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. On its website, FINRA describes itself as an independent, not-for-profit organization authorized by Congress to protect Americas investors by making sure the securities industry operates fairly and honestly. 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 presidentof 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, consistentwith its mission of protecting the public from inappropriate or improper behavior of registeredpersons.
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 FINRAs 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 werent 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. These included criminal charges for assault, sexual contact without consent, hit-and-run and habitual substance abuse.
On March 6, Eaglesham and Barry reported on a study conducted by the Public Investors Arbitration Bar Association that concluded that FINRA was scrubbing potential black marks from the information it provided to investors. The PIABA study stated that FINRA removed information from BrokerCheck that included previously failed industry-qualification exams, federal tax liens that have now been satisfied and personal-bankruptcy filings that are more than 10 years old. Like the Wall Street Journal investigation, the PIABA study also found that information available from state regulators that could not be accessed from BrokerCheck included information on whether a broker was ever under internal review for fraud or wrongful taking of property, or violating investment-related statutes, regulations, rules or industry standards of conduct.
In response, FINRA says it has had to make some tough decisions concerning broker disclosure. The SRO states that they have to make determinations on what information about registered representatives is appropriate to release, while at the same time balancing fairness rather than ignoring it.FINRA also adds that they have and for many years, encouraged investors to both use BrokerCheck and consult their state securities regulator before doing business with an investment professional.”
That said, both Journal articles imply a correlation between brokers personal behavior and possible criminal behavior on the job. In the age of Big Data, its only a matter of time before someone connects the BrokerCheck data with the data publicly available from state regulators and court records. Combining this data with FINRAs proposed CARDS system would greatly enhance FINRAs ability to fulfill its stated mission of investor protection and market integrity.
Robert Stowsky is a former analyst with Aite Group and has rejoined Brook Path Partners.
