Is FINRA Just a Trade Association for the Securities Industry?


The Financial Industry Regulatory Authority (FINRA) is lobbying Congress to become the regulator of 12,000 investment advisors and their firms, but critics say that should not happen. These critics claim that FINRA has done a poor job of protecting investors from unlawful sales practices by its member brokerage firms, according to an InvestmentNews article entitled “Finra’s fines don’t match the crimes, critics say.”

Investment advisor firms, which may or may not also be brokerage firms, are currently regulated by the Securities and Exchange Commission if they manage more than $25 million, or state securities regulators if they have less than $25 million under management. (That cutoff is scheduled to increase to $100 million under management in 2012).

FINRA is the securities brokerage industry’s “self-regulatory organization.” “It’s a very bad idea to expand the notion of self- regulation,” Denise Voigt Crawford, former commissioner of the Texas State Securities Board, was quoted as saying, adding: “They’re supposed to oversee the activity of the industry, but they are industry.”

There is an element of the fox guarding the henhouse, because FINRA’s funding comes from the brokerage industry. Moreover, compensation for FINRA’s top 10 executives was $11.6 million in 2009. The current FINRA CEO, Richard Ketchum received $2.24 million in salary in 2009, plus incentive pay and retirement benefits. To get an idea of the magnitude of the retirement benefits, consider that former FINRA CEO Mary Shapiro received $8.99 million as a “final distribution,” which included $7.6 million in vested retirement benefits when she left FINRA to become chairman of the SEC.

The relevance of these monetary entanglements is that they create a disincentive for the head of FINRA and other top executives to rock the boat in regulating its members firms, because that is where the money comes from. Follow the money, and you get concerned.

Those concerns seem to be born out by the low level of fines FINRA imposes on its member firms for violations. FINRA fined members $43 million in 2010 while the SEC, which has been criticized for lax enforcement, issued more than $1 billion in monetary penalties.

“When you look at the types of misconduct compared to the fines, you have to wonder if it will really deter the misconduct they’re tasked with cracking down on,” Michael Smallberg, an investigator at the Washington-based nonprofit Project on Government Oversight, was quoted as saying, adding: “Would Finra ever take serious action against who it’s relying on for its funding?”

To find out, look at how FINRA handled UBS Securities, which sold $1 billion of Lehman Brothers “100% Principal Protected” Notes. Despite naming them “100% Principal Protected,” when Lehman Brothers went bankrupt in 2008, UBS told investors that the notes were not principal protected. Investors lost virtually their entire investment in these notes.

FINRA found that UBS “misled” investors, but, in a settlement, only required UBS to pay $8.25 million to some investors and a $2.5 million fine ? about 1 per cent of the losses. Investor attorneys were outraged.

The $2.5 million fine of UBS is “the biggest crime of the century since Madoff,” Seth Lipner, a Garden City, New York-based attorney, who has represented more than 50 investors in Lehman notes, was quoted as saying, adding: “They pay more for paperclips.” (UBS used about $9 million worth of paper last year, according to the article, citing calculations based on numbers in its annual report.)

Some take a different view. One attorney cited in the article, who represents brokers and FINRA member firms, said: “I can promise you that nobody in the industry thinks that Finra is their friend or Finra is on their side. It’s almost comical that that’s the perception because that is completely untrue.”

But investor attorney J. Boyd Page, the senior partner of Atlanta-based Page Perry, said: “FINRA may occasionally pursue individual brokers and smaller marginal firms aggressively, but, over time, it has taken a very lenient approach in dealing with damaging misconduct by its larger member firms. Violations by these big firms have a much larger impact on many more investors, but those firms are the source of most of FINRA’s funding. Draw your own conclusions.”

Mr. Page further noted that FINRA often takes it easy on smaller firms, too. As an example, the article cites one case involving a 72 year old retired police officer, who was sold a private investment in a supposed oil and gas deal called Provident Royalties for $250,000. Provident was a fraud, he lost his entire investment, and filed an arbitration claim against Workman Securities, the brokerage firm that sold him the investment (and a FINRA member), which he settled for $81,250. Workman did not conduct due diligence on Provident and, therefore, FINRA ordered Workman to repay $700,000 to injured investors, but allowed Workman to offset the $642,802 it had already paid to settle individual arbitration claims. Thus, the net amount that FINRA recovered for all the defrauded Provident investors was only $57,198.

Mr. Lipner concluded: “As more investors turn to investment advisers for financial help, who regulates them will matter even more. If we want to seriously regulate investment advisers, we should not give it to FINRA because it hasn’t proved it’s competent to protect the public interest.”

Page Perry, a law firm based in Atlanta, Georgia, is co-counsel with Mr. Lipner and his Garden City, New York law firm, Deutsch & Lipner, in representing investors in cases involving structured products, including Lehman structured note and reverse convertibles.