FINRA's Board Unimaginatively Responds to Existential Crisis By Raising Fees

October 16, 2020

From my perspective, FINRA is an inept and frequently ineffective regulator, which I have long characterized as the lap dog of its larger member firms. Frankly, FINRA comes off as little more than a hijacked trade-group intent on eliminating its smaller members and promoting financial superstores and regional brokerages. Harsh words? Absolutely. Off the mark and unfair? I think not. 

In Notice of Filing and Immediate Effectiveness of a Proposed Rule Change to Adjust FINRA Fees to Provide Sustainable Funding for FINRA's Regulatory Mission (Release No. 34-90176; File No. SR-FINRA-2020-032 / October 14, 2020), FINRA asserts the following under "Overview" [Ed: footnote omitted}:

FINRA is submitting this proposed rule change to increase the revenues that FINRA, as a not-for-profit self-regulatory organization ("SRO"), relies upon to fund its regulatory mission. The proposed fee increases are designed to better align FINRA's revenues with its costs while preserving the existing equitable allocation of fees among FINRA members. FINRA has not raised its core member regulatory fees since 2013, even though the overall costs of FINRA's operations have exceeded its total revenues for most of the last decade. 

Although the proposed fee increases will not begin to take effect until 2022, FINRA is submitting this proposed rule change now so that it can: (1) provide significant advance notice of the proposed fee increases to member firms; (2) permit the proposed fee increases to be phased in over multiple years; and (3) continue to strategically "spend down" financial reserves over the next several years, to allow the proposed increases to be gradually phased in as much as possible. The proposed fee increases are intended to provide responsible and sustainable longer-term funding to enable FINRA to accomplish its regulatory mission in a manner consistent with FINRA's public Financial Guiding Principles ("Guiding Principles").

In making its argument for increased fees, FINRA offers, in part, this rationale [Ed: footnotes omitted]:

Economic Baseline 

The baseline for this proposed rule includes FINRA's historical costs and revenues, the current schedule of fees assessed by FINRA, and the direct and indirect allocation of those fees across member firms, associated persons, third parties, and investors. The baseline also encompasses the scope of activities conducted by FINRA today to meet its mission, and FINRA's current ability to meet changing market activities and conditions through investment in staff, physical infrastructure and technology. 

As discussed previously, as a not-for-profit organization, FINRA's operating principle is to target reasonable cost-based funding that allows it to appropriately fund its regulatory mission. Between 2010 and 2019, FINRA's costs grew by a compound annualized growth rate (CAGR) of 1.7%, or 16% over the entire period. Over the same period, reported costs increased by 42% for the industry, while U.S. core inflation grew by 19%. 

At the same time, FINRA has seen capital markets grow in size and complexity, and an increase in its own regulatory responsibilities. Substantial increases in trading volume in listed equities, options and OTC equities (over 75% increase since 2015) and complexity of the securities markets (the number of registered securities exchanges significantly increased since 2011, from 13 to 25) have led to a more complex trading environment. This, in turn, has required new approaches to enhance surveillance and investigations by FINRA staff. New SEC regulations (an estimated 15 significant new rules in the broker-dealer space since 2010 based on a FINRA analysis), FINRA rulemaking designed to support federal initiatives (e.g., crowdfunding, fixed income mark-up disclosure), and MSRB rules that require FINRA implementation have all increased FINRA's regulatory responsibilities substantially.  

During this period, the SEC has increased reliance on FINRA as the "first line supervisor" for broker-dealers. In response, FINRA continued to invest in its surveillance and examination programs. The SEC also created an updated oversight framework with substantially more inspections and reviews of FINRA, which in turn has required FINRA to commit significant new resources to support those inspections and reviews. 

Over the last decade, FINRA has observed changes in the number of registered persons and member firms. Between 2009 and 2018, the number of registered member firms decreased from 4,720 to 3,607 (a change of approximately 26.3%) while the number of registered representatives decreased from 633,280 to 629,847 (a change of 0.5%). Between 2009 and 2018, approximately 97% of the decrease in registered member firms came from small firms. Over the same period, the percentage of registered persons affiliated with small member firms dropped by a much smaller amount, from 12% to 10%. Despite the consolidation in the number of member firms, aggregate supervision costs fell minimally. 

There are at least two drivers for this result. First, the exiting firms tended to require fewer supervisory resources because they were generally assessed as posing lower risks to investors and markets; higher-risk firms typically require more oversight. Relatedly, exiting firms generally conducted a smaller, simpler set of activities; larger, more complex firms typically require more oversight. And second, the number of registered persons remained fairly constant as persons from exiting firms migrated to other firms, requiring FINRA regulatory resources to shift accordingly 

Despite the increased responsibilities and changes in its own oversight by the SEC, FINRA achieved the relatively low growth in its costs through a variety of mechanisms. Staffing generates the majority of FINRA's expenses and has been held relatively flat over the last decade. In that period, total compensation costs for FINRA employees engaged in carrying out its core business operations rose by 15% on a cumulative basis, compared to 24% for the average U.S. employee. Further, FINRA has been successful in reducing non-compensation related expenses in recent years, with a 12% cumulative reduction across operating expenses (excluding technology) over the last 5 years, and a 25% decrease in non-recurring expenses. FINRA's expenses have grown less rapidly than those of member firms. In addition, FINRA's proportional share of aggregate regulatory fees reported by member firms in total has fallen meaningfully. Charts 2 and 3, attached in Exhibit 3, present these findings.

