Asking the Wrong Questions of FINRA

Journal of Financial Planning: January 2012

Dan Moisand, CFP®, is a principal at Moisand Fitzgerald Tamayo LLC in Melbourne, Florida, and former president of the Financial Planning Association.

Congressional hearings are often criticized for having more show than substance. This past fall’s hearing about a draft bill creating an SRO for investment advisers had some of these qualities. In a guest post on the blog Nerd’s Eye View at, Duane Thompson, president of Potomac Strategies and former chief of government relations for FPA, described the surreal sight of a portrait of Michael Oxley hanging behind the House Financial Services subcommittee during the proceedings. The portrait is there because Oxley was chairman of that subcommittee. Today, Oxley is the chief lobbyist for FINRA.

His client, FINRA Chairman and CEO Rick Ketchum, was pitched a full set of softball questions designed to make the idea of a FINRA-run SRO for advisers sound good. Congress is asking the wrong questions of FINRA. What Congress should be investigating is whether FINRA should be shut down entirely.

The most basic critique of any SRO is an inherent conflict when one is paid by the parties to be overseen. To some, it is only a matter of time before the inmates run the asylum. Has this happened with FINRA?

The Madoff Connection

The face of regulatory reform is Bernie Madoff. Many press releases or speeches from groups on all sides of the issue include something like, “Madoff-like scams should be prevented, so we need to (fill in blank with proposal here).” So, I’ll start there too.

Madoff wasn’t merely a name associated with FINRA, in some sense Madoff was FINRA. Madoff (Bernie) joined FINRA’s (then NASD’s) Board in 1994 and was its vice chairman while his Ponzi scheme was under way. Madoff (Peter) also made it to that same office at one point. Madoff (Mark) was on the National Adjudicatory Council, a regulatory body that reviews disciplinary decisions made by FINRA. That was an appointed gig courtesy of then CEO Mary Schapiro, who we all know is now chair of the SEC. Madoff (Shana), a compliance officer of Bernie’s until the firm’s collapse, was a member of a compliance advisory committee of FINRA.

Despite the epic proportions of the scam, Madoff managed to get by the exams FINRA is so proud of because of their frequency. Clearly, frequency and effectiveness are two different things. The relationships Madoff had within FINRA were such that whistleblower Harry Markopolos testified to Congress that he felt his life would be in danger if he went to FINRA. That is quite the family business.

The Board’s Agenda

As I was putting this piece together, we got another glimpse of FINRA’s ineffectiveness courtesy of the election for a spot on FINRA’s National Adjudicatory Council. Karen Fischer, a compliance consultant, got enough signatures to get on the ballot. She is running against David Sobel, the general counsel at Abel/Noser Corporation, who was nominated by FINRA’s selection committee. Ms. Fischer said Mr. Sobel was “picked by FINRA. We don’t know how—probably on the golf course somewhere.”

Her sentiment that the game is rigged is hardly new inside FINRA. Small broker-dealer executives have been railing at the crush of rules FINRA has piled on them and battling to get representation on the board for decades, making even FINRA’s own members less than well-served.

I think of Lt. Col. Elton Johnson (U.S. Army Reserve), head of Amerivet Securities, who got seven sensible initiatives on the agenda for FINRA’s 2010 annual meeting—all of which passed by wide margins. According to Amerivet’s website, among these were:

  • Compensation for FINRA’s top 10 most highly paid employees should be reported regularly in the annual report (83 percent support)
  • Management’s relationships with Bernie Madoff and his family should be independently investigated (68 percent support)
  • FINRA investment transactions should be disclosed to members and the public (76 percent support)
  • FINRA Board of Governors meetings should be held in the “sunshine,” open to the public (77 percent support)

The FINRA Board promptly met behind closed doors and rejected all the initiatives. Given that result, it is easy to understand Johnson’s view that “no objective observer can look at the performance of FINRA over the last few years and characterize it as an effective regulator or being operated in its members’ best interest.”

