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John Lounsbury: “A Very Low Opinion of FINRA”

Posted by Larry Doyle on January 24, 2011 7:00 AM |

“Who will protect me?”

How many investors in our nation continue to ask that question?

A lot!!

Throughout the crisis of the past few years and certainly well beyond that, investors have come to appreciate that they really need to learn to protect themselves. Why is that? We have rampant evidence  that neither Wall Street nor the financial regulators overseeing Wall Street have truly protected investors. So now what?

This question of investor protection is perhaps the most critical component embedded in the Dodd-Frank Wall Street Reform and Consumer Protection Act. John Lounsbury, a former guest on No Quarter Radio’s Sense on Cents with Larry Doyle (August 30, 2009) writes a fabulous review of Dodd-Frank at his newly launched site Global Economic Intersection.  John writes eloquently on this topic and graciously references another blogger who has strong opinions on financial regulation. Let’s navigate Dodd-Frank: The Devil is in the Details,

The Dodd-Frank Act is supposed to reform the way Wall Street works.  It is supposed to correct abuses that led the world to the brink of disaster.  After passage the intricate details to be implemented required the formation numerous study groups to make recommendations about how to proceed.  Some of those studies are now reporting and the recommendations are not all that clear.

First, the full title of the act is the “Dodd-Frank Wall Street Reform and Consumer Protection Act.”   Remember all parts of this title as you read the following discussion.

Follow up:

Fiduciary Responsibility or Suitability?

In one area, the SEC was charged with determining how investment advisors should be regulated.  The commission has thrown the ball back to Capital Hill.  In a report this week, the SEC’s recommendations were the following:

>>Imposing user fees on SEC-registered advisors to pay for SEC exams;
>>Authorizing one or more self-regulatory organizations (SROs), under SEC oversight, to examine advisors; or
>>Authorizing the Financial Industry Regulatory Authority (FINRA) to examine dually-registered advisors who both sell products and dispense investment advice.

A follow-on report from the SEC was released Saturday which recommended that all investment advisors and retail securities brokers should be held to the same standard, a fiduciary standard.  Fiduciary responsibility requires that all actions be justified on the basis of what is best for the client.  Suitability responsibility (see further discussion below) requires that actions be justified as generally suitable for an individual fitting into a general category; no individual assessment of what is best need be undertaken.  From Financial Planning magazine:

A study released by the Securities and Exchange Commission Saturday has recommended that a single fiduciary standard be created for brokers and investment advisers.

As part of the Dodd-Frank law, the SEC was told it could hold brokers to a higher standard, forcing them to put their client interests above their own. Advisors are already held to that standard.

The much-anticipated study found that many investors are confused about the roles of brokers and advisors and are unsure of their protections when they receive advice. The study recommended the SEC create a uniform standard to simplify the client experience.

“Retail customers should not have to parse through legal distinctions to determine whether the advice they receive was provided in accordance with their expectations,” the study said.

The two Republican commissioners on the panel, Kathleen Casey and Troy Paredes, balked at the findings. They issued a joint statement that said there wasn’t enough evidence from the study to authorize a total overhaul. They argued that the SEC needed to do further study and analysis to make certain these changes wouldn’t hamper investors.

The report released earlier in the week focused on implementation details and largely produced the opinion that the SEC was throwing responsibilty for defining implentation back to Congress.  From Financial Advisor magazine:

The study was commissioned out of concern that the agency doesn’t have sufficient resources to adequately examine the 11,888 SEC-registered investment advisors. That’s up from 8,581 advisors in 2004. Meanwhile, the number of exams conducted by the SEC have decreased––from 18% of advisors in 2004 to 9% in 2010.

In the study, the agency said user fees imposed on RIAs would provide scalable resources to enable the  SEC to “achieve an acceptable frequency of examinations.”

The SEC noted that user fees might be less costly than creating an SRO to oversee advisors, although it hadn’t crunched the numbers on how much it would cost to establish an SRO.

Regarding an SRO, which is an entity with market specific expertise funded by membership fees, the SEC said establishing one or more SROs under SEC oversight could boost the frequency of advisor exams. Multiple SROs could target specific types of investment advisors. For example, there could be different SROs for financial planners and money managers.

But the SEC study noted that multiple SROs could be more costly than a single SRO because it would be harder for them to achieve economies of scale. In addition, they could muddle the picture by developing their own approach and rules to applying the Investment Advisers Act.

As a result, the SEC said it might be better to designate a single SRO for investment advisors. And the likely candidate would be FINRA. One reason, according to the study, is that creating another single SRO for investment advisors other than FINRA would mean dually-registered advisors would be subject to more than one SRO––one for broker-dealers, one for investment advisors). As the existing SRO for broker-dealers, FINRA already has that segment covered.

The problem with FINRA regulating advisors is that the organization doesn’t have a satisfactory implementation of fiduciary responsibility.  FINRA is the self-regulatory agency of the NYSE (New York Stock Exchange) and the NASDAQ Exchange.  Conduct of registered representatives of NASD (National Association of Security Dealers) broker-dealers is regulated by an organization of their employers.  Registered reps are held subjected to a “suitability” standard which is much looser than a “fiduciary” standard.

Larry Doyle has written about some penetrating questions that FINRA should have to answer.  In a comment to the Doyle article I wrote:

FINRA is the successor to the NASD (National Association of Security Dealers), and, as such, is an industry self-regulatory group. Their primary objective is to protect the interests of broker-dealers and their agents. In protecting those interests, they will, with great fanfare, reveal disciplinary actions from time to time. The most effective actions are taken against brokers (Registered Reps) when they, as individuals, are found to have commited fraud. When action is announced against broker-dealers, it is often token wrist slapping.

The CFP Board, with their associated industry professional association, the FPA, have long taken a position that financial planners have a fiduciary responsibility. (CFP is Certified Financial Planner and FPA is Financial Planning Association.) The NASD, and now FINRA, has taken the position that Registered Reps who are CFPs, even when they offer financial planning advice, should be exempt from fiduciary responsibility under the code of ethics provisions (of the CFP Board) and the SEC requirements for investment advisors under The Investment Advisors Act of 1940. In other words, Registered Reps should have no more responsibility to their clients than a used car salesman. If they blatantly misrepresent something, that is wrong. If they are subtly misleading, well, caveat emptor.

FINRA is on one side of this fiduciary responsibility argument and the FPA and the CFP Board are on the other. This conflict has been going on for many years. Having observed this debate, originally being in both houses (a CFP who was a Registered Rep), and for the past eight years as only a CFP registrant, I have come to a very low opinion of FINRA when it comes to customer protection. The litany of details you have outlined in this article are no surprise to me, even though a couple of them are new news.

Putting FINRA in charge of investor consumer protection is a joke.

John nails it. I commend him for standing up and calling FINRA out. Our nation needs people willing to stand and deliver. John does just that. I strongly recommend readers visit Global Economic Intersection regularly for more of this wisdom.

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own and not those of Greenwich Investment Management. As President of Greenwich Investment Management, an SEC regulated privately held registered investment adviser, I am merely a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

  • disenchanted

    This is a very good article, but not all inclusive. This only touches on the investor side, and not the small broker dealer side. What would make anyone think that the small investment advisor would not face the same rath as a small BD. History will repeat itself. As in the Securities Industry, the small will disapear and the big with big pockets to feed Finra will have Finra on their side. Then again, where does that leave the investor who thinks they are being protected because the industry is now regulated?






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