Industry Self-Regulation Is No Substitute for SEC Oversight

By MICHAEL SMALLBERG

The ongoing economic crisis in the U.S. has made it painfully clear that we can't trust the financial industry to regulate itself. Yet that is exactly what House Financial Services Committee Chairman Spencer Bachus (R-AL) has proposed in recently released draft legislation that would delegate significant government oversight authority to an industry-funded self-regulatory organization (SRO) for investment advisers—individuals and firms who advise clients how to save for their retirement, their children’s education, and other long-term investment goals. 

This morning, the House Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises held a hearing to discuss Chairman Bachus’s legislation and other proposals to improve oversight of the investment adviser industry. POGO sent a letter to the subcommittee arguing that industry self-regulation is not the answer.

Recent studies by the Boston Consulting Group and the Securities and Exchange Commission (SEC) raised troubling concerns about the SEC’s lack of adequate resources for overseeing investment advisers. However, both studies also identified critical problems with the self-regulatory model.

For instance, while self-regulatory groups are funded by fees imposed on their members, the SEC still has to set aside substantial resources to oversee examinations of the SRO, approve SRO rules, and consider appeals from sanctions imposed by the SRO, among other responsibilities. There is also a good chance that the SRO will become captured by the industry it is supposed to regulate “because it is not only funded by the industry it oversees, but also may include industry representatives in its governance structure.” The most basic critique of the SRO model is that “self-regulation is not real regulation at all: at best, self-regulation is less effective than government regulation, and at worst, is merely an ‘illusion’ meant to deflect calls for government oversight.” 

POGO has observed these and many other problems in the case of the Financial Industry Regulatory Authority (FINRA), the self-regulatory group for the brokerage industry. We urged the House subcommittee to take a close look at FINRA’s regulatory track record, especially since the organization is now angling to become the self-regulatory group for investment advisers.

POGO raised the following concerns with respect to FINRA:

• It has an inherent conflict of mission resulting from its self-funding model;
• It failed to adequately oversee broker-dealers whose trading abuses were at the heart of the financial crisis, and missed opportunities to crack down on the Stanford and Madoff Ponzi schemes, but unlike the SEC, it has not been subject to independent oversight or calls for systemic reform in light of these failures;
• As a private organization, it is not required to provide the basic level of transparency and accountability that exists at federal regulatory agencies, as illustrated by its recent refusal to provide transcripts or public access to board meetings; it is even difficult to obtain basic records showing how the SEC oversees FINRA;
• Its top 18 executives and board members received nearly $23 million in compensation and benefits in 2009, since FINRA believes it shouldn’t have to follow the pay model set by government agencies or non-profit organizations; this excessive executive compensation has created a strong potential for conflicts of interest in the case of former executives who are now at the SEC and are supposed to oversee FINRA;
• It recently introduced a limited revolving door rule, but in general, FINRA employees do not have to follow the same post-employment restrictions and ethical obligations required of government employees; there are countless examples of former FINRA executives going through the revolving door, including several who went to work for Allen Stanford;
• On FINRA’s Board, many members who are designated as public representatives have close ties to the securities industry;
• Its forced arbitration process deprives investors and consumers of their access to court, their due process rights, and their choice of venue and arbitrator; and
• While proponents of the self-regulatory model claim that it comes “at no cost to the taxpayer,” the SEC is still responsible for approving FINRA’s rules, monitoring its activities, hearing internal appeals, and overseeing Board activities.

Here’s our recommendation for Congress: “Instead of delegating additional authority to a private self-regulatory group, Congress should reduce the SEC’s current reliance on FINRA, improve FINRA’s transparency and accountability, and provide sufficient funding to the SEC to ensure that it is able to carry out its important regulatory duties on its own.”

You can read the rest of our letter here.

Michael Smallberg is a POGO Investigator

Comments

[sergio del toro]

finra should be abolished its only goal in its exist is to keep the same old game running (fill the pockets of our friends ,remove are critics) there past and recent actions easily conclude there true motives for existence...protect our own pockets and pretend to help the investor