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Expungement Proceedings Gone Wrong: a Rare Vacatur of an Arbitration Award

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  • Posted on: Sep 19 2016

It is a fact of life that many securities brokers and financial advisors will be the subject of one or more customer complaints during his/her career. To be sure, some of those complaints will be justified. However, many of them will not be. In those latter instances, innocent brokers and financial advisors will have a blemish on his/her record that can be cleared only through an expungement proceeding.

Expungement is essentially a three-step procedure. First, the broker or financial advisor must persuade a court or arbitration panel to expunge his/her record of the negative event. Rule 2080(b)(1) promulgated by the Financial Industry Regulatory Authority (“FINRA”) provides the grounds upon which an order of expungement should be granted: (a) the claim, allegation or information is factually impossible or clearly erroneous; (b) the broker or financial advisor was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation or conversion of funds; or (c) the claim, allegation or information is false. The process is started by filing an application naming the customer or the firm as a respondent. FINRA is also named as an additional party, unless FINRA waives the requirement.

Second, if an expungement award is issued by an arbitration panel, the award must be judicially confirmed.

Third, if confirmed, the award and the judgment (confirming the award) are to be sent to the Central Registration Depository (“CRD”) so that the matter can be removed from the broker or financial advisor’s record.

In addition to Rule 2080, the process for seeking expungement is governed Rule 12805 of the FINRA Code of Arbitration Procedure for Customer Disputes. Rule 12805 covers the responsibilities of the arbitration panel hearing an application for expungement. The rule requires the panel to “[h]old a recorded hearing session (by telephone or in person) regarding the appropriateness of expungement.”  In a case that has gone to hearing on the merits, a panel will often consider a request for expungement as part of its deliberations. Rule 12805 further instructs that if the panel grants expungement, it must “[i]ndicate in the arbitration award which of the Rule 2080 grounds for expungement serve(s) as the basis for its expungement order and provide a brief written explanation of the reason(s) for its finding that one or more Rule 2080 grounds for expungement applies to the facts of the case.”

If, however, a customer complaint is settled before a hearing on the merits, the panel must nevertheless hold a hearing on the record to evaluate the expungement application, including “review[ing] settlement documents and consider[ing] the amount of payments made to any party and any other terms and conditions of a settlement.” The broker or financial advisor must present testimony and evidence to the panel in support of the application, and the customer or other interested party must be given an opportunity to respond and be heard. Upon request of the broker or financial advisor, FINRA will typically keep the arbitration panel intact following the settlement for purposes of holding a hearing limited to the issue of the broker or financial advisor’s expungement request.

Expungement Gets Some Bad Press: Royal Alliance Associates Inc. v. Liebhaber

The foregoing expungement process received some adverse press in September of 2014, when The New York Times Dealbook published an article (“A Murky Process” dated September 25, 2014) about an expungement proceeding in which Sandra A. Liebhaber (“Liebhaber”), a customer of Royal Alliance Associates, Inc. (“Royal Alliance”), attempted to oppose an expungement application by her broker, Kathleen Tarr (“Tarr”) (FINRA ID No. 13-01522 (Los Angeles, 9/10/14)), and was rebuffed by the panel, which issued the expungement award. As discussed below, in Royal Alliance Associates, Inc. v. Liebhaber, B264619 (Cal. Ct. App. Aug. 30, 2016), the Court of Appeals of the State of California vacated the expungement award because the arbitrators failed to allow Liebhaber and her counsel the opportunity to present testimony and evidence at the hearing.

The Arbitral Proceeding

From July 2002 through July 2010, Tarr was employed as a financial advisor with Royal Alliance, a securities broker-dealer and FINRA member. Starting in 2007, Tarr sold high-commission variable annuities and non-traded real estate investment trusts, or REITs, to dozens of AT&T employees who were eligible to receive early retirement offers from the company. By 2010, many of Tarr’s customers complained that she improperly steered them into portfolios of illiquid securities that were unsuitable for their retirement accounts.

