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Wall Street’s Trade Group Chides FINRA for Regulation by Enforcement

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Wall Street’s trade group is chiding the Financial Industry Regulatory Authority for regulating by enforcement, arguing that its broker-dealer members are subject to enforcement actions or exam findings based not on specific regulatory requirements or official guidance, but rather “on unofficial legal positions taken by FINRA staff.”

The Securities Industry and Financial Markets Association wrote a recent comment letter to the self-regulator as part of FINRA’s requests for input on potential enhancements to certain engagement programs. SIFMA noted that examples of FINRA regulating by enforcement involved mutual fund share classes, market access controls and surveillance programs.

Further, SIFMA stated that a position taken in a settlement with a particular firm “then becomes an ‘interpretation’ which is applied to all firms.”

Another example, SIFMA argued, is when FINRA decisions are based on statements in speeches given by FINRA staffers or on outdated guidance in Regulatory Notices.

“Member firms find ‘regulation by enforcement’ extremely troublesome because it creates legal standards and imposes retroactive regulatory requirements and legal liability outside the formal rulemaking process,” SIFMA stated in its comment letter.

Robert Cook, FINRA’s CEO, instituted the FINRA360 initiative earlier this year, undertaking a comprehensive probe of the self-regulator’s operations and programs.

SIFMA also told FINRA that it would like to see “more rigorous application of FINRA’s framework for economic impact assessment, especially when consulting with key stakeholders in the development of rules and aggregating data to assess a proposal’s cost effectiveness, including consideration of alternative means of regulation.”

FINRA should also “do more to consider and internalize member input on regulatory matters,” SIFMA argued.

“Based on our experience, FINRA does not sufficiently consider and internalize member input or gather enough cost and benefit data — often resulting in unworkable or unnecessarily costly rules.”

SIFMA recommended that FINRA be “more transparent in how it incorporates comments in final rules, because it would facilitate more effective engagement from members.”

The Financial Services Institute also weighed in, stating that a poll of FSI members –which includes both brokers and advisors–expressed concern that by focusing its “investor outreach on avoiding bad actors, FINRA is unintentionally making investors associate financial advisors with bad intentions and in turn vilifying the industry.”

Said FSI: “In reality, financial advisors play an important role in investor education and we suggest that FINRA shift its focus to the value of seeking financial advice and the tools FINRA provides to investors to identify an advisor they want to work with.”

FSI also noted that its members expressed concern that FINRA’s “industry outreach is focused at the firm level, overlooking registered representatives and associated persons of IBDs.”

FINRA should form a “Registered Representative Advisory Committee,” FSI suggested. “While input from the firm level is important, advisors interact with investors every day and can provide valuable feedback as to what issues they encounter most often. Financial advisors also play a key role in investor education.”

SIFMA detailed the following as examples of enforcement actions where SIFMA members believe FINRA is regulating through its enforcement department:

Mutual Fund Share Class – In a settlement via Letter of Acceptance, Waiver and Consent (“AWC”) involving charges for mutual funds in charitable and retirement accounts that “may” have been eligible for discounted share classes, FINRA found that the firm failed to supervise for potential discounts under FINRA Rule 3110. However, FINRA did not address the threshold issue of whether the firm was actually required to offer a discount couched as a “may” rather than a “must” in the prospectus. Thus, FINRA found a supervisory violation without the underlying activity being in clear violation of any rule. Taking notice of this AWC, additional firms undertook their own reviews and self-reported potential violations under FINRA Rule 4530(b). In each instance, the self-reporting led to an enforcement action, but apparently, no action was taken against any non-reporting firms.

Market Access Controls – FINRA examination staff reviewed a firm’s market access procedures pursuant to SEC Rule 15c3-5 and despite finding no market access violations, referred supervisory findings to enforcement for disposition. The supervisory findings related to methodologies for determining credit limits for customers. Staff suggested that instead of setting a general credit limit that applied to all customers, there should have been individual credit limits for each customer, and recommended that the firm update their procedures, which they did. It has been under review by enforcement since 2013.

Surveillance Procedures – A firm paid a substantial fine to settle a complaint alleging that it failed to have adequate surveillance procedures, in particular, sufficient automated tools for reviewing wash trading. At the time, the only guidance FINRA offered in this area was NTM 02-21, which included the following suggestion that online brokers needed more automated tools: “Online firms should also consider conducting computerized surveillance of account activity to detect suspicious transactions and activity.”8 In another matter based on similar facts that went to hearing, a panel found in favor of the firm, finding that NTM 02-21 offered no further discussion of the type or degree of automation that clearing firms should have had.


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