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Barron’s Highlights FINRA’s Stench

Posted by Larry Doyle on March 6, 2010 8:01 PM |

The stench surrounding FINRA is attracting real attention.

The executives of Wall Street’s self-regulatory organization FINRA should not think that the recent dismissal of one legal complaint is reason for celebration. Why? Those who care for transparency measure success not in terms of judicial victories but to a much greater extent by public pressure and awareness. On that note, at long last real progress in creating transparency into FINRA is occurring.

From the highly regarded government watchdog Project on Government Oversight to now the leading weekend business periodical Barron’s, FINRA’s stench is attracting attention from more than the blogosphere and a few selected journalists (Bloomberg’s Susan Antilla, The Washington Examiner’s and Baltimore Sun’s Marta Mossburg, and also Barron’s Jim McTague).

The news in an article this weekend by Barron’s is not news to regular readers of Sense on Cents, but to most of America FINRA remains a foreign entity. Those days are changing. 

Barron’s excoriates Wall Street’s self-regulator today in writing, FINRA, First Heal Thyself:

IN 2007-08, regulators at FINRA were so distracted with empire-building and lining their pockets, they overlooked the world’s two largest Ponzi schemers: Bernie Madoff and, allegedly, R. Allen Stanford. So what’s the deeply flawed Financial Industry Regulatory Authority up to now? Building itself an even bigger empire.

The quasigovernmental body, which advertises itself as the white knight of 90 million investors, is lobbying Congress for the power to regulate 11,000 investment advisors who now fall under the jurisdiction of the Securities and Exchange Commission and state securities regulators. The states regulate those with less than $25 million in assets, but want Congress to bump that to $100 million. Why? The SEC does such a poor job, it visits an average of one advisor every nine to 11 years!

Finra currently regulates Nasdaq and New York Stock Exchange brokers and securities dealers, and pays its executive staff high-on-the-hog salaries, despite abysmal performances. This is the same behavior that contributed to the failure of big financial firms that operated under Finra’s purview. If Congress accedes to its power grab, the kingdom of Finra will be able to fatten its coffers with millions more dollars in fees from its new charges. Given Finra’s sorry enforcement record, there’s little reason to believe investors would be any better off.

Why would investment advisors want to shell out money for the privilege of being regulated when the SEC does it free? The state regulators oppose Finra’s grab because they say there’s no adequate oversight of the organization.

“They aren’t accountable to anyone but their own members,” says Texas Securities Commissioner Denise Voigt Crawford. As for being investor-friendly, she points to their “abhorrent” mandatory system of dispute resolution by arbitration, a process she says is stacked in favor of the firms.

FINRA’S STORY is that had it been regulating investment-advisory firms in 2007, it might have caught on to Madoff. Although Madoff’s brokerage business was regulated by Finra, his investment-advisory business, where the fraud took place, was regulated by the equally hapless SEC.

Says Finra spokeswoman Nancy Condon, “The absence of a comprehensive examination program for investment advisors impacts the level of protection for every member of the public who entrusts funds to one of those advisors. It’s clear that dedicating more resources to a regular and vigorous examination program and day-to-day oversight of the investment advisors could improve investor protection for their customers, just as it has for customers of broker-dealers.”

Finra’s critics find this argument risible, pointing out that there’s scant evidence that the regulator examined Madoff’s brokerage business in recent years. Furthermore, they contend Finra failed to properly regulate a host of firms at the center of the financial meltdown, including Bear Stearns, Lehman Brothers, and Merrill Lynch.

The nonprofit Project on Government Oversight says an internal Finra review shows Finra missed key opportunities to uncover alleged fraud by Stanford, in part because it is too cozy with Wall Street.

Finra is what is known in the securities world as a self-regulatory organization, or SRO. Congress wrote a provision in the Securities and Exchange Act of 1934 permitting exchanges to create SROs to regulate member conduct and punish scofflaws. The SEC conducts regular inspections of Finra. But there are no regular oversight hearings by the Congress.

