FINRA Reforms Are Needed To Protect The Investing Public

Mar 28, 2017 / Author Vernon Litigation Group
Blog Posts

Most investors in the United States must rely on the FINRA arbitration process to attempt to recover damages caused by investment professionals. Additionally, the investing public must rely primarily on FINRA regulators (along with the SEC) to protect investors from bad actors and bad actions of investment professionals. Unfortunately, many believe FINRA is not up to either job, much less both the regulatory and arbitration side of the investor watchdog role overseeing the securities industry. Recently, JD Alois wrote a great article in Crowdfund Insider that highlighted some of the reasons why FINRA is, at the very least, in need of reform.

FINRA’S Private Corporation Status A Big Problem

Specifically, FINRA is a “self-regulatory organization” (SRO). This is a concern because much of the funding for FINRA and FINRA’s highly compensated executives comes from large broker/dealers such as Morgan Stanley, UBS, Merrill Lynch, and others who do not fear FINRA.

The basis for this concern is evidenced by the weak policing done by FINRA on its own members. According to the above referenced Crowdfund Insider article by Alois, FINRA assessed $176 million in fines and demanded $27.9 million in restitution in 2016 from the broker dealers it regulates. That amounts to about $200 million in fines/restitution paid collectively by the 3800 hundred broker/dealers regulated by FINRA due to wrongdoing. To put this in perspective, just one FINRA member (Morgan Stanley) generated net revenues of more than $34 Billion in 2016. In other words, the entire industry paid fines and restitution amounting to less than 1/10th of 1% of Morgan Stanley’s revenues for that year. To put it simply, the paltry fines and restitution ordered by FINRA do not deter the financial industry from engaging in the type of wrongdoing it is famous for (i.e. making billions by abusing the trust of investors).

FINRA Less Effective Than SEC

The problem of FINRA’s status as a self-regulatory organization is compounded by the fact that FINRA has a budget of almost $1 billion, yet accomplishes far less financially than the SEC in terms of being an industry enforcer. In particular, in 2016, the SEC (with a budget of $1.6 billion) obtained judgments and orders twenty times greater than the fines and restitution orders obtained by FINRA. That’s just$200 million in fines and restitution by FINRA compared to $4 Billion by the SEC.

FINRA Lacks Transparency

Equally disturbing, FINRA is further distinguished from the SEC by its lack of transparency. The SEC is a government agency, and operates as such. FINRA basically functions as a governmental entity without the transparency. FINRA hides behind its status as a private company that is not subject to state and federal public records laws. FINRA should not be able to have it both ways and should subject itself to the same transparency as other government agencies (or lawmakers should force this change).

Experts Call For Reform

This position has been detailed by David Burton, the Heritage Foundation’s Senior Fellow in economic policy (and referenced by Alois in his Crowdfund Insider article) as follows: “FINRA is a regulator of central importance to the functioning of U.S. capital markets. It is neither a true self-regulatory organization nor a government agency. It is largely unaccountable to the industry or to the public. Due process, transparency, and regulatory review protections normally associated with regulators are not present, and its arbitration process is flawed. Reforms are necessary. FINRA itself, the SEC, and Congress should reform FINRA to improve its rule-making and arbitration process.” According to Alois, “Burton calls FINRA’s Constitutionality into question saying Congress must act and address lingering questions regarding due process and transparency.” While we at Vernon Litigation Group do not agree with some of Burton’s reasons for wanting FINRA reform, we agree significant reform is needed to make FINRA more effective and to have a greater impact on actually protecting investors from the ongoing abuses by its members.

FINRA simply cannot be left to continue to fail as the protector of the retail investor. Absent changes, it appears Congressional involvement will be needed as FINRA’s flaws begin to become more public and widely known.