Brokerage regulator’s portfolio, practices remain secret

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Watchdog groups have long called for more oversight of the Financial Industry Regulatory Authority (FINRA), a quasi-governmental, self-regulatory organization that polices thousands of broker-dealers. Even FINRA’s own members have approved seven proposals that would require FINRA’s board to be more transparent – but the non-binding votes have been ignored.

FINRA assists the Securities and Exchange Commission in regulating brokerages, but as a self-regulatory organization (SRO) it is exempt from open record and disclosure laws that other government agencies must follow. Critics say it is too cozy with the securities firms it regulates, has inherent conflicts of interest, and has a poor track record in failing to detect wrongdoing in high-profile cases such as those involving Bernard Madoff and Allen Stanford.

FINRA, which is funded by the same entities it regulates, has about $1.4 billion in total equity but does not disclose any of its investments. The purpose of the investment portfolio is to support FINRA operations since it is not a government agency that receives funds from Congress, said a FINRA spokesman.

“What is a regulator doing holding this type of investment anyway? SROs and most regulators have assets in U.S. Treasury bills to avoid conflict of interest,” says Sense of Cents blogger Larry Doyle. A longtime critic of FINRA, Doyle helped break the news that FINRA sold its auction rate securities in 2007 — well before that market froze in March 2008 and without alerting the investors it is supposed to protect.

Advocacy groups and some brokerage dealers under FINRA’s authority have called for it to release its investment policies, practices, and transactions. More importantly, they want to find out if FINRA invests in — or gets investment advice from — any of the entities it regulates.

FINRA asserts that its investments must remain confidential to avoid any appearance of favoritism. “There is danger in looking like were endorsing a certain investment over another. We don’t want to look like were putting a ‘Good Housekeeping Seal of Approval’ on certain advisors,” says Howard Schloss, the head of corporate communications at FINRA.

The Project for Government Oversight also complains that FINRA’s board gives lavish pay packages to its executives. In 2008, a year in which FINRA lost $568 million in its investment portfolio, its top 20 executives received nearly $30 million in salaries and bonuses, POGO said.

Advocacy groups are also worried that FINRA may become a model for the creation of additional SROs to oversee U.S. hedge funds and investment advisers. The new Dodd-Frank financial reform law orders the Government Accountability Office to study the feasibility of an SRO to oversee hedge funds and other private funds, and it also instructs the SEC to review if an SRO would be helpful in policing investment advisers.

According to POGO’s Michael Smallberger, the SEC currently has the manpower to examine only about 1 out of every 10 investment advisors. The SEC may be eager to shift oversight of investment advisors to another entity so that it could use its funding and staff for other investor-protection matters.

Another concern: The revolving door between FINRA and the SEC. Current SEC chairman Mary Schapiro is a former senior executive at FINRA, where she earned more than $3 million a year.

Schapiro was also among several FINRA officials sued for allegedly misleading brokers about the merger between FINRA’s predecessors, the National Association of Securities Dealers and the regulatory unit of the New York Stock Exchange. The lawsuits were thrown out by U.S. Judge Jed Rakoff in New York earlier this year on the grounds that the organizations were entitled to “absolute immunity” from damages because they were acting within the scope of their regulatory responsibilities.

“Certainly over time, there are individuals that came from the SEC to FINRA and vice versa. The organizations share a common mission, and people that have experience in securities regulation are candidates for either organization,” said FINRA’s Schloss.

UPDATE — 9/24/10: In a previous version of this article, we incorrectly reported that FINRA has about $6 billion in shareholder equity. The organization actually has $1.4 billion in total equity.

ABOUT THE DATA

What: Investment portfolio of the Financial Industry Regulatory Authority, a self-regulator organization that polices brokerages.

Where: Not public.

Availability: FINRA has no plans to make the information public on its website, which publishes disciplinary actions, names of registered firms, and annual reports.

The Data Mine is a joint project of the Center for Public Integrity and the Sunlight Foundation.

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