Expungement- FINRA’s dirty little secret

Both FINRA and the SEC encourage investors to investigate the record of a financial professional before hiring them. It would certainly be valuable for any customer to know if the stockbroker to whom they are considering turning over their life savings had previous problems with other customers.

For more than 20 years FINRA has provided a free online tool called BrokerCheck. It provides potential customers with a history of where the broker has worked and in which states the broker is licensed to do business.

A BrokerCheck report is supposed to provide accurate information about regulatory problems that the broker may have had and basic information about complaints and arbitration claims that other customers may have asserted against the broker. Unfortunately arbitration claims, even those with serious allegations of misconduct are frequently not reported to the public.

From the outset brokers have strongly opposed this disclosure. They believe that many arbitration claims filed by their customers are frivolous, false or factually incorrect. There have never been any facts or data to support that assertion.

FINRA has always had a rule in place that permitted arbitrators to expunge the claim from the broker’s BrokerCheck record after the hearing or if the claim settled. The rule and the procedures have been tightened up over the years, but the fact remains that BrokerCheck’s record of a broker who has been the subject of multiple customer complaints and arbitration claims may reflect none of them.

There are actually reports of brokers who have been the subject of more than 20 customer complaints or arbitrations having some or all of these complaints expunged. In other words the worst offenders may get the most benefit from expungement. Brokers who have had the most serious problems may have those problems affirmatively concealed from investors.

Over the years there have been multiple studies, law review articles and comments regarding the pros and cons of permitting the expungement of customer claims against stockbrokers. The issue is lot easier to understand if you put it into some context.

If your neighbor slips and falls in front of your home on a snowy morning before you have had a chance to shovel the sidewalk and sues you for medical bills and lost wages, the lawsuit is matter of public record and will be a matter of public record forever. If you fail to pay your student loans or are late with a mortgage payment it will be noted on your credit report for many years.

FINRA arbitrations are private matters. If they are not reported on a BrokerCheck report they are unlikely to show up anywhere else that a prospective customer might access.

Some commentators have suggested an arbitration claim is similar to a bad review on Yelp or similar website. But they are not. A FINRA arbitration claim often means that a customer has lost money that they did not expect to lose. This usually means that the broker did not make a full disclosure of the risks involved.

As an attorney who has represented a great many customers in FINRA arbitrations I always understood that my job was to recover as much of my client’s losses as I could. No claim is perfect and every claim has its strengths and weaknesses. It is for this reason that the vast majority of arbitration claims that are filed with FINRA end up settling.

The question of expunging the broker’s record comes up in settlement discussions almost every time. Most of the defense lawyers with whom I have dealt over the years have been ethical and rarely made expungement a condition of the settlement which is not permitted.

More often, I would offer not to oppose the broker’s request for expungement if they made one to the arbitrators because the client rarely cared about anything more than getting the best monetary settlement they could. That is not the same as suggesting that I believed or in any way acquiesced to the idea that the claim was frivolous, false or factually incorrect in the first place.

Any attorney will tell you that clients do not always walk in the door with all of the paperwork that you would like to see or a firm recollection of all of the relevant facts. It was always my practice therefore to send a draft of the claim, with the client’s approval, to the brokerage firms’ compliance department before I filed the claim with FINRA. I would ask them to tell me if I had the facts correct and would solicit their interest in an early disposition of the matter.

Occasionally, they would respond that the broker named in the claim was actually out of the office when the offending transaction occurred and that a different broker had actually spoken with the client and was the official broker of record. Better to deal with these factual glitches up front than to fight over expungement later.

Understand that both FINRA and the SEC consider information about customer complaints to be information that any customer would consider to be important before they began doing business with a stockbroker.

In the context of an offering of securities the SEC routinely sanctions issuers who omit material facts. In the context of a BrokerCheck report, the Commission has sanctioned the omission of facts that everyone agrees are material.

Every year there are articles in industry publications bemoaning the public’s lack of confidence in the industry. Wouldn’t full disclosure of prior complaints instead of burying them help to restore the public’s confidence?

I have every reason to expect that this controversy will continue, in part because many people in the industry will never get over the arrogance of a customer who dares to file an arbitration claim. Even those with the most to gain, the honest brokers who work for years without a single customer complaint are silent.