Over the same period between 2010 and 2019, FINRA's regulatory and use-based revenues remained effectively flat, influenced by few fee increases and a relatively steady number of registered persons. FINRA's total revenues grew at a compound annual growth rate of 1.1% per year, or 10% between 2010 and 2019. Between 2010 and 2013, FINRA increased regulatory fees by an aggregate amount of less than $22 million. The period between 2013 and 2020 represents one of the longest windows in which FINRA has not raised regulatory fees. As a comparison, as illustrated in Chart 4, member firm revenues grew at a compound annual growth rate of 4.8% per year, or 52% between 2010 and 2019. As a not-for-profit regulator, FINRA has also maintained a policy of returning revenues in excess of its operating costs through rebates. Over the same review period that is the focus of this analysis, 2010 through 2019, FINRA rebated regulatory fees to member firms five consecutive years between 2010 and 2014. The aggregate amount rebated was approximately $57 million. . . .

at Pages 31 - 35 of the Notice

Bill Singer's Comment

After years of watching the number of FINRA member firms decline, it is clear that we are at the doorstep of an existential crisis. Much of FINRA's quoted rule proposal above makes that argument. 

Dwindling numbers of member firms. 

Decreasing revenues. 

Vanishing profits. 

Commission-free trading. 


And in the face of such challenges, FINRA's response is to raise fees. How droll a reaction to such a growing threat. FINRA's rule proposal is pathetic and laughable. 

Birthed in 1971 from the maverick, innovative nursery of NASD/NASDAQ, now, FINRA is an addled, ossified mess of a fossil. For those who would write the epitaph of FINRA, it would likely harken back to the words in Walt Kelly's "Pogo" cartoon: "We have met the enemy and it is us."

FINRA's proposal is the still-born child of a clueless Board of Governors bereft of Street savvy and any ability to innovate out of the crisis. Frankly, among the very first steps FINRA should have proposed before increasing fees is to slash the size of its Board from 24 to 12. I would reduce the number of so-called Public Governors from 13 to 7, eliminate the set-aside seat for the Chief Executive Officer, and reduce the Industry Governors from 10 to 5 (and eliminate the present byzantine structure of segmented industry seats). I would abolish the current, reprehensible system by which the Board is gerrymandered into fiefdoms. I would stop seating those who lack an understanding of our industry but who are entrenched in managerial roles for which they are not suited -- unquestionably, I would return the voting for Industry Governors to one-firm-one-vote. 

All of those in the FINRA community must accept the symbiotic need to police the industry, to root out the bad actors, to empower regulatory staff with the prerogatives and tools to fairly investigate and prosecute misconduct, and, in the end, to persuade the public for whom the industry exists that, yes, the private sector is a more nimble and effective regulator than big government. Sadly, FINRA's  rule proposal fails to advance an expanded role for associated persons, public customers, issuers, and other market participants. The "solution" to FINRA's existential crisis is not going to be found in higher fees. The answer is in refashioning the very nature of self regulation.

I urge FINRA to reinvent itself as a "private sector regulatory organization" ("PSRO") and to expand and enhance its mission from one for the broker-dealer industry towards one for the larger private sector served by the larger financial services community. In furtherance of that change, the PSRO would serve in a holding-company role that oversees each of three regulatory divisions dedicated to Small member firms (smallest 25% of broker-dealers), Mid-sized member firms (50% of broker-dealers measured from midpoint), and Large member firms (largest 25% of broker-dealers). Pursuant to that restructuring, each division would draft a rulebook responsive to the unique needs of its constituency. The PSRO would fully enfranchise associated persons, and provide for the proportionate representation on the Board for such stakeholders as public customers, issuers, and regulators. Without question, a PSRO Board seat should be set aside for an investors' advocacy group such as PIABA.

As part of reimagining the SRO into a more expansive PSRO, all industry registration and continuing education should be undertaken directly by an applicant through the PSRO holding company and not through the member firms. FINRA should establish an Anti-Fraud Fund whereby all defrauded public customers would obtain restitution in the event that member firms or associated persons fail to timely honor any awards for compensatory damages, costs, and fees. Finally, I would abolish mandatory arbitration for customers and associated persons.

As much as my juices are flowing and I would love to launch into another passionate jeremiad against self-regulation, FINRA, and its feckless Board of Governors, at some point, enough is enough. The current FINRA rule proposal is yet another in a long line of sterile efforts. It is myopic. It is misguided. It is counter-productive. It is what always comes from those who serve on multiple boards, and who pass around the resumes of their pals, who also serve on multiple boards. It is the unimaginative output of those who lack imagination and have no desire to rock the boat. 

After years of protests and dissent, I just can't work myself up for another diatribe on the same subject. Been there. Done that. For those of you who are interested, please read:

Statistical Voodoo In The 2020 FINRA Industry Snapshot Report ( Blog /  August 3, 2020)

How one family's nightmare illustrates the growing threat of real estate wire fraud (CNBC by Andrea Day, Louise Connelly, Jennifer Schlesinger, and Scott Zamost)

FINRA's Board Unimaginatively Responds to Existential Crisis By Raising Fees ( Blog)

Justice Department And Indian Authorities Announce Enforcement Actions Against Technical-Support Fraud Scheme Targeting Seniors / First Parallel Action by U.S. and Indian Governments Against Elder Fraud (DOJ Release)

Fugitive Charged with Leading Multimillion Dollar Fraud Scheme, Falsifying Evidence, and Tax Crimes (DOJ Release)

Private Equity CEO Enters into Non-prosecution Agreement on International Tax Fraud Scheme and Agrees to Pay $139 Million, to Abandon $182 Million in Charitable Contribution Deductions, and to Cooperate with Government Investigations (DOJ Release)

SEC Charges Andeavor for Inadequate Controls Around Authorization of Stock Buyback Plan Company to Pay $20 Million Penalty (SEC Release)

In the Matter of the Claim for an Award in connection with Redacted (SEC Order Determining Whistleblower Award Claim)