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Brokerages Demand Greater Transparency from Self-Regulatory Organization

You don’t often hear about regulated entities calling on a regulator to be more open and transparent about its oversight activities. Yet that’s exactly what happened last week at the 2010 annual meeting of the Financial Industry Regulatory Authority (FINRA), a private self-regulatory organization that oversees more than 4,500 broker-dealers operating in the U.S.

Earlier this year, POGO sent a letter to Congress calling for greater oversight of FINRA and other self-regulatory organizations (SROs). We raised concerns about FINRA’s weak enforcement record leading up to the financial crisis, its failure to crack down on the Madoff and Stanford Ponzi schemes, the lack of disclosure on its private investments, its lavish executive compensation packages, its incestuous relationship with the securities industry it oversees, and more.

After we sent our letter, we heard from the heads of many firms that are regulated by FINRA. Nearly everyone was outraged by the compensation packages approved for FINRA’s executives (in 2008, a year in which the financial system nearly collapsed and FINRA lost $568 million in its investment portfolio, FINRA’s top 20 executives received nearly $30 million in salaries and bonuses). We also learned that a number of FINRA’s member firms had filed a lawsuit alleging that current and former FINRA executives—including SEC Chairman Mary Schapiro—made highly misleading statements about the regulatory merger that led to FINRA’s creation in 2007.

U.S. District Judge Jed Rakoff recently decided to dismiss the lawsuit against Schapiro and other officials. But that hasn’t stopped FINRA’s member firms from pushing for more transparency and accountability.

Lt. Col. Elton Johnson, Jr. is the president of Amerivet Securities, a small California-based brokerage firm that is regulated by FINRA. In anticipation of FINRA’s annual meeting, Johnson submitted seven proposals for opening up FINRA’s records and holding the organization accountable:

  1. FINRA should be required to disclose in each annual report the compensation for the top ten most highly paid FINRA employees and the amount of any funds paid to compensation consultants;

  2. There should be an independent study of ties between current/former FINRA directors/officers with Bernard L. Madoff, his family members and any of their affiliates;

  3. There should be disclosure of FINRA investment transactions, policies and practices;

  4. The Board of Governors meetings should be public, unless absolutely necessary to protect the confidentiality of individual regulatory issues;

  5. FINRA members should have a non-binding “say-on-pay” for the five most highly compensated FINRA employees;

  6. FINRA should employ an independent private sector inspector general to oversee its performance; and

  7. FINRA should disclose (without redaction) all its correspondence with the IRS concerning the $35,000 payment to members in connection with the consolidation of NASD and NYSE Regulation.

Not surprisingly, FINRA fought back against every single one of these proposals. In a notice sent around to its member firms last month, FINRA made some incredible arguments as to why the proposals should be rejected. For instance, FINRA thinks it shouldn’t have to make its board meetings public because it could “stifle candid deliberations,” and because “FINRA is not aware of any corporation so transcribing and publishing transcripts of board meetings,” even though it acknowledges that many governmental bodies are required by law to do so. In addition, FINRA argues that there’s no need for an independent review of the relationship between current and former FINRA officials and the Madoff family because FINRA already conducted its own self-review. FINRA also believes that it doesn’t need to be overseen by an independent watchdog (similar to an inspector general) because it already has an internal audit department and an ombudsman’s office, and because creating a truly independent watchdog would “inevitably necessitate the expenditure of significant time, effort and funds.”

Unfortunately for FINRA, most member firms were not persuaded by these arguments. At FINRA’s annual meeting last week, the firms approved all seven proxy proposals. And while the proposals are non-binding, it’s worth pointing out that they passed with overwhelming support. Larry Doyle at Sense on Cents has obtained and posted the results of the votes, which show that the strongest support came from FINRA’s smaller member firms, many of whom have told us that FINRA unfairly punishes them while letting larger firms get away with gross misconduct.

Member firms also elected seven new industry governors to FINRA’s board. One new governor, Richard Brueckner, shouldn’t have any problem representing industry, seeing as he also serves on the board of the Securities Industry and Financial Markets Association, which was recently added to the Center for Responsive Politics’ list of Heavy Hitters as one of the organizations “spending the most to influence policy and politics over the years.”

FINRA’s board will be reviewing the proxy proposals at its next meeting – just don’t expect them to make the meeting public.

In the meantime, the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act contains several provisions that could lead to an increase in power for FINRA or another SRO. For instance, the Government Accountability Office (GAO) will be studying the feasibility of creating an SRO to oversee hedge funds and other private funds (Section 416), and the SEC will be reviewing whether it would be helpful to have an SRO assisting in the oversight of investment advisers (Section 914).

The Dodd-Frank bill also requires the GAO to report to Congress every three years on the SEC’s oversight of FINRA and other related entities (Section 964). These reports will cover issues such as conflicts of interest, executive compensation, funding, post-employment restrictions, and transparency—many of the same issues that have been highlighted by Amerivet and other FINRA critics.

We hope that these reports and the ongoing conflict between FINRA and its member firms will cause Congress to think twice before delegating any more authority to FINRA or another private self-regulator.

By: Michael Smallberg
Investigator, POGO

Michael Smallberg, Investigator Michael Smallberg is an investigator for the Project On Government Oversight. Michael's investigations center on oversight of the financial sector.

Topics: Financial Sector

Related Content: Financial Oversight, FINRA

Authors: Michael Smallberg

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