My recent Forbes column, Regulating Wall Street by J. Wellington Wimpy, warned the public about the games being played by the House Committee on Financial Services as it began consideration on Oct. 1, 2009, of the Discussion Draft of the Investor Protection Act of 2009. By now, we are all used to some of the backdoor deals and unprincipled compromises that too often masquerade as politics—so, to that extent, we have become a bit numb to the nonsense. However, I think that Capitol Hill took its legislative legerdemain to new depths, when Representative Spence Bachus (R. Ala) inserted an amendment to the draft Act that gave the Financial Industry Regulatory Authority (FINRA) the power to oversee any adviser associated with a registered broker-dealer, including about 500 dually registered FINRA members.
I know—giving some self-regulatory organization (SRO) such as FINRA a measly 500 new members to regulate doesn't seem like anything to get into a lather over. However, when is enough enough already? We're talking about combating Wall Street fraud, protecting investors, reforming failed regulators and that seems like an opportunity for some politicians to dole out favors or paternalistically pat us all on the head and send us out for milk and cookies while the big boys take care of business?
Bachus' action is troubling on a number of levels—as is the ratification of his amendment by the Committee.
First, the investing public is essentially sandbagged when legislators drop explosive amendments onto any proposed act with little notice or warning—and to do so when drafting the Investor Protection Act seems even more unseemly. Were the representatives even able to read the draft amendment in that smoke-filled back room?
Second, the proposed allocation of expanded regulatory power over registered investment advisors (RIAs) to FINRA comes at the same time that the Committee passed an amendment from Representative Carolyn McCarthy (D.NY) deferring the implementation of a self-regulatory option for RIAs and instructing the Securities and Exchange Commission (SEC) to embark upon a six-month investigation of the issue. Anyone ever hear about the danger of mixing matter and anti-matter?
Third, Bachus's Capitol Hill coup rewards what many view as a failed regulator (FINRA) and a failed system of regulation (self-regulation) with the plum of more revenue in the form of expanded jurisdiction. Nothing compelled this hasty arrogation to FINRA. After all, this same House Committee had recently revised the threshold by which RIAs were delegated between the states and the SEC, and the states welcomed the increased oversight. I am not aware of any credible literature urging that FINRA be immediately handed some 500 dual registrants.
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?
On November 2, 2009, the North American Securities Administrators Association (NASAA) sent a Letter to House Financial Services Committee Leadership Regarding Investor Protection Act Amendments. Consider this powerful attack by NASAA:
We are very concerned with the far-reaching implications of an amendment offered by Ranking Member Spencer Bachus that would permit the SEC to delegate responsibility to the broker-dealer SRO, FINRA, to enforce compliance by its members and associated persons with the provisions of the IPA. In other words, the amendment would provide the SEC with the authority to empower FINRA to enforce the fiduciary duty provisions in the Investment Advisers Act against not only broker-dealer members but also any affiliated investment advisory firm or any associated person. Additionally, the amendment would give FINRA sweeping rule-making authority.
During the discussion of this amendment, Chairman Frank remarked that regulation should be a government function and NASAA wholeheartedly agrees. NASAA is opposed to any effort to expand the jurisdiction and authority of private, membership organizations into an area that is more appropriately the province of government. The regulation of investment advisers is the responsibility of state and federal governments accountable to the investing public. Extending this responsibility to a private, membership organization amounts to an "outsourcing" of a government regulatory obligation.
Recognizing the need for careful analysis of the risks and benefits of delegating additional authority to an SRO, the Committee approved a study proposed by Rep. Carolyn McCarthy to determine whether the very action provided in the amendment was even necessary. The Bachus amendment directly contravenes the spirit and intent of the McCarthy amendment. Until such time as this and other studies called for in the IPA are complete, the Committee should refrain from taking such a dramatic step. The Committee’s desire to improve the regulation and examination of investment advisers is understandable. The SEC’s examination of advisers is woefully inadequate and that is why, as noted above, NASAA supports raising the dividing line for registration of advisers with state securities regulators. The IPA also contains other appropriate provisions designed to address this issue: increased funding for the SEC and providing the SEC with the authority to collect fees from investment advisers covering all costs relating to the agency’s adviser examination activities.
Additionally, on November 2, 2009, the Consumer Federation of American, Investment Adviser Association, Shareowners.org, National Association of Personal Financial Advisors, Certified Financial Planner Board of Standards, Inc., and the Financial Planning Association issued a Joint Letter stating, in part:
Perhaps the most serious threat to the fiduciary duty came on a seemingly unrelated amendment. That amendment by Ranking Member Bachus, which was adopted on a voice vote, would permit the SEC to delegate responsibility to the broker-dealer self-regulatory organization, FINRA, for enforcing compliance with the Investment Advisers Act for its members and persons associated with its members. Based on an analysis of IARD data, the authority to oversee “persons associated with members” could extend FINRA’s jurisdiction to between 25 percent and 30 percent of all federally registered investment advisory firms. In aggregate, these firms manage almost 80 percent of advisory firms’ total assets under management. In addition, according to the North American Securities Administrators Association, roughly 88 percent of all investment adviser representatives are dually registered as representatives of broker-dealer firms. As a result, the amendment would appear to permit the SEC to designate FINRA as the de facto SRO for the majority of investment adviser representatives, including financial planners who combine advice and implementation services. The SEC could delegate this authority to FINRA with no further involvement of Congress and no prior analysis of the risks and benefits of that approach.
Moreover, the amendment gives FINRA not only inspection and enforcement authority, but also rule-making authority under the Investment Advisers Act. Both are problematic.
In the first instance, this amendment appears to reward FINRA for its failures in the Madoff and Stanford cases, and its misleading statements about the causes of those failures, with a broad expansion of authority. While FINRA has brazenly claimed that a gap in its authority prevented it from examining Madoff’s advisory operations, in fact Madoff was solely a broker-dealer during virtually the entire duration of the scheme, and FINRA had full jurisdiction over its conduct. Moreover, although FINRA supporters claim this broadened authority is needed to supplement inadequate SEC oversight, separate provisions of the bill already address that resource problem by reducing the number of advisers that are subject to SEC oversight, by authorizing substantially increased SEC’s funding, and by providing for user fees to support enhancement of the SEC’s inspection program. Despite the SEC’s failings, we believe that this approach is preferable to delegating broad investment adviser oversight responsibility to an organization with a broker-dealer mindset.
Even more disturbing than its expansion of inspection authority is the amendment’s broad grant of rulemaking authority to FINRA. For years, FINRA and its predecessor organization, NASD Regulation, have sided with brokers in opposing efforts to hold brokers to a fiduciary standard when they provide investment advice. With the rulemaking and enforcement authority this amendment would provide, FINRA could become the main arbiter of how the fiduciary duty is applied to conduct by brokers, SEC-registered advisers with broker-dealer affiliates, and most financial planners. All of the concerns outlined above regarding weaknesses in the underlying legislation would be magnified if FINRA were given this rulemaking role and continued to adopt its industry-centric approach to the issue.
