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The Trouble With FINRA
The financial industry’s little-known watchdog lacks teeth.
By Jack Waymire
Everyone in the financial business calls FINRA by its acronym, so it’s easy to forget the organization’s full name—the Financial Industry Regulatory Authority. FINRA claims to be the largest independent regulator for all securities firms doing business in the United States, and I suspect that’s true—it’s hard to think of another one that comes close. (It’s hard to think of another one, period.) But even the largest regulator isn’t very big: Based in New York and Washington, the four-year-old organization—it grew out of a 2007 merger of preexisting industry enforcement bodies—has 3,000 employees and 20 regional offices overseeing 4,525 brokerage firms, 163,530 branch offices and 631,085 registered securities representatives.
FINRA isn’t in the news much, nor does it want to be; the organization is not known for transparency. But in recent months it has become the subject of an under-the-radar debate: Critics charge that FINRA unfairly targets small firms for regulation and punishment while turning a blind eye to industry giants. “FINRA knows that small broker-dealers and individual representatives cannot afford to fight [a regulatory action], so FINRA initiates the fight and bets that firms will settle the charges, regardless of how questionable they might be,” says Mark Astarita, an attorney who created SECLaw. com. The organization’s alleged motive? The vast majority of its operating budget comes from regulatory and user fees, most of which are paid by the big brokerage firms. (Remember how the rating agencies for securities are paid by the firms they oversee? Same thing.) FINRA wants to look like a tough cop, but it’s gun-shy about taking on its biggest sources of revenue. Picking on the small guys, however, can generate a revenue stream for FINRA while creating the appearance of vigorous enforcement.
You could be forgiven for thinking that this mini-controversy is just an internecine squabble between self-interested constituencies in the financial services industry—which it is—except that this squabble actually has serious implications for investors: Its resolution could enlarge (or shrink) the breadth and vigor of FINRA actions. At the very least, it may bring more attention to FINRA and the hopelessly compromised way it conducts its business.
Because FINRA has a structural problem: Its mandate is to produce regulations to which financial firms and representatives are supposed to adhere. But FINRA can’t develop regulations with real teeth, because doing so would dampen Wall Street profits—and Wall Street profits fund FINRA, eight of whose top 10 executives earned over $1 million last year.
Consider one example of how FINRA’s conflict of interest hurts investors. The agency does not require Wall Street firms and their representatives to practice full disclosure when they sell investment products and services—it’s up to investors to ask the right questions and know good responses from bad ones. That might not be a problem for sophisticated investors, but for the vast majority of retail investors, it borders on the deceptive. Why doesn’t FINRA mandate full disclosure? Because the firms that pay its salaries would fiercely oppose such a move.
FINRA emphasizes its commitment to investor education, and it does have one somewhat useful service called BrokerCheck, which you can find at finra.org. Investors can use BrokerCheck to review the compliance records and licensing of sales reps. The service has gotten better recently, but it’s a long way from being investor-friendly, and I’d bet most retail investors don’t even know it exists. I’d also bet that only a small percentage of investors use BrokerCheck when they select advisors. If they do, many likely have only a vague understanding of what they’re reading; BrokerCheck content isn’t easy to decipher.
These may seem like inconsequential examples, but that’s the point: If FINRA can’t get the small stuff right, how can investors trust it to carry out its larger mandate?