The Financial Industry Regulatory Authority (FINRA), which regulates securities firms and whose mission is to protect investors and educate them about the basic principles of investing, was a reckless market speculator, according to Randall Smith’s September 25th article in the Wall Street Journal, “After 27% Fall, Finra Plays it Safe.”
Beginning in 2004, FINRA hired outside advisors to revamp its investment portfolio to be like some of the large college endowment funds that were racking up big gains from aggressive investments in hedge funds and other “alternative” investments. FINRA reallocated its portfolio to approximately 50% stocks and private-equity funds, 20% hedge funds and other alternative assets, 15% real estate and commodities, and only 15% in safer bonds and other fixed-income investments, according to the article. FINRA used 60 different money managers, including 10 hedge funds and 20 private equity funds, said people familiar with the matter.
At first, FINRA’s strategy paid off with its juiced-up portfolio reportedly increasing in value by $615.8 million to $2.4 billion by 2007. But by the end of 2008, the market declines had “erased almost all of those gains.” Last fall, FINRA began to reconsider its investment strategy, and in April of this year, dumped its outside advisors, switching to “a lower volatility with the objective of a lower risk portfolio,” and boosting its fixed-income to 50%, more than triple the previous allocation.
FINRA’s high-risk behavior has apparently caused concern among some of its member firms. Amerivest Securities, Inc. filed a lawsuit against FINRA, seeking to examine its books and records, and alleging, among other things, that FINRA was “reckless in pursuing high-risk strategies inappropriate to preservation of capital.” Amerivest’s attorney added that FINRA should not have been “speculating in the market.”
While FINRA’s status as a (possibly reformed) market speculator raises questions about its commitment to investor protection, there is a larger and more important question: Is regulation of securities firms properly entrusted to a self-regulatory organization? Or is the self-regulatory organization an inherently flawed approach to regulation of securities firms?
North American Securities Administrators Association (NASAA) held its annual conference last week. In her speech to the members and guests, new President, Denny Crawford of Texas, spoke about the failure of self-regulation, which cannot be fixed because is an inherently flawed concept. “I believe that regulation is the proper province of government. It is not a profit-driven business and cannot be subject to traditional cost benefit analysis,” said Ms. Crawford.
One of FINRA’s highest priorities is expanding its turf to become the self-regulatory organization to the investment advisor industry. “A self-regulatory organization for investment advisors is inappropriate because it embodies a flawed approach to regulation since a self-regulatory organization is inherently conflicted and is not independent,” said Ms. Crawford.