Are Ketchum’s Arguments for SRO the Best FINRA Can Come Up With?

On the RIA side, as I wrote in my March 20, 2012 blog, in 2010 (the last year for which we have data), “the SEC took 113 enforcement actions against investment advisors or investment companies.” That’s 1,488 vs. 113, and those 113 include some investment companies. Even accounting for the difference in the number of brokers vs. RIAs (50,200 retail brokers vs. 41,500 RIAs, give or take), that’s some discrepancy: It would seem that perhaps brokers require more visits because FINRA regulation actually offers less consumer protection. 

My old brain was still reeling from Ketchum’s “consumer protection” argument when it got stomped on by his second point: That the costs of a FINRA SRO for advisors will be very reasonable, and that FINRA itself is the best resource for determining those costs. “Much has been said by opponents of increased oversight for investment advisers about the potential costs of an IA SRO…We at FINRA thought it was important to take an accurate and realistic look at what the numbers would actually look like for our organization…Our numbers reflect a realistic estimate for extending FINRA’s examination program to cover investment advisers.”

Mr. Ketchum goes on to attack the significantly higher cost estimates by the independent Boston Consulting Group: “The cost projections in the BCG study…are inaccurate and based on flawed methodology. By its own admission, BCG never consulted with FINRA or the SEC to discuss projected costs of IA oversight.”

So let’s be clear: By conducting a truly “independent” study, rather than taking FINRA’s word about the “reasonableness” of the costs it will incur on a project it’s advocating to undertake, the BCG study is “flawed”? At first, I was certain that senility had finally set in. Then, when the fog start to recede from my mind, I recalled a statement that Mr. Ketchum made just this past April 23, in which he announced his plan to raise BD fees in an effort to offset what he described as FINRA’s “significant loss for fiscal year 2011.” 

It seems that despite having “taken a hard look at spending across FINRA to be sure we are operating as effectively and efficiently as possible…the cost of meeting our regulatory mandate is still expected to outpace our revenues.” (See Melanie Waddell’s April 27 AdvisorOne story.) In fact, the broker-dealer SRO is operating so efficiently that it’s now necessary to increase its fees as follows: 

• Its minimum advertising filing fees will go up 25%: the maximum fee, up 20%; and the fee for each page over 10 pages, up 100%. 

• Its corporate financing fees will go up 50% (from .01% to .015%); and the cap on those fees will increase some 200%, from $75,000 to $225,000.

These not-insignificant increases are to shore up cost overruns in a business that the FINRA and its predecessor organizations (NASD and NYSE Regulation) have been running since 1939 (72 years for you quants). 

Now I’m not saying FINRA doesn’t know what it’s doing: We all know that in business, stuff happens. Yet, according to Ketchum, FINRA’s loss resulted from “The broader economic downturn (continuing) to affect trading volumes and industry revenues, which in turn has led to a decrease in FINRA’s revenues.” Yeah, who could have seen that coming? Still, to a skeptical mind, that might suggest that maybe we shouldn’t be so quick to write off those independent cost estimates. (And we’ll just save for another time the issue of FINRA raising its regulatory costs while its member firms are still reeling from the effects of the Great Recession.) 

And that’s it: To my mind, Mr. Ketchum’s whole rationale for why FINRA should regulate RIAs boils down to these two points: FINRA makes more visits to brokerage firms, which collectively violate the law a lot more than RIAs; and FINRA can do it in a cost-effective way—despite its recent cost overruns, which somehow failed to find their way into his testimony. 

Maybe he knows it’s already a done deal. But I can’t see how the congressmen at today’s hearing, or anyone else who reads Mr. Ketchum’s remarks can saying anything but: “Dude, really?” 

(Click on this link to view Mr. Ketchum’s complete testimony before the House Financial Services Committee on June 6, 2012.)