Will New Court Ruling Give Troubled Advisors Clean Slate?

FUNDfire, October 5, 2012

Your Q&A is your opportunity to get your questions answered by industry leaders.

Q.  What are the main takeaways for advisors of the recent California court ruling on broker-dealers clearing their FINRA records of past customer complaints?

— Advisor, high-net-worth focus, California

Answered by Dimitri Nemirovsky, the cofounding partner of the Reyhani Nemirovsky law firm. Bryan Reyhani, the other cofounding partner of the firm, cowrote this response.

A.  A recent California court ruling may well be a game-changer for advisors seeking to remove customer complaints and disciplinary actions from their Financial Industry Regulatory Authority (FINRA) records.

In Lickiss v. Financial Industry Regulatory Authority, the California Court of Appeal for the First Appellate District reversed a trial court’s dismissal of an expungement request by an advisor, Edwin Lickiss. Expungement is the removal of records from public inspection. Rejecting FINRA’s longstanding position regarding the process by which advisors can expunge their record, the court held that advisors had permission to seek the clearing of their records on grounds of basic equity or fairness. A final decision is still pending.

The framework for obtaining expungement relief is set forth in FINRA Rule 2080. The provision states that advisors seeking such remedies must obtain a court order directing the relief, or a court order confirming an arbitration award contained it. The rule requires that the party seeking expungement name FINRA as a party.

FINRA may waive the latter requirement if it determines that: the allegation or information is factually impossible or clearly erroneous; the registered person was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation or conversion of funds; or the allegation or information is false.

FINRA may also waive the naming requirement if it determines that “the expungement relief” and accompanying findings on which it is based are meritorious. It can also do so if the information removal would have no material adverse effect on investor protection, the integrity of FINRA’s record system or regulatory requirements.

Lickiss filed his petition in California state court seeking to remove from FINRA’s Central Registration Depository 17 customer complaints and arbitrations and one regulatory enforcement action. He argued that the court had jurisdiction pursuant to FINRA Rule 2080 and its inherent equitable power to clear his record.

The advisor also argued that the disclosures related to matters dating back to the mid-1990s, that his record had remained clean since that time, and that the disclosures all related to investments in a single equity trust that went bankrupt in 1993.

Lickiss urged the court to balance the equity of his expungement request by weighing the harm the disclosures created for his business against the potential harm to investors that clearing his FINRA disclosures would cause.

FINRA asked the court to dismiss Lickiss’s petition on the basis of Rule 2080, arguing that equity permitted the court to rely exclusively on the rule and that Lickiss failed to meet the rule requirements.

Although the trial court agreed with FINRA and granted its motion to dismiss, the Court of Appeal reversed that decision and remanded the case back to the trial court for further proceedings. The Court of Appeal reasoned that by narrowly and rigidly assessing the legal sufficiency of Lickiss’s petition, the trial court “disregarded basic principles of equity” and the decision “was nothing short of an end run around equity.”

The Court of Appeal further noted that Rule 2080 is a “procedural rule that does not provide any substantive criteria as to when expungement would be appropriate.” Lickiss asked the court to make a fair ruling. He argued that his expungement request should be granted because the decades-old disclosures on his Central Registration Depository documents were impeding his ability to generate business and that granting the expungement would not be a detriment to the public. The Court of Appeal mentioned those factors in explaining its decision to overturn the trial court’s pro-FINRA ruling.

It will be interesting indeed to see how the trial court rules on Lickiss’s request given the reasoning by the Court of Appeal. If the trial court grants Lickiss’s expungement request, FINRA will likely move to appeal the ruling.

If the court rules in favor of Lickiss, obviously the precedent will open the floodgates and advisors will file similar cases in droves. If the court rules against Lickiss, I don’t think there will be a chilling effect. What I think we will see, because the appeals court ruled that trial courts have the authority to make equitable rulings, are advisors rolling the dice, especially in other jurisdictions.

Notwithstanding the outcome of the case, however, the Lickiss decision will likely lead to similar filings in state courts around the country by advisors seeking to expunge their Central Registration Depository records on grounds of basic fairness and equity. While this is a case pending in California, advisors in other jurisdictions can file me-too cases hoping for a favorable result based on the unique facts and circumstances of their cases. That will have implications for the wealth management community, some of whose members may be granted a clean slate, and high-net-worth investors themselves, who use the records for advisor due diligence.