Buried among the usual hodgepodge of stuff in a recent weekly FINRA blast email was a notice that the SEC was accepting comments on FINRA’s request to change the composition of the NAC, the National Adjudicatory Council, so that it mirrors the FINRA Board of Governors, and instead of having an equal number of industry and non-industry members, the latter will constitute a majority. According to FINRA’s letter to the SEC proposing the rule, this move to a non-securities industry majority is necessary for the following reason:
[t]he condition that the number of Public Governors exceed the number of Industry Governors permits the FINRA Board to consider the needs of the entire securities industry, including issuers, large and small investors and securities firms and their professionals, while at the same time broadly assuring the independence of FINRA’s regulatory function…. Requiring that the number of Non-Industry Members exceed the number of Industry Members [on the NAC] will enhance overall the independence of the NAC and reinforce the integrity of the NAC as an impartial and fair adjudicatory body.
Frankly, this confuses me. How does having non-industry people on the Board and the NAC somehow ensure that FINRA is “independent?” Independent of whom? And, more to the point, what exactly does FINRA mean by independent?
Clearly, being independent, whatever it means, is something that FINRA constantly touts about itself. I picked up a piece of FINRA BrokerCheck propaganda yesterday while in the Dallas District Office for an OTR, and in the section called “More About FINRA,” it states in the very first sentence that “FINRA is an independent, non-government regulator.” Similarly, on its website, FINRA writes that it “is not part of the government. We’re an independent, not-for-profit organization authorized by Congress to protect America’s investors by making sure the securities industry operates fairly and honestly.” These pronouncements comport with my personal understanding that FINRA was independent in the sense that it is not part of the government. It has often been referred to as a quasi-governmental agency in that it answers to the government, specifically, the SEC, but it is not the government itself. The industry creates rule proposals, and the SEC has to approve or disapprove them. Thus, FINRA is, inarguably, independent of the government. So, what kind of independence is this new proposal referring to?
More importantly, assuming that having non-industry people in positions of management somehow creates independence for FINRA, what is the big deal about that sort of independence anyway? FINRA is a self-regulatory organization, formed as a result of a 1940 Act of Congress designed to permit broker-dealers to create their own entities to regulate their own conduct, a/k/a self-regulation. To govern broker-dealers effectively, it would seem to be necessary to be able to understand what broker-dealers do, how they operate, the challenges they face, and what it takes to deal with those challenges in the real world, not the theoretical world of rule-makers. Given that, how do non-industry members possibly help in this effort? I would gladly sacrifice the independence that non-industry members on the Board and the NAC supposedly provide in exchange for people actually knowledgeable about what my clients do for a living and the rules that FINRA is enforcing.
For instance, last week, I argued an appeal of a FINRA disciplinary decision to a two-person NAC subcommittee, only one of whom was associated with a broker-dealer; the other – a smart man, no doubt, and certainly respectful of me and my arguments – was a college professor who had never been registered. The case was principally about AML issues, whether my client had been sensitive enough to certain alleged red flags, and whether it responded appropriately. My appeal focused on many details of everyday life at a broker-dealer, such as the account opening process, the review of customer background information, the approval of trading activity in customer accounts, interactions with a clearing firm, etc. Making that argument to someone who had never, even once, done any of those things, struck me as the antithesis of self-regulation. How could he possibly understand what would be reasonable, and what would be unreasonable?
The whole point of FINRA being a self-regulatory organization is that broker-dealers are judged by their peers, who (theoretically, anyway) understand what really goes on, i.e, the difficult balancing act BD’s attempt every day to achieve compliance, at such high costs in terms of time and money, in a for-profit world. Seems to me that FINRA ought to be less concerned about its supposed independence, stop denying its provenance as a self-regulatory organization created by broker-dealers (and the people who work for broker-dealers, which, as I understand it, does not include college professors), and strive harder to fulfill its original statutory mandate.