A powerful securities regulator found itself in the cross hairs during a House hearing.
The head of the Financial Industry Regulatory Authority (FINRA) took questions from Democrats and Republicans in a hearing entitled “Oversight of the Financial Industry Regulatory Authority” in front of the Capital Markets, Securities, and Investments sub-committee of the House Financial Services Committee.
Bill Huizenga, the Republican from Michigan who chairs the sub-committee, while recognizing FINRA’s critical oversight role, said, “Critics have noted that for the last decade FINRA has engaged in mission creep and transformed itself from a traditional SRO [self-regulatory organization] into a quasi-governmental regulatory organization more akin to a fifth branch of government or as some have called it a deputy Securities and Exchange Commission [SEC].”
Part of the problem may be the way in which FINRA is structured.
Its roots go back to 1939 when Congress created the National Association of Securities Dealers (NASD), an SRO to regulate securities dealers.
In 2007, the NASD along with the regulator of the New York Stock Exchange (NYSE) merged into FINRA; in effect, the self-created regulatory arm of the US exchanges.
As an SRO, while created by an act of Congress, it is considered independent.
For instance, whereas the President nominates the chair of the SEC and the Commodities Futures Trading Commission, the President of FINRA, currently Robert Cook, is chosen by FINRA’s Board of Governors.
The ultimate securities regulator is the SEC. And, in fact, Brad Sherman, a Democrat from California, noted that in 2016, FINRA referred 785 matters to the SEC for enforcement because FINRA itself did not have the capability to enforce them.
FINRA provides licensure for approximately 3,700 securities firms with more than 600,000 individual brokers, and it has the power to mediate disputes between clients and brokers. However, certain powers are the exclusive preserved of the SEC.
The only witness, Cook (who served from 2010 to 2013 as the SEC’s Director of the Division of Trading and Markets), argued that FINRA’s role was symbiotic with that of the SEC. He said:
FINRA is the first line of oversight for a significant portion of the U.S. securities markets, complementing the work of the Securities and Exchange Commission through our regulation of broker-dealer firms and individual brokers. FINRA is organized as a not-for-profit Delaware corporation, registered with the SEC as an SRO, and subject to comprehensive SEC oversight. Every brokerage firm and broker that sells securities to the public in the United States must be registered with FINRA. We do not regulate investment advisers, mutual funds, insurance companies, or banks.
French Hill, a Republican congressman from the State of Arkansas who likes FINRA’s structure, had the following to say:
“One of my favorite expressions over the years was when William O. Douglas was SEC Chairman. He said that self-discipline is always more welcome than discipline imposed from above. And he was a pretty big supporter of the self-regulatory organizations that were set out by the SEC during his term in office.”
Hill followed up by noting, “Sometimes it’s hard to distinguish between what the SEC is supposed to do and what the SRO is supposed to do.”
In response, Cook gave an answer that provided little clarity, “I think we’re a combination (private and state actor) that’s created by Congress to achieve a certain purpose which is to facilitate regulation of the markets through active engagement of the industry, drawing on their expertise, not using tax payer money, not using the government, but at the same time ultimately serves investors.”
As an SRO, FINRA is not funded by the taxpayer but rather by member firms.
Cook may have unwittingly highlighted just how complicated securities regulation is when he noted that FINRA is one of 34 SRO’s created to regulate securities.
Though nominally a self-regulatory organization, Hill also noted that it is subject to a great deal of oversight from the SEC: “Do you think there’s much ‘self’ left in the self-regulatory after all the court cases of the nineties?” he asked.
In response, Cook noted that in the 1990s, the SEC determined that the broker industry had become too influential in FINRA affairs at the expense of investors’ interests and thus gave the SEC more oversight.
Cook said that the SEC had conducted 24 inspections of FINRA since the beginning of 2016.
As an SRO, FINRA is not subject to many of the public scrutiny that other regulators must follow.
Cook noted, for example, that FINRA is not subject to the Freedom of Information Act (FOIA), which requires public agencies to produce documents requested by the public.
FOIA is one of the most significant tools available to investigative journalists; as such, while FINRA is subject to SEC and Congressional scrutiny, an argument could be made that it is subject to far less public scrutiny.
One example of FINRA’s oversight role came last month when, together with another securities SRO, the SIPC (Securities Investor Protection Corporation), FINRA issued a press release regarding reporting requirements.
“The Securities Investor Protection Corporation and the Financial Industry Regulatory Authority have announced a services agreement designed to ease reporting burdens and compliance costs for member firms.” The two SROs said in a statement. “The new, simplified filing process will also reduce inconsistent or incomplete filing of annual audited financial statements and supplementary reports.
“Effective Sept. 1, firms that currently file annual reports separately with SIPC and FINRA will file just once, using FINRA’s existing reporting portal. The portal will provide both agencies with the information, enabling the firms to meet the two agencies’ respective reporting requirements with a single filing.”