Congress Prepares To Sandbag Investors And Their Financial Advisers With More Wall Street Self Regulation

May 31, 2012

House Financial Services committee members sit...

House Financial Services committee members sit in the tiers of raised chairs, while those testifying and audience members sit below. (Photo credit: Wikipedia)

Having spent a few years with the sublime, we now move into the realm of the ridiculous.  The House Committee on Financial Services posted the following notice of a scheduled hearing:

June 6:

The Financial Services Committee will examine H.R. 4624, the Investment Adviser Oversight Act of 2012, at a hearing that begins at 10 a.m. in room 2128 Rayburn House Office Building.

Under consideration will be the Investment Adviser Oversight Act of 2012, a bill co-sponsored by House Financial Services Committee Chairman Spencer Bachus (R-AL) and Carolyn McCarthy (D-NY), which is submitted to amend the Investment Advisers Act of 1940 by providing for the registration and oversight of national investment adviser associations.  This bill would  authorize "one or more self-regulatory organizations (SROs) for investment advisors funded by membership fees."

I'm proud to say that I was among the first vocal opponents of the Bachus-McCarthy bill because I saw it as little more than a Congressional con game to foist the Financial Industry Regulatory Authority ("FINRA") upon the investing public and the investment advisory community.  Consider my published record on the matter:

"Regulating Wall Street By J. Wellington Wimpy" (, November 2, 2009):

[R]ep. Carolyn McCarthy, D., N.Y., offered an amendment to authorize a study of whether investment advisers should be subject to regulation by an SRO. The McCarthy amendment passed this hot potato to the SEC for investigation and anticipates a report within six months. Wimpy is smiling. There must be some 24 Tuesdays in those six months of SEC investigation and report drafting.

I see this aspect of the committee's legislative role as shameful-sorry, but strong words are required for such pusillanimous behavior.

Surely, there is enough information before the members of the Financial Services Committee as to whether self-regulation is a viable form of Wall Street regulation in this day and age. Forests of trees are now devastated to produce the paper on which self-serving studies and reports have been printed by both sides of the SRO debate. If you wish more than that, how about simply Googling that SRO query and sitting at a computer screen for several hours (if not days) as you plow through the massive number of hits?

Further, what more history does the committee need to review to determine whether FINRA performed commendably during the past few years-and whether such results constitute a track record that should promote that SRO for an expanded role? . . .

"Rep. Bachus Slips One In (and not everyone is cheering)" (, November 3, 2009)

Representative Bachus' amendment and its passage by his colleagues would be baffling if it weren't symptomatic of so much that is wrong with our political system.  Has the House Committee been reading a different history of Wall Street's regulatory failures than the rest of us?  Was FINRA's regulation of Wall Street so superlative during the Madoff and Stanford years that the SRO is deserving of this accolade?

"FINRA Fires (Streamlines) Five Regulators" (, January 21, 2010)

In 2008, thirteen current or former FINRA executives made more than $1 million per annum in compensation. Such outlandish salaries were forked over in a year when the self-regulator lost nearly $700 million! . . . It gets better.  In 2009, FINRA reportedly set aside $1 million for Capitol Hill lobbying efforts.

"The Great Debate: FINRA" (, January 25, 2010) :

[M]ore to the point, FINRA may have saved some $30 million through early-retirement and the recent layoffs; however, did it first eliminate its asinine advertising campaign, its effort to supplant the CFP Board as the new RIA/Financial Planning self-regulatory organization, and its million dollar lobbying campaign? Finally, you forget that I was a regulator at both the AMEX and NASD - under no circumstances have I ever suggested that the rank-and-file of regulators are over-paid. This is purely a shot at senior management.

Ketchum's Pitch

During his September 13, 2011, testimony before the Subcommittee on Capital Markets and Government Sponsored Enterprises Committee on Financial Services, FINRA Chair and CEO Rick Ketchum offered, in part, these observations:

Self-regulation in the securities industry has a long and effective history, and both Congress and the SEC have periodically examined and reaffirmed its critical role. In designing the statutory scheme of securities regulation in the 1930s, Congress envisioned that most of the day-to-day responsibilities for market and broker-dealer oversight would be performed by independent regulatory organizations under the SEC's direct supervision.

In the oversight regime for broker-dealers, FINRA supplements the work of the SEC in terms of front-line regulation. Among the functions FINRA provides to that regime are:  conducting examinations to ensure compliance with applicable laws and rules; undertaking enforcement and disciplinary proceedings with respect to regulated firms, including barring firms and individuals from the industry; administering registration and disciplinary databases to provide critical information to regulators and the public; and implementing continuing education and training programs. SROs for investment advisers could provide similar benefits to augment government oversight of that industry.

Self-regulatory organizations provide these benefits without significant additional cost to taxpayers, since they are typically funded by fees assessed on regulated entities. Self-regulatory organizations also have more flexibility than their government counterparts to devote and direct resources to large, multiyear technology development efforts that can support a variety of regulatory programs, including those focused on examinations, enforcement, market transparency and licensing qualifications. . .

[B]efore concluding, I want to be very clear-if FINRA becomes an SRO for investment advisers, we would implement regulatory oversight that is tailored to the particular characteristics of the investment adviser business. FINRA would establish a separate entity with separate board and committee governance to oversee any adviser work, and would plan to hire additional staff with expertise and leadership in the adviser area. That said, given our experience operating a nationwide program for examinations and our ability to leverage existing technology and staff resources to support a similar program for investment advisers, we believe we are uniquely positioned to serve as at least part of the solution to this pressing problem. In addition, FINRA's current programs would be enhanced and investors be better protected if we had the authority to examine the full operations of dually registered firms, where currently we can only see the broker-dealer side of what is typically a fully integrated business.

