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Is FINRA Set to Be the Big New Regulator on the Block?
This week marks the anniversary of the Lehman Brothers collapse and the onset of the 2008 financial crisis. Three years later, calls to shed light on the more shadowy corners of the financial industry continue.
In one of the latest examples, Congress is eying draft legislation that would mean more scrutiny for investment advisers, who, until the passage of the recent Dodd-Frank financial reform legislation, could often find refuge in regulatory exemptions.
At the same time, the Financial Industry Regulatory Authority (FINRA) is pushing to be the one to oversee that sector, which includes hedge funds and other financial planners who charge a fee to help clients park their money in the purchase and sale of securities.
As it currently stands, FINRA serves as a self-regulatory organization (SRO) that oversees 4,500 broker-dealers—writing and enforcing rules, examining securities firms, and informing investors, among other duties. But the organization says it can and should be overseeing an even larger swath of financial services, according to the prepared Congressional testimony of Rick Ketchum, FINRA's chairman and chief executive.
Citing a U.S. Securities and Exchange Commission that's stretched too thin and serious inconsistencies between the ways that broker-dealers and investment advisers are regulated, FINRA on Tuesday told Congress that it should be tasked with more regulatory responsibilities for this specialized sector of Wall Street financial institutions.
That's in part due to the fact that investment adviser and broker-dealer business "have, in many ways, converged," said Ketchum.
When it comes to enforcement action, FINRA has a significant enforcement record compared to the SEC. "There's no contest," says Duke University corporate and securities law professor Jim Cox:
In 2010, FINRA brought 1,310 disciplinary actions, collected fines totaling $42.2 million and ordered the payment of almost $6.2 million in restitution to harmed investors. FINRA expelled 14 firms from the securities industry, barred 288 individuals, and suspended 428 from association with FINRA-regulated firms. Last year, FINRA conducted approximately 2,600 cycle examinations and 7,300 cause examinations.
By comparison, according to Ketchum's testimony, the SEC "oversees more than 11,000 investment advisers, but in 2010 conducted only 1,083 exams of those firms due to lack of resources." Furthermore, investment advisers, on average, are examined less than once every 11 years by the SEC, and "while the SEC examines only about 9 percent of investment advisers each year, 55 percent of broker-dealers are examined each year by the SEC and FINRA," Ketchum said.
Ketchum's testimony drew heavily from two studies that the SEC concluded earlier this year. One of the studies found that providing more uniform fiduciary standards for the two kinds of financial institutions would better protect investors. The other pointed to the many difficulties the SEC faces in keeping tabs on those already under its watch, particularly in light of new, additional regulatory mandates outlined by Dodd-Frank. The SEC "will not have sufficient capacity in the near or long term to conduct effective examinations of registered investment advisers with adequate frequency," Ketchum said, quoting the studies.
However, Ketchum's testimony stressed that the SEC would, in turn, continue to have ultimate oversight over FINRA's actions as an SRO.
Cox says there would be several benefits to FINRA adopting that mantle of oversight for these institutions. Investment advisers and broker-dealers have historically been antagonistic towards one another, explains Cox. Placing "contending factions" under the same tent, he says, might turn FINRA into a stronger regulator, more independent of broker-dealer influence.
FINRA "would cease seeing themselves as promoters of broker-dealers," Cox says.
Another longstanding criticism of regulatory enforcement actions is that they tend to be directed at individual brokers, rather than at systemic failures. Again, broadening FINRA's base could also improve that situation, says Cox.
A more basic argument, he says, is that it simply doesn't make sense that broker-dealers are subject to SRO oversight, while investment advisers are not.
Up until Dodd-Frank was passed, "many of these investment advisers were outside the bailiwick" of regulators, says Cox, because they fit within one of many exceptions to regulatory registration allowed by the Investment Advisers Act of 1940.
But with changes wrought by the latest financial regulation legislation, investment advisers must choose between registering with state securities regulators or with the SEC. Now "you're not going to be able to hide," says Cox.
Some have already opted out of the regulatory spotlight. For example, billionaire investor George Soros made headlines earlier this summer when he announced plans to return monies to investors and convert his Soros Fund Management hedge fund into a family office, a category that remains exempt from regulatory oversight.
Various industry representatives have already come out for and against FINRA's proposal. According to The New York Times, the North American Securities Administrators Association, comprised of state securities regulators, is "vigorously" opposed. And the Investment Adviser Association said it would prefer "strong regulation and oversight by the SEC."
Meanwhile, David Bellaire, general counsel and government-affairs director for the Financial Services Institute, which advocates for "independent broker-dealers and advisers," told Bloomberg that "investor protection would be 'enhanced' by having a single self-regulatory organization such as FINRA."
"A fractured regulatory oversight created dark corners for people to hide," he said in the in the interview.