SEC Approves Rule Preventing Barters for Expungement Cooperation – What You Can Do to Ensure Compliance

by Eversheds Sutherland (US) LLP

On July 22, the U.S. Securities and Exchange Commission (SEC) approved the Financial Industry Regulatory Authority’s (FINRA) proposed Rule 2081, which prevents firms or associated persons from conditioning settlement or otherwise paying customers for their cooperation in the complaint expungement process. The full text of the rule is below:

2081. Prohibited Conditions Relating to Expungement of Customer Dispute Information

No member or associated person shall condition or seek to condition settlement of a dispute with a customer on, or to otherwise compensate the customer for, the customer’s agreement to consent to, or not to oppose, the member’s or associated person’s request to expunge such customer dispute information from the CRD system.

FINRA will soon publish a Regulatory Notice with the effective date for Rule 2081.

While not previously prohibited by FINRA Rules, the practice that Rule 2081 addresses does not seem widespread. A decade ago, FINRA issued Notice to Members 04-44 “to remind members that the use of certain provisions in settlement agreements with customers or other persons that impede, or have the potential to impede, NASD investigations and the prosecution of NASD enforcement actions violates NASD Rule 2110 … .” The Notice did not mention expungement, instead prohibiting the use of confidentiality provisions that left no carve-out for responding to regulators and requirements that customers withdraw regulatory complaints or sign misleading affidavits. Nevertheless, the warning shot seems to have substantially reduced the practice of including expungement cooperation terms in settlement agreements.

The prudence of ending these practices became even more apparent when FINRA Rule 12805 became effective in December 2008. That rule required arbitrators to “review settlement documents and consider the amount of payments made to any party and any other terms and conditions of a settlement.” In case any arbitrators failed to understand what other “terms and conditions” to check in a settlement, in October 2013 (just two days before the Public Investors Arbitration Bar Association (PIABA) publicly released its expungement “study”), FINRA issued a Notice to Arbitrators and Parties on Expanded Expungement Guidance, which guided arbitrators to “inquire and fully consider whether a party conditioned a settlement of the arbitration upon agreement not to oppose the request for expungement … .” In short, the negative connotations that would arise from these contractual terms have long outweighed their utility. Customers rarely want to testify and potentially pay an attorney to participate in expungement proceedings after they have been paid.

            So how should firms and their counsel adjust their practices in light of Rule 2081?

  • First, and obviously, do not include any terms in customer settlement agreements binding customers to consent to, or not oppose, expungement. The trick may be in the implementation. Settlement agreements involve many boilerplate terms that do not get a lot of attention. If old settlement agreements contain problematic language regarding expungement, it is important for all involved in the process of drafting and finalizing the agreement to understand the need to find and excise outdated terms.

  • Second, respondents should be careful about mentioning expungement during settlement negotiations. FINRA has indicated that “the proposal would not preclude a respondent from inquiring whether any party intends to support or oppose a request for expungement relief.” SEC Release No. 34-72649 at 9. However, “FINRA states that it would consider any actions by a member firm to influence another party to a settlement agreement for purposes of obtaining expungement relief, whether expressly or otherwise, to be a potential violation of the proposed rule.” Id. The line between these two statements becomes diminishingly thin in the context of settlement negotiations, particularly when those settlement negotiations are recreated after the fact for FINRA’s scrutiny. It is unclear how FINRA would find out about any attempts to influence settlement negotiations.  However, any discussion of expungement during settlement negotiations could be interpreted by the other side as an attempt “to influence another party … whether expressly or otherwise.”

  • In its comment letter, the Securities Industry and Financial Markets Association (SIFMA) suggested the following language be included in settlement agreements: “(i) the respondent intends to seek expungement relief; (ii) such expungement request was not a condition of the settlement agreement; (iii) respondent has not paid any consideration related to the expungement request; and (iv) claimant may participate in the hearing on expungement if he/she so chooses.” Id. at 10. FINRA expressly endorsed this language. Id. Including this language in customer settlement agreements would be a good practice. The language will provide additional reassurance to panels reviewing the expungement request and will be helpful in assuring arbitrators that there were no “winking” agreements with the customer regarding expungement.

Rule 2081 will not be the end of expungement reform. This area has been under particular scrutiny from FINRA, PIABA, and members of Congress. At the end of its order approving Rule 2081, the SEC made clear that it also sees a need for additional changes: “The Commission encourages FINRA to conduct a comprehensive review of its expungement rules and procedures to determine whether additional rulemaking is necessary or appropriate to assure that expungement in fact is treated as an extraordinary remedy that is permitted only where the information to be expunged has no meaningful investor protection or regulatory value.”

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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