For this reason FINRA is unlikely to acquiesce to allowing BrokerCheck to report any and all claims made against a broker without providing some type of escape mechanism. In the meantime, it is impossible for a customer to know if the BrokerCheck report that FINRA urges them to read is accurate. As a practical matter a BrokerCheck report is worthless.

Allow me to offer a practical solution.

If you are considering hiring a new broker and find that BrokerCheck reports no complaints or arbitration claims, send the broker the following e-mail:

Dear Mr. Smith: We have done some research and were very pleased to learn that throughout your many years in the brokerage business you have never had a complaint or arbitration with a customer. Please confirm that this is true and that none have been removed from your record.

That should protect any customer and level the playing field. It is one thing for a broker to have arbitration claims expunged from their record and quite another to lie about it.

Remembering the “customer’s man”

Several weeks back I had lunch with a colleague who, like me, had started in the brokerage business in the 1970s. At one point he referred to himself as a “customer’s man”. It was a term used to describe a registered representative that I had not heard in years. It evoked a way of doing business that has largely been lost.

At that time, commissions and costs were fixed across the industry. Today, we see these costs as an impediment to our ability to maximize investment returns. We have lost sight of the value that a good customer’s man brought to the process.

A good customer’s man got to know you.

The brokerage firms encouraged every customer’s man to get to know every one of his customers and to get to know them well. You would meet in person to share lunch, drinks or dinner or to play squash, tennis or golf. Over time and many conversations you would get to know quite a bit about each others’ lives and families. Your customer’s man would become one of your trusted advisers.

A good customer’s man was a good stock picker.

Customers’ men were always on the look-out for the next stock that was about to make a move. They were selling their ability to pick stocks and to buy them for you at the right price.

Your customer’s man would always tell you which stocks he was following and why he was following them. He would call to tell you when the price had dipped and to recommend that you give him an order to buy a few hundred shares for you. You would not hesitate.

A good customer’s man made money for you.

Customer’s men were judged by how much the stocks that they recommended went up. It was a simple metric that everyone understood. Very few built their book of customers by advertising or seminars. The best built their books by word of mouth. They asked existing customers for referrals. Customers who made money following their broker’s recommendations gave the best referrals.

From the 1970s forward if the firms wanted more customers, it meant having more brokers with bigger and bigger books of customer accounts. The big action was moving established producers around from firm to firm. Front-end bonuses for really big producers became really big. Just about every broker wanted to be a bigger producer.

That attitude was good for the firms and they encouraged it. Brokers became almost exclusively focused on bringing in more customers. No longer were they judged for the stocks that they picked or how much money their customers made. Producers were now judged on how many “assets under management” they have.

The actual management and investing of the customers’ funds was increasingly handled elsewhere. Enticing new customers meant selling the investing and management skills of others.

This was logical as so many of the customers’ men had not seen the 1987 crash coming. If they had, logic suggested that they would have pulled their customers out before it happened.

It was time to let the experts manage your investments. Customers were sold many different kinds of managed funds, annuities and other “packaged” financial products. All of these products were expensive from the customers’ standpoint. The firms had built in significant underwriting costs and management fees.

Many of these fund managers drank from the Kool-aid that said that price/earnings ratios of 50 or more were sustainable and likely to go higher. Individual brokers who questioned the wisdom of the high paid fund managers and research analysts were brought into line or shown the door.

When the tech market inevitably crashed, many in the industry argued that “no one had seen it coming.” They said the same when the market crashed again in 2008. It was a phrase that was repeated so often that people started to believe it.

It re-enforced the idea that the average financial adviser can do no better than average. Everyone just started buying the index, certain that no human being who actually works in the markets every day could actually have awareness of what was going on or to help customers profit from it.

The index was much cheaper than a human adviser in any event. Lower costs were more efficient and would increase returns, provided, of course, the market goes up.

A good customer’s man always put the interests of his customers first. It was an era when almost every business adhered to the idea that “the customer was always right.” When is the last time that you heard that phrase or saw it posted in a business or an office?

Today, the industry staunchly opposes any regulation that would require individual brokers to put their customers’ interests first. That should tell you everything that you need to know about the financial services industry today.

The individual registered representative, the back-bone and the public face of the brokerage industry will likely not survive another generation. Their jobs are already foolishly being replaced by computer driven robo-advisers.

The industry will survive and prosper without the customer’s men. It is already oblivious to what it has lost.