June 1, 2012

Accountability for the Self-Regulator

Hester Peirce

Former Senior Research Fellow
Summary

The Government Accountability Office (GAO) issued a report yesterday about the Financial Industry Regulatory Authority (FINRA), a powerful self-regulatory organization (SRO). Although self-regulation sounds like a good alternative to government regulation, the reality is not so clear.

Contact us
To speak with a scholar or learn more on this topic, visit our contact page.

The Government Accountability Office (GAO) issued a report yesterday about the Financial Industry Regulatory Authority (FINRA), a powerful self-regulatory organization (SRO).  Although self-regulation sounds like a good alternative to government regulation, the reality is not so clear. 

The SEC, with Congressional approval, has officially shifted its responsibility for day-to-day oversight of brokerage firms and their employees to FINRA, which is a non-profit organization.  FINRA, although not technically a government regulator, acts a lot like one– writing mandatory rules, conducting inspections, levying fines, and kicking people out of the industry.  Yet it operates without the same constraints or degree of oversight that government regulators have.  FINRA is currently engaged in a lobbying campaign to increase its authority.  Now is a good time to subject FINRA to increased accountability, better processes, and more transparency. 

The GAO found a number of problems:

·         The SEC, which relies on FINRA oversight of broker-dealers, has not put in place a comprehensive, risk-based framework for ensuring that FINRA is doing its job.

·         Neither FINRA nor the SEC looks at FINRA rules after they are adopted to see whether they are working.

·         The SEC has not looked at the transparency of FINRA’s governance, which is an important feature of an SRO.

·         The SEC has not looked at FINRA’s executive compensation. (As an aside, SEC Chairman Mary Schapiro, who now oversees FINRA, used to head FINRA and reportedly got a $7.3 million payout when she left FINRA.)

In addition to the problems the GAO identified, further issues stem from FINRA’s unique regulatory powers.  FINRA is the only game in town.  If you want to work with the investing public as a stock broker, you have no legal alternative but to sign up with FINRA.  As a consequence, FINRA wields great power over the firms and individuals that it regulates.  

Nevertheless, FINRA is not subject to the Administrative Procedure Act, which governs how government agencies make rules.  Nor is it subject to economic analysis requirements, which are intended to help government agencies determine how best to spend their resources. 

The problems at FINRA should not be ignored, particularly at a time when FINRA is seeking to expand its jurisdictional reach.  FINRA has asked for authority to regulate investment advisors, along with the broker-dealers and exchanges it already regulates.  Congress, before giving FINRA the green light to expand its jurisdiction, ought to make sure FINRA is transparent and accountable for what it does and how it does it.