The Project On Government Oversight (POGO) Blog

Congress Should Reduce Reliance on Self-Regulatory Organizations for Financial Markets

By DANA LIEBELSON

The Project On Government Oversight is urging lawmakers to reduce the government's reliance on private self-regulatory organizations. These self-regulatory organizations, as POGO writes in a letter sent Monday to Congress, are a breeding ground for conflicts of interest and ultimately hurt the public interest.   

In particular, POGO cites the National Futures Association, a self-regulatory organization, which has a board filled with industry representatives and collects membership fees from those firms it is supposed to oversee. An organization like this could “have enhanced susceptibility to industry capture,” according to a recent report by the Securities and Exchange Commission.

As POGO points out in its letter:

New Video: What is an SRO and Why is it Bad for Your Money?

By ANDRE FRANCISCO

The world of financial regulation has a lot of acronyms, but there are two important ones for you to understand if you are concerened about who exactly is watching Wall Street to make sure there isn't another financial collapse. If you are unsure what SEC or SRO means, let POGO's financial guru Michael Smallberg explain in this short video.

After you watch the video, or if you already know how bad of an idea an SRO is, take action and urge your representative to reject a bill that would let Wall Street police itself.

Andre Francisco is a POGO online producer

Follow @andrefrancisco

GAO Highlights Inadequate Oversight of Financial Sector's Self-Regulatory Organization

Congress's investigative arm says Wall Street's self-regulatory organization only has limited oversight from the SEC.

By MICHAEL SMALLBERG and ANDREW WYNER

As the House Financial Services Committee considers legislation to create a private self-regulatory organization (SRO) for investment advisers, a recent Government Accountability Office (GAO) report has raised serious concerns about the inadequate oversight of the Financial Industry Regulatory Authority (FINRA), the largest existing SRO for the securities industry.

The GAO’s report falls in line with POGO’s view that FINRA and other SROs, which operate with significant authority, have not been subject to the same level of oversight that applies to government agencies.

FINRA has argued that it is “subject to comprehensive oversight” by the Securities and Exchange Commission (SEC). But the GAO’s report found that the SEC’s oversight of FINRA is “varied, with some programs and operations receiving regular oversight and others receiving limited or no oversight.”

For instance, the GAO found that the SEC has never reviewed the lucrative compensation packages provided to FINRA’s executives (POGO recently noted that FINRA’s top ten executives received nearly $13 million in pay and benefits in 2010). And the SEC has only been able to provide occasional oversight of FINRA’s finances and governance.

POGO Opposes Bill to Shift Oversight of Investment Advisors to Industry

By ANDREW WYNER

POGO sent a letter today to the House Committee on Financial Services stating opposition to the Investment Oversight Act of 2012 (H.R. 4624), which would, as we argued in the letter, "delegate governmental authority for the oversight of investment advisers to one or more industry-funded self-regulatory organizations (SROs)."

The Committee is scheduled to examine the legislation at a hearing next Wednesday.

POGO’s disapproval of H.R. 4624 stems largely from the high costs associated with shifting governmental authority to SROs—including the Financial Industry Regulatory Authority (FINRA), the largest SRO—to regulate investment advisers. POGO is also concerned by FINRA’s conflicts of interest, lack of transparency and accountability, lobbying expenditures, and its executive compensation packages. Based on FINRA’s flaws, POGO believes Congress should reduce the authority of FINRA and other SROs instead of handing them more authority to oversee investment advisers.

According to a December 2011 analysis conducted by the Boston Consulting Group (BCG), authorizing an SRO to oversee investment advisers will cost taxpayers anywhere from $550 million to $670 million each year.

POGO Joins Brief Asking Supreme Court to Hold Self-Regulatory Organizations Accountable

By MICHAEL SMALLBERG

Should a private organization that's acting with quasi-governmental authority—such as the Financial Industry Regulatory (FINRA)—enjoy the same kind of sovereign immunity that applies to government agencies, even when the organization is sued for misconduct related to its private business?

POGO signed on to an amicus brief this week asking the Supreme Court to take up this very question. We joined Public Citizen, Consumer Action, and U.S. Public Interest Research Group (PIRG) in signing on to the brief, which was written and submitted by Public Citizen’s Litigation Group.