The Opposition

The list of outside groups that can clearly see FINRA’s failings is long. David Tittsworth of the Investment Advisor Association stated in an October 2010 comment letter, “We oppose extending FINRA’s jurisdiction to investment advisers due to its lack of accountability, lack of transparency, costs, track record, and bias favoring the broker-dealer regulatory model.”

The nonpartisan watchdog Project on Government Oversight (POGO) urged Congress to take a close look at FINRA’s regulatory track record, which raises several concerns, including:

  • Conflict of mission resulting from its self-funding model
  • Failure regarding the trading abuses at the heart of the financial crisis and the Stanford and Madoff Ponzi schemes
  • Failure to provide the basic level of transparency and accountability that exists at federal regulatory agencies
  • Executive compensation scheme that has created a strong potential for conflicts of interest for former executives now at the SEC supposedly overseeing FINRA
  • Lack of post-employment restrictions and ethical obligations required of government employees (several went to work for Allen Stanford)
  • “Public representatives” on FINRA’s Board have close ties to the securities industry

David Massey, North American Securities Administrators Association (NASAA) president, stated in November 2010 that FINRA “has restricted the release of information to the government and has affirmatively taken the position that it is prohibited from active collaboration with governmental regulators, including the governmental entity responsible for its oversight. As such, previous synergies with the SRO have been lost, and it has become increasingly difficult for the governmental regulators to meaningfully control oversight or investigations over registrants subject to the current SRO model.”

Let’s not forget the public, who FINRA is supposed to protect. I have written several times about product junkies who always seem to recommend certain products to all clients with no regard to an appropriate proportion of the clients’ net worth being exposed to the risks of such product. How is it that these frequent FINRA exams don’t do anything to stop the guy who puts large percentages of money in the same product? I rarely hear of registered representatives who think the FINRA rules or exams are effective. Quantity doesn’t equal quality.

Of course, if clients have a complaint they face FINRA’s mandatory arbitration process, which routinely garners strong criticism. William Galvin, the secretary of the Commonwealth of Massachusetts, said the mandatory arbitration system is “an industry sponsored damage-containment and control program masquerading as juridical proceeding.” That doesn’t sound like much of a consumer-protection mechanism to me.

We also recently learned that the FINRA director in Kansas City flat out falsified documents the SEC requested. FINRA “settled” with the SEC by agreeing to hire an independent consultant and promise to do better. This has many wondering whether Ms. Schapiro had anything to do with this embarrassingly light penalty because she was FINRA chief when this occurred. Given the ties and the money involved, when Schapiro says the SEC is underfunded and understaffed, it is easy to be skeptical. Fair or not, no one should be wondering. The public needs and deserves to have some confidence that Schapiro and others aren’t FINRA moles.

So to sum up, FINRA doesn’t serve the public as well as it seems to serve the commercial interests of its largest members. Many of its own members can’t stand the lack of transparency and accountability, and often think “the fix” is in. And regulators like the SEC and NASAA can’t work with them effectively.

The Solution(s)?

Shutting down FINRA may sound impossible, but the United Kingdom has put an end to the charade and shut down its SRO in regulatory reform. The trend in much of Europe is in this direction. If they can do it, surely we can.

Given the issues raised by so many parties, Congress should at least ask the question, “Should FINRA continue to exist?” and explore other options thoroughly before expanding the dysfunctional organization FINRA seems to be.

The SEC lightens its load next spring to the tune of 3,200 small and mid-size advisers shifting to state regulation. Congress should tell the SEC to take this time to improve its exam process. Can they do more “desk audits,” use outside accountants to do some exams or parts of exams (as the SEC has already approved in the custody rules), and utilize technology more wisely, for instance, to verify assets? Most importantly, if FINRA does survive, Congress should be mandating that the SEC get the transparency and accountability from FINRA it should already have in its role as overseer.

If the SEC really can’t handle RIAs, Congress would be wise to insist on a new SRO entirely independent of FINRA that does have transparency, accountability, sensible exam processes, and dispute resolution that seeks justice, not settlement. RIAs will have to pay more for compliance and regulation through user fees to the SEC, fees for outside auditors, or fees to FINRA anyway. Seems to me starting with a clean slate may be easier and more sensible than cleaning up FINRA.

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