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Court to Consider Secret Regulation of Wall Street

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The public has a right to know how the government polices an industry-funded self-regulatory group, according to an amicus brief filed this week by the Project On Government Oversight and its allies.

The brief calls for the reversal of a district court decision that would “shield almost all information shared between regulated financial institutions and their regulators” and undermine Congress’s intent for the government to operate with a “presumption in favor of disclosure.”

The case in question involves the Financial Industry Regulatory Authority (FINRA), a self-regulatory organization (SRO) for the U.S. securities industry.

FINRA has been granted significant regulatory powers, but it is not a government agency and is not subject to the Freedom of Information Act (FOIA). POGO has objected to the lack of transparency and accountability in the industry’s self-regulatory system, especially in the aftermath of the 2008 financial crisis and the revelation that FINRA failed to crack down on the Madoff and Stanford Ponzi schemes. We’ve also called on the government to reduce its reliance on self-regulatory groups.

Among its many activities, FINRA administers a dispute resolution process through which investors can bring claims before an arbitration panel. Arbitration is often mandatory in securities disputes, and arbitration awards are typically binding. Consumer groups have raised concerns that forced arbitration denies investors and consumers their right to sue in court when they’ve been harmed by a company. A report by Reuters this summer raised additional concerns that FINRA has failed to weed out arbitrators with a checkered past.

The Securities and Exchange Commission (SEC) is supposed to oversee FINRA’s work, including its arbitration process. Unfortunately, the public is often kept in the dark about the SEC’s oversight.

In 2010, a group of lawyers representing investors filed a FOIA request for records showing how the SEC monitors FINRA’s process for selecting and disqualifying arbitrators. The SEC denied the request under FOIA Exemption 8, which “protects from disclosure records that relate to examination, operating, and condition reports, prepared by or on behalf of the Commission, in connection with its supervision and regulation of financial institutions.” The lawyers’ group appealed, arguing that the records “do not properly fall within Exemption 8” because their release “would not undermine FINRA’s credibility as a ‘financial institution’ nor would [it] subvert the cooperative relationship between” FINRA and the SEC.

In March 2013, the U.S. District Court for the District of Columbia upheld the SEC’s denial, finding that “all records relating to the SEC’s examination reports—including reports relating to the administrative functions of FINRA—are exempt from disclosure under the FOIA.”

But that wasn’t all. Even though the parties hadn’t raised this issue, the district judge opined that a secrecy repeal passed by Congress in 2010 could inadvertently further shield FINRA from public scrutiny. Congress repealed a sweeping provision in the Dodd-Frank Act that would have enabled the SEC to withhold “records or information…obtained by the [SEC] for use in furtherance of the purposes of this title, including surveillance, risk assessments, or other regulatory and oversight activities.” In 2010 testimony, POGO’s Director of Public Policy Angela Canterbury told Congress this provision “would provide the [SEC] with an unnecessary and overly broad exemption to FOIA and a blanket authority to withhold public records.” POGO and other good government groups urged Congress to strike the provision. Congress did just that, and further clarified that any entity regulated by the SEC—including newly regulated entities such as hedge funds—would be considered a “financial institution” (i.e., the SEC could use Exemption 8 to deny requests for records that truly relate to examination reports involving these entities).

In this week’s brief, POGO—joined by Citizens for Responsibility and Ethics in Washington (CREW) and OpenTheGovernment.org—argued that the district court’s opinion was erroneous for three reasons:

1) The court misapplied Exemption 8 to “records that do not relate to an ‘examination, operating, or condition report’ and to some records that relate to no report of any kind”;

2) The court’s invocation of the Dodd-Frank secrecy repeal is “inconsistent with [the amendment’s] legislative history” (Congress enacted the amendment to “enhance the SEC’s obligations to disclose records to the public…not to expand SEC’s withholding authority” [emphasis in original]); and

3) The court’s decision would “effectively permit the SEC to invoke [E]xemption 8 to protect nearly all of its records” involving FINRA. In fact, the district judge acknowledged this outcome in her decision. “This may mean, as the plaintiff cautions, that ‘Exemption 8 applies to everything the SEC scoops up in the course of its interaction with FINRA,’” she wrote.

We hope the Court of Appeals for the D.C. Circuit takes this opportunity to reverse the district court and affirm the public’s right to know how the government regulates our financial markets. Giving the public more information about government oversight of groups such as FINRA will help ensure that we don’t end up with another financial crisis fueled by the mistaken belief that Wall Street can regulate itself.

Image by Flickr user lobstar28.

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: Government Secrecy, FINRA, Open Government, Information Access, Securities and Exchange Commission

Authors: Michael Smallberg

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