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The Heat Rises on FINRA as Advisor SRO

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Just as a government watchdog is pressuring the Securities and Exchange Commission (SEC) to beef up its oversight of the Financial Industry Regulatory Authority (FINRA), Congress is mulling whether to give FINRA the power to oversee advisors.

The Government Accountability Office (GAO) told the SEC in late May that the securities regulator needs to start performing “retrospective reviews” of FINRA’s rules—as does FINRA—to ensure the regulator’s rules are achieving their intended purpose and so that FINRA can do away with ineffective rules.

FINRA responded to the GAO report, stating that it believes the report “demonstrates the broad and robust oversight the SEC provides to our operations, with annual or continuous review of our core regulatory programs.” FINRA added that it agreed with GAO’s recommendation that such retrospective reviews of FINRA rules “could be valuable” and promised to work with the SEC to implement such a process.

But GAO criticized the SEC for failing to conduct “limited”—or any—oversight of FINRA’s operations, such as governance and executive compensation.

A day before the GAO report came out, another watchdog, The Project On Government Oversight (POGO), voiced its own concerns about FINRA, in particular that its regulatory effectiveness could be undermined by “its inherent conflicts of interest, its lack of transparency and accountability, its lobbying expenditures, and its executive compensation packages.”

POGO, a nonpartisan independent watchdog that investigates corruption, misconduct and conflicts of interest, noted these criticisms of FINRA in a letter to House Financial Services Chairman Spencer Bachus, R-Ala., and the ranking Democrat on the committee, Barney Frank, D-Mass.

The GAO and POGO criticisms of FINRA came only a week before the House Financial Services Committee began debating Bachus’ SRO bill, the Investment Advisor Oversight Act of 2012 (H.R. 4624). FINRA is the lead candidate in assuming such an SRO role. A vote on Bachus’ SRO bill in the committee was expected before Congress left for the July 4 recess.

Harvey Pitt Weighs In

GAO’s recommendations regarding review by the SEC of FINRA’s rules is in keeping with President Obama’s 2011 executive order which mandates that all regulatory agencies undertake a periodic review of their existing rules. However, Harvey Pitt, former chairman of the SEC, told me in a June 4 interview that he believes GAO findings shouldn’t have a “negative” impact on FINRA’s chances of becoming an SRO for advisors.

“FINRA’s success or failure in becoming the regulator for advisors will depend on its ability to persuade Congress that having an existing infrastructure already in place and having the resources to devote to expanding their internal assets” makes FINRA the better choice than creating a new SRO from scratch, Pitt said.

SRO aside, Pitt said the GAO study, dubbed, “Opportunities Exist to Improve SEC’s Oversight of the Financial Industry Regulatory Authority,” is significant in that it illustrates the importance for all governmental or quasi-governmental entities to adopt policies on reviewing their rules. “As the courts have required regulators to focus more carefully before the adoption of rules […], it is equally incumbent upon agencies to focus on how well the rules they adopt actually are achieving their intended roles, and how well those rules are being enforced,” he said.

Pitt, who served as chairman of the SEC from 2001 to 2003, said in the interview that he believes there’s a need for a systematic process to be adopted by FINRA, other self-regulators and the SEC for post-adoption reviews of rules, “and not just on a one-time basis, but at regular intervals.”

Opposition to FINRA as SRO

In its letter to Bachus and Frank, POGO cites FINRA’s “conflicted mission,” which leads to “cozy ties with [the] industry.” FINRA, the group says, “collects fees from its member firms and invests in the securities industry, while also assuming responsibility for regulating and disciplining these firms, raising concerns about an inherent conflict of mission.”

POGO said it believes that FINRA’s “inherently conflicted self-funding model has contributed to an incestuous relationship” between FINRA and the industry it is charged with regulating.

The watchdog also cited FINRA’s “lack of transparency and accountability” and urged the House Financial Services Committee to “probe these issues before delegating any additional governmental authority to FINRA or another SRO.”

In the case of FINRA, POGO said, “even industry groups have expressed frustration with the organization’s lack of transparency and accountability,” citing the U.S. Chamber of Commerce’s concerns that FINRA is not bound by “the system of checks and balances that applies to government agencies.”

Yet another reason FINRA should not be an SRO candidate, POGO argued, is the money it spends on lobbying and executive compensation. “FINRA spent nearly $4 million on lobbying between 2008 and 2011, according to the Center for Responsive Politics,” POGO said. “These figures do not include the significant lobbying expenditures and campaign contributions made by FINRA’s member firms.”

Instead of delegating additional authority to private self-regulatory groups, POGO told the lawmakers that Congress should reduce the SEC’s current reliance on FINRA and other SROs, work to improve FINRA’s transparency and accountability policies, and “provide sufficient funding to the SEC to ensure that it is able to carry out its important regulatory duties on its own.”

What’s Next?

With a limited budget—and no signs that Congress plans to boost that budget—and more time constraints put on the agency by the Dodd-Frank Act, the question remains as to whether the SEC would be able to adequately police FINRA as an advisor SRO.

Barbara Roper, director of investor protection for the Consumer Federation of America (CFA), made this point clearly in the letter she sent to Bachus, Frank and other committee members just two days before the June 6 hearing on the SRO bill.

Roper told the lawmakers that while she’s “disappointed” the hearing focuses on just the SRO option and not the other two options that have been proposed—user fees and greater funding for the SEC—as a “realist,” CFA is prepared to consider an SRO as a “meaningful improvement over the status quo if that SRO is appropriately designed.”

Unfortunately, Roper argued, Bachus’ bill “does not meet the standard of an appropriately designed SRO.” She told committee members that rather than moving forward “with a bill that clearly fails to solve the issues it is intended to address,” the Committee should review alternatives that increase the quality of oversight at a “reasonable, and equitably shared, cost” to advisors and their clients.


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