Liebhaber was a customer service representative for AT&T and one of Tarr’s clients.  In May 2013, Liebhaber filed a complaint against Royal Alliance, claiming that Royal Alliance was negligent, breached its fiduciary duty to her, and violated state securities laws by selling her “illiquid, high-risk investments” that were “inappropriate and unsuitable” for her individual retirement account. Slip op. at 3. Liebhaber sought $325,000 in compensatory damages.  Royal Alliance settled the action for $30,000, or less than 10% of requested damages, after an arbitration panel was convened but before a hearing was held. Id. Royal Alliance requested that the arbitrators keep the case open so that it could seek expungement of Liebhaber’s claim and settlement from Tarr’s CRD record. Id. at 3-4.

On June 9, 2014, Royal Alliance submitted a request for expungement on behalf of Tarr to the previously convened arbitration panel. Liebhaber remained a party to the action; Tarr was not, however, named as a party. Royal Alliance sought expungement because it faced other FINRA arbitrations in which former customers claimed that Tarr had caused them harm.  In later briefing, Royal Alliance explained that it wanted to use the expungement award in “ongoing arbitrations and in any later filed arbitration[s]” as evidence of no wrongdoing.

Less than a month later, on June 30, 2014, Liebhaber’s counsel advised the arbitration panel that he did not intend to file a pre-hearing brief but planned to call Liebhaber and Tarr as witnesses at the arbitration hearing. According to the Court, the record was devoid of a response by Royal Alliance or the arbitration panel, as well as written evidence and submissions by the parties. Slip op. at 4.

On August 12, 2014, the panel held a telephonic hearing to consider the expungement application. Liebhaber and her counsel, Royal Alliance and its counsel, and Tarr participated in the hearing.

Royal Alliance argued that expungement was warranted because Liebhaber’s allegations against Tarr were false, stating that the investments Tarr recommended were suitable for Liebhaber, and Liebhaber’s alleged net losses could be attributed to withdrawals from her retirement account and “the 2008 market crash.” Slip op. at 4. Royal Alliance also noted that a complaint similar to Liebhaber’s had been previously expunged from Tarr’s record. (Note: Tarr had 44 customer complaints and a termination on her record.) Tarr also spoke during the hearing, but did so without being sworn in by the panel. Tarr vigorously disputed Liebhaber’s allegations, noting that the allegations against her were inimical to her background as “the daughter and granddaughter of ministers.” Slip op. at 4-5. Tarr spoke uninterrupted and without questions. Id. at 5.

Liebhaber’s counsel contended, among other things, that Royal Alliance failed to show that her claims against Tarr were false or factually impossible, and proposed a procedure in which both Tarr and Liebhaber would be asked to respond to questions about Liebhaber’s claims. Tarr’s counsel objected to the proposed procedure.  The presiding arbitrator concluded that such questioning was unnecessary. Another panel member, however, wanted to hear such questioning, especially since “the [FINRA] guidelines are pretty clear that we’re supposed to be looking at everything because this was a settled case, and that the more information we have, the easier it is for us to make what I would consider to be a fair and well reasoned decision regarding expungement.” That arbitrator undermined the point, however, by adding that such questioning should not exceed “another two hours.” The third arbitrator agreed with the presiding panel member. Thereafter, the presiding arbitrator denied Liebhaber’s request. Slip op. at 6. Liebhaber’s counsel stated for the record his objection to the panel’s ruling, noting that he had “not been given a full and fair opportunity to respond to … the claims that have been made in the hearing.” Id. at 7.

After rebuttal and additional discussion about the panel’s ruling, the panel concluded the proceeding. On September 10, 2014, the panel issued an award recommending expungement. Slip op. at 7. The award tracked the language of Rule 2080, and found that Liebhaber’s “claim, allegation, or information” against Tarr was “factually impossible or clearly erroneous; and … The claim, allegation, or information is false.” Slip op. at 7-8. The panel cited several reasons for its findings, including the difference between the damages Liebhaber sought ($325,000) and the settlement amount ($30,000). Id. at 8. The panel concluded the amount of the payment reflected a business decision by Royal Alliance rather than Liebhaber’s actual net out-of-pocket losses. Id.