NASAA Says Naaaaah!

On the same day that FINRA's Ketchum testified, Steve Irwin,  Pennsylvania Securities Commissioner and Chair of the North American Securities Adminstrators Association ("NASAA") stated, in part, that

The existing securities industry SRO model - as typified by FINRA - is replete with conflicts of interest. Members of the industry serve on the SRO's board and occupy other positions of prominence such as serving on various advisory committees.

Even where there is an independent Board of Directors, SROs remain organizations built on the premise of self-rule and are, as a matter of first principle, accountable to their members, not the investing public. Any SRO that depends on its members as its primary funding source faces a heightened susceptibility to industry capture. If FINRA denies an application, or expels a member in an enforcement matter, FINRA loses money. The Section 914 Report made this very observation when it noted that a SRO funded by its members and containing "industry representatives" in its governance structure could have an enhanced susceptibility to industry capture.

No matter how many safeguards are instituted, a SRO has substantial and inherent conflicts of interest that governmental regulators do not. This is particularly true where industry and investor interests' conflict, as in the case of mandatory pre-dispute arbitration clauses and the disclosure or expungement of prior settlements, judgments and investor claims.

As a membership organization, FINRA answers firstly to its members and not to the investing public. Regardless of safeguards that may be put in place, the conflicts will still exist. . .


On April 23, 2012, the Financial Industry Regulatory Authority ("FINRA") sent the following letter to its members:

Update: FINRA Board of Governors Meeting

April 23, 2012

Dear Executive Representative:

The FINRA Board of Governors met last week to discuss a number of issues, including several rulemaking items. A summary of the rule proposals, as approved by the Board, is included below.

I want to provide some background on the pricing proposals that the Board discussed. The broader economic downturn continues to affect trading volumes and industry revenues, which in turn has led to a decrease in FINRA's revenues and resulted in a significant loss for fiscal year 2011. In light of this, we have taken a hard look at spending across FINRA to be sure we are operating as effectively and efficiently as possible. This review has resulted in significant spending reductions of $36 million that were implemented as part of our 2012 budget. Cumulative savings from this effort will reach nearly $60 million by the end of 2013.

Despite this effort, the cost of meeting our regulatory mandate is still expected to outpace our revenues. With input from the Small Firm Advisory Board, Board of Governors and a new Board pricing working group, we are proposing adjustments to a number of user-based fees, all of which have remained static for more than five years-with many of them not being adjusted in the last 10 years. We believe the proposed user fee adjustments offer the fairest approach to modernizing FINRA's revenue structure.

You'll see we're also proposing changes to branch office and membership application fees. These adjustments reflect the expansion of these programs and are necessary to keep pace with the cost of conducting branch exams and application reviews. In addition, we are proposing to increase the Trading Activity Fee, which we will adjust every six months (up or down), based on trading volumes.

Our goal in pursuing these proposals is, of course, to ensure that we are sufficiently capitalized to meet our regulatory responsibilities so that we can best protect investors. We will continue to update you on the proposals we bring to the Board, and the action it takes on these items.

In the meantime, I look forward to continuing our dialogue.


Richard G. Ketchum

Chairman and CEO

Are They Serious?

So, lemme see if I got all of this - you know, the fancy sidestepping and ducking that just seems to be the bob-and-weave of all those folks enamored with Washington, DC and the culture of Capitol Hill.  The sponsors of the Investment Adviser Oversight Act of 2012 are quite taken with the SRO concept and - if they would fess up - likely think that FINRA would be the perfect candidate to anoint with the plum of the investment advisory industry's SRO.  

Memo to selfMonitor how many staff members of this House Financial Services Committee wind up with jobs at FINRA or whatever SRO is ultimately set in place for the RIA community.

Ya gotta love that pregnant line in a now month old communication from FINRA's Ketchum to the SRO's members: The broader economic downturn continues to affect trading volumes and industry revenues, which in turn has led to a decrease in FINRA's revenues and resulted in a significant loss for fiscal year 2011. In light of this, we have taken a hard look at spending across FINRA . . .

In April 2012 we were told of a "significant loss" at FINRA. In May 2012, FINRA still left that nebulous term out there. Now, heading into June and an upcoming Congressional hearing, I'm still unclear as to how many millions, tens of millions, or hundreds of millions of dollars constitutes FINRA's "significant loss."  When the hell will FINRA practice some of that transparency it always lectures its members about?  When will the SRO disclose the actual dollar amounts of that "significant loss?"

Assuming that one of the sterling selling points to theFinancial Services Committee about FINRA is the SRO's allegedly cost-efficient model, how do those who seem prepared to vote in favor of self-regulation for investment advisers feel about the likely spending cuts? Should we expect to see dramatic reductions in FINRA's lobbying costs, public relations expenses, salaries, bonuses, etc.?  Given that FINRA sustained a $700 million only a few years ago, did the SRO learn anything from that event? If so, why do we now find ourselves at deja vu all over again?

Another Memo to SelfMonitor how close FINRA's 2011 losses come to JP Morgan's alleged trading loss. Also, monitor how close those losses comes to those in Morgan Stanley's Facebook IPO.

You elected officials who find it fun to dabble with the primordial forces of Wall Street and tinker with the core concepts of investor protection, might I suggest that you read my comprehensive take on why modern-day regulation is a failure: