On January 6, 2015, the Financial Industry Regulatory Authority (FINRA) published its tenth annual Regulatory and Examinations Priorities Letter. In that letter, FINRA identified five areas, which it described as “recurring challenges,” that have harmed investors and resulted in compliance and supervisory breakdowns at member firms. At the top of FINRA’s list of problem areas is the continuing failure of some brokerage firms and their registered representatives to put customer interests ahead of their own. Here is how FINRA described this recurring problem:
“Putting customer interests first: A central failing FINRA has observed is firms not putting customers’ interests first. The harm caused by this failure may be compounded when it involves vulnerable investors (e.g., senior investors) or a major liquidity or wealth event in an investor’s life (e.g., an inheritance or Individual Retirement Account rollover). Poor advice and investments in these situations can have especially devastating and lasting consequences for the investor. Irrespective of whether a firm must meet a suitability or fiduciary standard, FINRA believes that firms best serve their customers – and reduce their regulatory risk – by putting customers’ interests first. This requires the firm to align its interests with those of its customers.”
This central failing is related to, and sometimes caused by, the other four recurring problem areas that FINRA identified: firm culture; supervision, risk management and controls; product and service offerings; and conflicts of interest. “Many of the problems we have observed in the financial services industry have their roots in firm culture” – i.e., a poor culture in which top management tolerates or even encourages improper sales practices and lax supervision. Fee and compensation structures that incentivize brokers to push certain products continue to lie at the heart of many conflicts of interest, according to FINRA. For example, high-commission, complex investment products with misleading “teaser rates” are often sold to investors by brokers who do not fully understand the risks of the product, and, therefore, do not disclose those risks to the investor.
The financial services industry, by and large, has not addressed these problems to the satisfaction of its own self-regulatory organization (FINRA). FINRA has proposed a rule to help it detect sales practice violations by brokers, called the Comprehensive Automated Risk Data System (CARDS). Under CARDS, firms would be required to periodically submit to FINRA data relating to securities and account transactions, holdings, and account profile information, excluding personal identifying information. The financial services industry is so upset about CARDS that it is going to war with FINRA over the proposed rule. See New York Times article entitled “In Push for Change, Finra Is Opposed by the Wall St. Firms It Regulates.”
Its argument is that CARDS would expose customers’ personal identifying information to security breaches via reverse engineering, even though CARDS would not collect such personal identifying information. Fred H. Cate, a senior fellow at the Center for Applied Cybersecurity Research at Indiana University in Bloomington, was quoted as saying that, while there were some valid concerns about data security, “it felt to me like an industry that doesn’t want to comply with the rules, sort of dragging out every argument it could think of, as opposed to focusing on what practical steps could be included to be sure information is secure.”
The message for the public is clear – the financial services industry does not want to be forced to put investors’ interests ahead of its own, and does not want FINRA to be an effective regulator.