The Petition to Confirm the Expungement Award

Pursuant to FINRA Rule 2080, Royal Alliance sought confirmation of the expungement award. Liebhaber opposed the petition, and requested that the award be vacated on the grounds that: “(a) Liebhaber’s rights were substantially prejudiced by misconduct of the arbitrators; (b) the arbitrators exceeded their powers in denying Liebhaber’s request to present evidence at the hearing; and (c) Liebhaber’s rights were substantially prejudiced by the refusal of the arbitrators to hear evidence material to her claims.” Slip op. at 10.

On May 18, 2015, the trial court held a hearing to consider the petition to confirm the award. In connection with the hearing, the court issued a tentative ruling to vacate the award. Following oral argument, the trial court adopted its tentative ruling and vacated the expungement award.  The court did so “on the ground that Liebhaber’s rights were substantially prejudiced by misconduct of the arbitrators, the arbitrators exceeded their powers, and Liebhaber’s rights were substantially prejudiced by refusal of the arbitrators to hear evidence material to the controversy.” Slip op. at 12. The court also found that the arbitrators violated FINRA Rule 2080 “by allowing Ms. Tarr to provide an unsworn statement in support of expungement while also preventing Liebhaber’s attorney from cross-examining Ms. Tarr in order to determine if the requirements of Rule 2080 were met.” Id.

THE COURT OF APPEALS’ DECISION

The Court of Appeals affirmed the trial court’s ruling. It found that “Liebhaber’s rights as a party to the arbitration proceedings were substantially prejudiced within the meaning of [the California Code of Civil Procedure] section 1286.2, subdivision (a)(5),” which “provides that the trial court ‘shall vacate’ an arbitration award if ‘The rights of the party were substantially prejudiced by . . . the refusal of the arbitrators to hear evidence material to the controversy or by other conduct of the arbitrators contrary to the provisions of this title.’” Slip op. at 16.

Addressing the first question – whether the arbitrators refused to hear evidence material to the controversy or engage in other conduct contrary to the provisions of California law – the Court Appeals found that the panel in fact had refused to give Liebhaber the opportunity to be heard, present oral evidence, and cross-examine Tarr during the hearing. Slip op. at 16-18.

As to the second question – whether Liebhaber’s rights were substantially prejudiced – the Court of Appeals found that they were. In so holding, the Court concluded that “‘the arbitrator[s] might well have made a different award’ if they had allowed Liebhaber to tell her side of the story or question Tarr’s.” Slip op. at 19 (citation omitted). Consequently, the Court held that “the hearing was not fair,” because Royal Alliance received “an unfettered opportunity to bolster its written” submission, while Liebhaber was “denied even a limited chance to do the same.” Id. at 20.

TAKEAWAY

Royal Alliance teaches the importance of making a record during an arbitration proceeding. As discussed above, Liebhaber’s counsel created a substantial record showing that Liebhaber did not have a fair hearing. He was able to use that record to show prejudice from the arbitrators’ conduct – one of the bases for vacatur of an arbitral award.  Since vacatur of an award is very difficult to obtain, as discussed in a July post on this blog, having a detailed record is a good way to persuade a court of entitlement to such relief.

Royal Alliance also teaches that, although customers typically remain silent during expungement proceedings, they do not have to remain so, even after settling their claims. As discussed above, Liebhaber felt strongly enough to ensure that other investors would know about Tarr’s behavior notwithstanding the settlement. Of course, customers who believe their broker or financial advisor has been falsely charged with wronging should likewise speak up during an expungement hearing.

* * *

It should be noted that FINRA participated as a party in the confirmation proceeding and opposed the actions of the arbitrators. At the hearing, FINRA told the trial court that FINRA had “an interest and really a duty here, in protecting the integrity of the [CRD and BrokerCheck record system] and the information contained in it.” As such, given the record of proceedings, FINRA argued that the arbitrators broke FINRA’s rules in denying Leibhaber and her counsel the opportunity to testify and be heard.

Also, not long after Liebhaber challenged the expungement award, FINRA revised its expungement guidance with respect to customer participation at expungement hearings. The Arbitrators’ Guide now provides, as mentioned above, that arbitrators should “allow customers and their counsel to participate in the expungement hearing in settled cases if they wish to.”

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