The case in question involves a deal that led to the creation of FINRA, the self-regulatory organization (SRO) for the securities industry. FINRA was formed in 2006-2007 when the National Association of Securities Dealers (NASD) acquired the regulatory arm of the New York Stock Exchange (NYSE). The deal required an amendment to NASD’s bylaws that would increase the voting power of the organization’s larger member firms, and was therefore subject to a vote by NASD’s members. After the deal was approved, one of NASD’s smaller member firms, Standard Investment Chartered, Inc., filed a lawsuit alleging that NASD’s proxy statement seeking approval of the deal was fraudulent.

Standard’s lawsuit brings up the issue of sovereign immunity, which generally protects federal, state, and tribal governments from lawsuits that could subject them to monetary liabilities. In contrast to the immunity available to sovereign entities as a whole, certain officials are entitled to absolute immunity, but only for performing sensitive functions such as legislating, adjudicating, and prosecuting. In other words, absolute immunity is based on the specific function performed by the government official, whereas sovereign immunity applies more broadly to federal, state, and tribal governments.

Courts have historically extended absolute immunity to non-governmental individuals who perform functions such as judging and prosecuting, but only to the extent that they perform these functions. In keeping with this principle, the Fifth Circuit has extended absolute immunity to NASD and other SROs, but only in cases where they perform prosecutorial and adjudicatory functions.

Over the years, however, courts have vastly expanded SRO immunity. Some courts began to liken SRO immunity to sovereign immunity, focusing on SROs’ status as quasi-governmental regulators. Other courts granted SROs immunity even in cases when they weren’t performing strictly prosecutorial or adjudicatory functions, as long as they were acting in a quasi-governmental capacity.

Court Slaps Down Financial Self-Regulatory Group

By MICHAEL SMALLBERG

POGO has long criticized the Financial Industry Regulatory Authority (FINRA), the self-regulatory group for the securities industry, for being a toothless watchdog. This week, the U.S. Court of Appeals for the Second Circuit may have knocked out another tooth by ruling that FINRA does not even have the authority to enforce its own fines.

The ruling stems from a protracted legal battle involving FINRA’s predecessor, the National Association of Securities Dealers (NASD), and Fiero Brothers, a small brokerage firm owned by John Fiero. In 1998, NASD alleged that Fiero and others drove down the price of securities underwritten by Hanover Sterling & Co. through illegal short selling. A few years later, a NASD hearing panel barred Fiero, expelled his firm, and ordered a $1 million fine.

But the firm and its owner simply refused to pay the fine, and NASD/FINRA ended up in federal court trying to collect the money. In a surprising setback for the self-regulatory group, this week’s ruling by the Second Circuit held that NASD/FINRA does not have the authority to bring judicial actions to collect fines.

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.” 

Self-Regulatory Group Introduces Revolving Door Rule -- But Does It Go Far Enough?

By MICHAEL SMALLBERG

The Financial Industry Regulatory Authority (FINRA), the self-regulatory group for the securities industry, has proposed a one-year revolving door rule for senior officers who leave the organization, as reported this week by Bloomberg. But will the new post-employment restrictions have any serious impact at an organization that is inherently cozy with the industry it oversees?

According to the proposed rule, former FINRA officers—including VPs, senior VPs, and other high-ranking executives—will face a one-year cooling off period during which they can’t represent or testify as an expert witness on behalf of a FINRA-regulated entity in disciplinary and other proceedings that take place before FINRA adjudicators.

The purpose of the rule, according to FINRA, is to “uphold a high degree of fairness” in disciplinary proceedings and to “safeguard against former FINRA officers potentially exerting undue influence.” Yet it appears they’re in no rush to put the rule in place—it isn’t scheduled to be implemented until July 2, 2012, assuming it isn’t suspended or disapproved by the Securities and Exchange Commission (SEC), which oversees FINRA.

Three Problems with Self-Regulation

By MICHAEL SMALLBERG

A new report issued by the Government Accountability Office (GAO) explores whether a self-regulatory organization (SRO) should assist the Securities and Exchange Commission (SEC) with its oversight of private funds, including hedge funds and private equity funds.

The GAO acknowledges that the SEC currently does not have the capacity to effectively examine registered investment advisers. But does that mean Congress and the SEC should allow the private fund industry to regulate itself?

