Heard Off the Street: Changes to keep brokers in check?

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The securities industry group that polices the brokerage community has a new way to prevent brokers from having their misdeeds erased in a vital database that investors can rely on when choosing a broker. Just how much more protection the change provides investors remains to be seen.

The genesis of the requirement was a study released last year by the Public Investors Arbitration Bar Association, a group of lawyers who represent investors in disputes with brokers and the firms that employ them. The study found that in about 90 percent of the disputes, the brokers targeted by investor complaints were able to get the record of the allegations erased from BrokerCheck, a database investors can use to perform a background check.

BrokerCheck (brokercheck.finra.org) is maintained by the Financial Industry Regulatory Authority, or FINRA. The Wall Street-funded group regulates about 635,000 brokers. It also oversees arbitrators who resolve disputes between investors and brokers and brokerage firms.

Investors filed 2,334 complaints with FINRA last year, down from 5,067 in 2009 when markets were not as kind to investors as they have been recently.

One of the reasons that records of the allegations were being obliterated — or expunged in FINRA jargon — was that brokers and their firms required that the incident not appear on BrokerCheck as a condition of settling the dispute.

Faced with the choice of either receiving money in exchange for promising not to oppose a broker’s request to keep the incident off BrokerCheck or risking an unfavorable outcome if the dispute went to an arbitration hearing, investors took the money. Their attorneys, hired to serve their best interests, told them to do that.

So expungements were routinely granted by arbitrators hired to hear complaints and approved by court order.

FINRA’s new rule, approved by the Securities and Exchange Commission last month, prohibits expungements from being a condition of settling disputes. That means investors can accept cash to settle their disputes and still oppose a broker’s request to keep the incident off BrokerCheck.

“It should certainly have an impact on reducing the number of expungements that are issued,” said Vicki Kuftic Horne, a Fox Chapel attorney who represents both sides in arbitration cases.

However, some attorneys believe the new requirement won’t have that much of an impact. They say as a practical matter, most investors are not interested in opposing a broker’s request to wipe the slate clean. That requires them to hire an attorney to contest the expungement, money most investors don’t want to spend.

“I don’t know that it’s ultimately going to change things,” said Glenn Gitomer, a Philadelphia securities attorney. “When a customer approves a settlement, in all likelihood they’re not likely to oppose expungement.”

Barry Estell, a retired securities attorney in Kansas City, Kan., said the new rule is “completely unenforceable.” He believes brokers and brokerage firms will still be able to insist that an investor not oppose expungement without making it a condition of settlement. Mr. Estell is opposed to expungement in general, noting that allegations made in lawsuits remain part of the public record even if the person who made them does not prevail.

“The whole idea of expunging a record is an outrage,” he said. “It’s just FINRA protecting its membership.”

Fox Rothschild’s Ernest Badway, a New York attorney who represents brokerage firms in arbitration cases, said expungement is warranted in many instances because the allegations that investors make frequently lack merit. The new rule means that when brokers settle nuisance complaints, the unwarranted allegations made in those complaints are “going to travel with them for the rest of their careers,” he said.

“I think it’s going to have a horrible impact,” Mr. Badway said. “I think they’re pandering to the [investors’] bar.”

The PIABA released its findings that expungements were granted about 90 percent of the time Oct. 16. Two days earlier, FINRA issued guidance to arbitrators emphasizing that expungement is an “extraordinary remedy” that should only be used when an investor’s claim is made against the wrong person, is false, or if the broker was not involved in the incident.

The warning seems to have had an impact. While arbitrators recommended expungement in 94 percent of cases that were settled in the nine months before the guidance was issued, the expungement rate fell to 83 percent in the six months after the guidance, according to Securities Arbitration Commentator, a newsletter that tracks securities disputes.

Whether prohibiting expungement from being a condition of settling disputes will have a similar impact is open to debate. What is certain is that investors always are well served by doing their homework, including consulting BrokerCheck and understanding the risks involved, before placing their bets.

Len Boselovic: 412-263-1941 or lboselovic@post-gazette.com

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