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The Financial Industry Regulatory Authority (“FINRA“) is in the middle of a media campaign touting themselves as the investor’s friend.  They urge people to check out their broker for free using FINRA’s BrokerCheck report.  Today, New York Times reporter Lynnley Browning reported that FINRA’s BrokerCheck is worth what you pay for it — nothing. 

The problem is that, up until 2004, and some say even after, brokers have been able to negotiate for expungement of their records as a condition of a confidential settlement of an arbitration case.  While Browning quoted a source who said, “‘the vast majority’” of expungement requests were legitimate,” that has not been my experience.  Through nearly twenty years of representing and protecting investors at the SEC and in private practice, I have found that most truly frivolous claims go to a hearing, whereas meritorious claims get settled, almost always with a provision in the settlement documents requiring the claimant to cooperate in wiping the broker’s misconduct from the record. 

So, imagine yourself as an investor curious as to whether your broker or prospective broker has survived past bear markets without any customer complaints.  You could ask FINRA, and they may tell you that your broker is squeaky clean.  In truth, your broker may be wearing several coats of whitewash. 

Our standard practice at Investor’s Watchdog is that, when we input a new arbitration action that includes expungement, we check backwards to find out whether the broker has any other expunged actions in his or her background.  Last week we checked on a broker working for a major worldwide brokerage firm in South Florida and found that she has 10 customer complaints, although her FINRA record is clean.   

In her story, Browning got to the heart of the problem quickly:

The practice highlights a tension in the United States securities markets, which rely on private, so-called self-regulatory organizations like Finra to police industry members.

A nonprofit organization based in Washington, Finra is financed through dues paid by the nation’s securities firms and their armies of employees. It has the authority to bring civil lawsuits and enforcement actions against its members. That structure, however, bothers some industry observers.

“BrokerCheck gives you no assurance that you’re dealing with somebody who has a clean record,” said Pat Huddleston, a former branch enforcement chief at the Securities and Exchange Commission. Mr. Huddleston, who runs the consumer advocacy Web site Investor’s Watchdog, argued that Finra should not expunge anything. He has compiled what he calls his “whitewash list” and charges investors $49 and up for reports that describe arbitration proceedings or settlements, gleaned from public records, that Finra has expunged.

“There’s an inherent conflict of interest when a self-regulating organization of brokerage firms has the responsibility to also protect the interests of investors,” said Steven Caruso, the former president of the Public Investors Arbitration Bar Association, a self-regulating organization whose 500 lawyer-members represent investors in disputes with the securities industry.

Under pressure from the Public Investor’s Arbitration Bar Association (“PIABA”), an organization of lawyers representing investors, FINRA has lately tried to clean up the expungement problem.  As Browning reported:

By 2004, regulators imposed tougher rules under which records could be wiped clean only if an arbitration panel found that an investor’s allegations had been factually impossible or false, or that the accused broker had not been individually involved in the matter.

PIABA is a terrific advocate for investors, and they pressed forward with a study designed to reveal the dangers of allowing expungements.

Last September, the association released a study that found Finra had allowed records to be expunged in more than 98 percent of arbitration awards in 2006 in which the broker requested a clean record as a condition of settling privately. More than 71 percent of those cases were not based on any analysis by the arbitrators of the broker’s request, the association said.

The study cited one mutual fund broker, Joseph R. Karsner IV, of Karsner & Associates, who was granted 18 expungements for 18 separate arbitration awards and customer complaints in 2006. A lawyer for Mr. Karsner, Richard Magid, said that “Mr. Karsner did everything according to the rules” and that his investors had simply gotten burned in a market downturn.

Browning exposed the continued danger of touting FINRA’s BrokerCheck as a solution to investors seeking information.

[T]he tougher rules are not retroactive, which means that some brokers with sketchy histories still have clean records on BrokerCheck.

With apologies for being too promotional in a blog post, there is only one place to learn your broker’s true background, and you’re there now.