Among other things, the GAO raised concerns that the self-regulation of private fund advisers has the potential to:

1. increase the overall cost of regulation by adding another layer of oversight;


2. create conflicts of interest, in part because of the possibility for self-regulation to favor the interests of the industry over the interests of investors and the public; and


3. limit transparency and accountability, as the SRO would be accountable primarily to its members rather than to Congress or the public.

POGO believes these factors have significantly hindered the effectiveness of the Financial Industry Regulatory Authority (FINRA), the SRO for the broker-dealer industry. A recent article in Bloomberg raises additional concerns about having FINRA or any other SRO oversee investment advisers, such as FINRA’s binding arbitration process and the generous compensation packages paid out to FINRA executives. 

Rather than outsourcing even more of the SEC’s authority to an industry group, we urge Congress to give the SEC and other government regulatory agencies the funding they need to accomplish their mission, including their expanded responsibilities under the Dodd-Frank financial reform legislation.

Michael Smallberg is a POGO Investigator.

SEC Withholds Records on Oversight of Self-Regulatory Group

By MICHAEL SMALLBERG

Suzanne Barlyn's latest column in Dow Jones Compliance Watch raises new concerns about the Securities and Exchange Commission's (SEC) Freedom of Information Act (FOIA) practices and the lack of transparency at the Financial Industry Regulatory Authority (FINRA) and other self-regulatory groups.

Barlyn reports that the SEC is refusing to hand over records to the Public Investors Arbitration Bar Association (PIABA) regarding the SEC's oversight of the forced arbitration process at FINRA, the self-regulatory organization for the securities industry.

Although it is considered to be a private organization, and therefore not subject to FOIA, FINRA has been given significant authority to assist the SEC in its regulation of the securities industry. Among its many regulatory activities, FINRA runs the largest dispute resolution forum in the securities industry, including a process through which investors can bring claims before an arbitration panel that is supposed to be comprised of "impartial persons who are knowledgeable in securities industry disputes." Arbitration is often mandatory in securities disputes, and arbitration awards are typically binding, "subject to review by a court only on a very limited basis," according to FINRA's website.

Many consumer groups have raised concerns that forced arbitration denies investors and consumers their constitutional rights to sue in court when they've been harmed by a company.

Last year, PIABA filed a FOIA request seeking records on the SEC's oversight of FINRA's process for selecting arbitrators. The SEC denied PIABA's 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."

Did Education Department Officials Leak Market-Sensitive Info to Stock Traders?

Department of Education Inspector General Kathleen Tighe could soon discover if officials reporting to Secretary Arne Duncan leaked market-sensitive material to short sellers--including a non-public audit from her own office. Did anyone trade on the confidential information?

By ADAM ZAGORIN

The Department of Education (DoED) in Washington has never been known as a hotbed for scandal. But now, following the widely-reported announcement of a new DoED rule governing companies in the lucrative, for-profit education sector, DoED Inspector General (IG) Kathleen Tighe will be the first and perhaps the only person to look into controversial claims that may implicate the office of Education Secretary Arne Duncan.

“I am confident that the independent audit we are conducting will address the issues that have been raised,” Tighe told POGO.

Among other things, Tighe will examine whether confidential DoED information and draft documents, including one produced by her own office, were transferred to Wall Street short-sellers seeking informational advantage in their bets on the future of the $35 billion for-profit education industry. Beyond the propriety of the Education Department's conduct, the phenomenon raises broader questions about the integrity of government decision-making in the face of relentless Wall Street scrutiny.

SEC Commissioner with Ties to Industry Calls for More Industry Self-Regulation

By Michael Smallberg

A commissioner at the Securities and Exchange Commission (SEC) issued an unusual statement Wednesday criticizing an SEC study on the oversight of investment advisers, and calling on Congress to delegate significant SEC authority to a self-regulatory organization (SRO). In her statement, however, Commissioner Elisse B. Walter did not disclose that she was previously a senior executive at the Financial Industry Regulatory Authority (FINRA)—the nation’s largest SRO—or that the organization paid her more than $3.7 million in salary and bonuses in 2008.

SEC Chairman Mary Schapiro, another former FINRA executive, recused herself from voting on the study released Wednesday. It appears that Walter is not operating under the same restrictions when it comes to FINRA-related matters. In fact, Walter attended a meeting in November 2010 with top executives and industry representatives from FINRA to discuss the SEC study, one of several meetings held between SEC officials and outside parties regarding the oversight of investment advisers.