cases and require in-person or video conference hearings. Perhaps the increased expungement expense is designed to make Reps and/or Firms reconsider the cost/benefit of expungement. See end note 46 of the proposal.