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April 1, 2014

In the CARDS

FINRA's use of broker data to protect investors is under attack: Are they protecting investors or covering for bad brokers?

By Robert Stowsky

The Financial Industry Regulatory Authority, better known as FINRA, has come under some scrutiny in the past few weeks for how it uses and plans to use data. As the self-regulatory organization for the securities industry, FINRA monitors daily trading activity, oversees licensing of brokers and brokerage firms that make up its membership, and both sets rules for conduct and operations and enforces those rules through fines and other disciplinary actions.

FINRA relies on a combination of electronic submission of trade reports and self-reporting by its members to detect inappropriate activities. It is looking to expand its electronic surveillance at the same time it is coming under fire for how it maintains its records on individual brokers.

FINRA currently conducts a voluntary survey of its members called the Risk Control Assessment "to better understand the business activities that individual member firms engage in, the products and services they sell, and the kinds of clients and counterparties they deal with," according to its website. The SRO is now proposing an electronic system called the Comprehensive Automated Risk Data System. CARDS would require investment managers and custodians to submit client account holding information to FINRA directly. FINRA would then use this data to detect inappropriate activity on the part of brokers, such as selling improper investment products to their clients, or moving questionable business practices from firm to firm.

Some players are not happy with the CARDS game. A Feb. 20 Wall Street Journal article by Matthias Rieker reports that some brokers and investors see this as "an overreach" and "a huge invasion of privacy." There is also industry support for CARDS. The article quotes John Terry, the president of Hot Springs, Ark., investment advisory firm High Street Asset Management, as saying CARDS would give FINRA "a proactive tool to aid in the monitoring of client accounts, consistent with its mission of protecting the public from inappropriate or improper behavior of registered persons."

While FINRA is looking to expand its access to client data through CARDS, its BrokerCheck system designed for providing information about individual brokers to investors is being criticized for leaving out critical data regarding brokers' histories. Data for BrokerCheck comes from FINRA's Central Registration Depository. Two articles in the Wall Street Journal by Jean Eaglesham and Rob Barry highlighted faults in both how FINRA gathers and maintains the information it collects. In their March 5 article, Eaglesham and Barry compared BrokerCheck records to state regulators' records and court filings and found that more than 1,600 brokers had bankruptcies or criminal charges that weren't reported by FINRA. Brokers are required to report bankruptcy petitions filed in the last 10 years and any felony charges or convictions. In addition to a number of unreported bankruptcy filings, Eaglesham and Barry found that dozens of brokers with criminal records that did not require reporting under FINRA rules.