Can you imagine a world where your investment advisor could tell you pretty much anything and get away with it? Believe it or not, that was the world investors lived in just a couple of decades ago.
In the early days of the stock market, industry membership organizations worked to self-regulate the behavior of brokers, but there simply wasn’t enough oversight. With so much in the hands of the U.S. Securities and Exchange Commission (SEC), big issues began to fall through the cracks.
In fact, former SEC chairman Christopher Cox conceded in a September 2008 statement to The New York Times that years of flawed oversight and “voluntary regulation” were partly to blame for the 2008 financial crisis.
The good news was that in 2007 — one year before the collapse — the Financial Industry Regulatory Authority, or FINRA, had been created to help oversee the financial industry.
What Is FINRA?
FINRA is a private, not-for-profit organization that regulates certain aspects of the securities industry.
The self-regulatory nature of FINRA means that regulation is completed through its members, who also happen to be the parties being regulated. Nonetheless, the system has worked well since its foundation in 2007.
The biggest difference between FINRA and the regulatory authorities of the past is that FINRA regulation is a requirement, not a badge that you can voluntarily put on your firm. If an entity wants to be a securities broker or broker-dealer in the United States, it must first receive approval to do so from FINRA.
Moreover, when a broker or broker-dealer takes part in the sale of securities, they are subject to oversight by FINRA that cannot be opted out of, unlike the voluntary regulation model of the past.
What Does FINRA Do?
Put simply, FINRA is charged with keeping the financial markets safe by maintaining the integrity of brokers and broker-dealers. The organization works closely with the SEC to complete four main tasks, according to the FINRA website:
- Write and Enforce Rules. The rules written and enforced by FINRA are designed to govern the ethical activities of all registered broker-dealers and registered brokers in the United States. The rules dictate who can sell securities to investors, how those securities can be sold, and how investments should be managed to maintain ethics and fairness in the stock market.
- Examine Firms for Compliance With Rules. FINRA also keeps close tabs on brokers and broker-dealers in the United States to ensure they follow the rules set forth to maintain an ethical market. When brokers and broker-dealers do not follow the rules, stiff financial penalties and the potential for expulsion from the investing community can result.
- Foster Market Transparency. Ultimately, FINRA aims to make sure that investors have all information required to make educated financial decisions, and that the information at their fingertips is accurate. In particular, FINRA’s primary interest is ensuring that brokers and broker-dealers share both adequate and accurate financial information about the investment opportunities they propose.
- Educate Investors. Finally, FINRA aims to educate investors, ensuring that they are aware of how they should be treated by their brokers and the information that should be made available to them prior to an investment being made.
On its website, FINRA provides an example of what they do. Just a few weeks after her husband passed away, an elderly widow was victimized by her broker, who placed more than 700 trades in more than 200 different securities, costing the widow around $184,000.
When this took place, FINRA stepped in, charging the broker with securities fraud and excessive and unsuitable trading in the client’s account. Not only did this action stop the woman’s further victimization, but it also ensured that the broker would not be able to take advantage of other investors in the future.
Why Was FINRA Formed?
In the late 1990s and early 2000s, technology was ushering in a stock market revolution. