NASD Proposes Curbing Purges Of Broker Disciplinary Data

By Lynn Cowan
Of DOW JONES NEWSWIRES

WASHINGTON -- The National Association Of Securities Dealers has proposed tightening the restrictions on what information can be deleted from a broker's public disciplinary records.

The change, if adopted, would significantly bolster the quality of public information about firms' and individual brokers' disciplinary histories.

The proposal, released Wednesday, would eliminate many of the methods currently used by firms and brokers to purge negative arbitration decisions from the NASD's central registration depository. The depository, or CRD, is the primary tool investors are told to consult when considering hiring a specific broker or firm. For years, investor advocates and state regulators have complained that bad brokers and their firms have been allowed too much leeway to "clean up" their disciplinary histories by purging, or expunging, individual arbitration cases.

The NASD's proposal, which must go through a month-long public comment period and approval by the Securities and Exchange Commission, involves two major changes to the way expungements would be granted.

First, specific guidelines are given for what type of cases can be expunged; previously, that determination was left up to individual arbitration panels.

Second, in one of the most significant changes, the ability of a firm to coax an expungement out of its aggrieved customer as part of settlement negotiations would be virtually eliminated, except in cases where there was a clear factual error - as when a customer names the wrong firm or broker.

"There is potential for inappropriate use of the expungement process, particularly where parties have agreed to expunge customer dispute information as part of a settlement," the NASD noted in its proposal. "Both the investing public and regulators have interests in maintaining customer dispute information within the CRD system that may not be considered when two private parties agree" to settle a claim.

It has historically been up to the arbitrators to determine whether a case merits expungement. In January 1999, that process was altered slightly when arbitrators were told they could no longer order the NASD to expunge information; instead, they could recommend it, but the recommendation would have to be confirmed by a court. Plaintiffs' attorneys complained that the change meant little, because overwhelmed judges simply "rubber-stamped" the recommendations.

Generally, arbitrators have recommended expungement when a complaint is decided in favor of the firm or broker, or when the two parties agree to it as part of a settlement. Even lawyers who detested the ability of firms to expunge through a settlement admitted that they sometimes advised their clients to accept such offers; although they disliked the idea, it was often in their clients' best interest to settle that way, they said.

Besides restricting the ability to include expungement in a settlement, the new rule would eliminate expungements that occur simply because a firm or broker prevailed against a customer in an arbitration hearing. Most arbitration panels don't explain the reasons behind their decisions, and claims can be denied for lack of documentation, failure to prove that a broker's negligence harmed the investor, or if arbitrators feel that a customer's mistakes also contributed to his losses.

Instead of a simple win, a case would have to meet one of three requirements to merit expungement under the NASD's proposal. In the first, similar to the guideline regarding settlements, cases that show a clear error - the broker doesn't work for the firm named, or the broker was named erroneously - can be wiped off the CRD system. The second allows those complaints that are without legal merit to be purged. Finally, information that is defamatory could be wiped out, too.

Lest investors fear that all negative information would be considered defamatory, the NASD included a footnote in its proposal generally defining defamation as a false statement that hurts the firm or broker's reputation. The guidelines also outline some of the common standards used by courts - such as actual malice or reckless disregard for the truth - to determine defamation.

A National Association of Securities Dealers proposal would allow a panel of arbitrators or a court to determine whether its guidelines for expungement had been met.

(An item published at 8:56 a.m. EDT, reported that only an independent fact-finder, not the arbitrators, would determine whether the guidelines had been met.)

The NASD also is considering putting additional regulatory muscle behind its proposed expungement changes. Although it already has broad authority to go after firms and brokers who undermine the arbitration system, the NASD could adopt a new rule or issue an interpretive release that specifies the consequences for anyone trying to expunge records that shouldn't be erased.

The new rule or interpretation would stipulate that the NASD could pursue disciplinary action if an expungement is sought after an arbitration panel rules against a firm or broker. Similarly, the NASD would specify that it could pursue action if anyone tries to purge a case that doesn't contain an expungement order and a finding of at least one of its proposed criteria.

The NASD's CRD system has been around since 1981. The database contains all arbitration awards issued against a firm or an individual broker since that time, as well as any regulatory or legal action taken against them.

The NASD, a membership organization that regulates brokerages and their employees, also operates the largest dispute resolution system in the industry. When an investor has a complaint against a broker or firm, their customer contracts require them to take their case to an arbitration panel rather than court. While both the New York Stock Exchange and the NASD offer arbitration forums, the NASD's is the most widely used. Once a complaint has gone through the system, the broker or firm is required to report it to the CRD system - unless an expungement has been ordered.

Attorneys and state regulators use the CRD system to prepare for other arbitrations and investigations. Investors also are urged to consult the CRD before hiring a broker or firm. Although individual arbitration awards are searchable online by case number or keyword, investors who want a complete disciplinary history of their broker - including state actions, regulatory sanctions, complaints and bankruptcy information - must make a request by mail, e-mail or a toll-free hotline to the NASD's regulatory division. The documents are usually delivered in one to two business days. Information on making such a request is available online at www.nasdr.com.

The president of the Public Investors Arbitration Bar Association, a group of lawyers who represent investors with brokerage complaints, said the NASD's proposals are "almost perfect" PIABA had been one of the most vocal critics of expungement practices, and had argued that they needed to be changed.

"The NASD should receive the highest commendation for having done this," said Seth Lipner, a Garden City, N.Y. attorney and president of PIABA. "This really shows that the folks running NASD Regulation, like (head of dispute resolution) Linda Feinberg, is properly wearing her regulator hat and is looking at things objectively."

PIABA intends to write a formal letter of comment to the NASD. The Securities Industry Association, a trade group of Wall Street firms, wasn't immediately able to comment on the proposal.

Lipner said that he felt the initial proposal needed to be more specific about its guidelines, and better define what is meant by "without merit" or "defamatory."

"I think the lawyers understand what it means, but not all arbitrators are lawyers," Lipner said.

Lipner added that the biggest change the proposal would make would be eliminating expungements through settlements. He said under the current system, firms and brokers can "buy a clean record" by offering a monetary settlement in exchange for the customer's agreement to expunge.

"They agree, and the arbitrator signs it because what does he care? Then the judge approves it because everyone has already agreed," Lipner said. "There's no safegaurds."

The Securities Industry Association, a trade group for Wall Street firms, said it hadn't had time to fully digest the NASD's expungement proposal, but its preliminary reaction wasn't positive. The group's top concern is the chilling effect any changes could have on the ability of firms to settle complaints with customers, said Amal Aly, assistant general counsel at the SIA.

Another issue among member firms is a proposed requirement that the NASD be notified about an expungement order prior to its submission to a court for confirmation. Aly said the extra procedure, at first glance, seems onerous.

"We are conducting an extensive review and are planning to submit a comment letter," Aly said. "These are very preliminary views."

SIA opposition to a change in the way disciplinary records are handled wouldn't be surprising. In 1999, when the NASD decided to require all arbitrator-ordered expungements be confirmed by a court, neither investor advocates nor the SIA was pleased. PIABA, the attorneys group representing investors, felt that the change did little beyond adding a second rubber stamp to the process. The SIA opposed the change, saying a rule to limit the arbitrators' power to expunge was "ill-conceived and unfair" because it limited firms' and brokers' ability to quickly delete frivolous or inaccurate complaints from the database.