In 2006, the NYSE and the Nasdaq each had an SRO. In 2007, the two exchanges agreed to create Finra, to realize cost efficiencies and regulatory harmony. The merger required emendation of the Nasdaq market’s bylaws by some 5,000 members.

Its SRO decided to prod the change by offering members $35,000 apiece from $2 billion in members’ equity it had amassed as a result of the public listing of the Nasdaq stock market between 2001 and 2006. The SRO had owned shares of Nasdaq stock. In a prospectus and in road shows, Finra contended that the Internal Revenue Service threatened to yank its nonprofit status if it paid Nasdaq’s members $35,000 each.

Several broker-dealers subsequently sued Finra, alleging the officers had lied and subsequently had used some of the money to give themselves exorbitant pay raises. Mary Schapiro, who led Finra then, received $7.3 million in salary and accumulated benefits when she left; now chairman of the SEC, Schapiro makes $158,500 a year. This month, Judge Jed Rakoff of the U.S. District Court for the Southern District of New York dismissed the lawsuits, not on their merits, but because under the law, Finra and its officers enjoy “absolute immunity” from private actions challenging their official conduct as regulators. The judge’s action startled the investment-advisory community.

“I don’t think Finra is accountable to anyone,” says David Tittsworth, executive director of the Investment Advisor Association in Washington. He’s right. Congress should change this, not give Finra an expanded kingdom.

Perhaps the board at FINRA will be much more aggressive in not only opening up the books and records of FINRA going forward but will grow a conscience and provide further transparency about activities in the past.

FINRA must not only be transparent but they also must be accountable. If the executives, both past and present, are not held accountable, then the board must be held accountable.

America is now finally being introduced to the organization that I believe is the nexus of the Wall Street-Washington incest. Thank you Jim McTague and Barron’s for drawing further attention to FINRA’s stench which needs to be aired out.


Related Sense on Cents Commentary

To access all of my writing on FINRA over the last 14 months, click here. I also appeared on a Fox Business segment covering FINRA last September. That post is truly enlightening: “Attorney Claims Wall Street’s Cop, FINRA, Invested in Madoff.” That’s right. Watch the 18 minute clip embedded in that post. Your view on Wall Street and its oversight or lack thereof may be forever changed.

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  • coe

    I caught the article in Barron’s, LD…too bad there was no mention of the Auction Rate issue, but nonetheless, once the mainstream business periodicals sink their teeth into a story, my sense is that there is likely to be more probing, not have been about 16 months ahead of the curve..

  • disenchanted

    This has been hashed and rehashed. When is
    it going to come to fruition? It is
    obvious that Finra needs to open their
    books and come clean to put an end to this.
    I have one defense for Finra, and that is the
    arbitration issue. It should be voluntary, but
    is a better venue than court. The courts have
    no clue about the industry. An industry arbitration
    can peg a bad apple better than a judge or jury
    and we have over and over.

  • One might investigate the cozy relationship of the Securities Arbitration Conference on Arbitration (SICA) with FINRA (NASD + NYSE). SICA was used as a front to publish an alleged report extolling the purported merits/fairness of securities arbitration. The SEC Staff sat in on meetings where the plot was hatched and executed. Though FOIA litigation with the SEC, we learned the shocking nature of the SICA-FINRA relationship.

    Securities Dispute Arbitration

  • DT

    Combine the SEC with FINRA (NASD) and you have two of the most corrupt, unethical, dishonest agencies in the world. Where one level lies and the next swears to it. From top to bottom these agencies are the true scum bags of this country.

    THIS ARTICLE IS A MUST READ AND TYPICAL OF sec/finra TACTICS. I have proof in writing of how they lie about their own rules and how each level will lie again even if you have them dead to rights in their lies. I have publicly called them scum, liars and every other derogitory word daring them to sue me. They won’t, especially FINRA (NASD) because as long as they have you under their BS volunteer organization rules you will always lose to them. In a court of law with due process you can expose them and their lies. That is why they fight to keep things out of court.

  • DT
  • Pingback: FINRA Story « Phil’s Favorites – By Ilene()

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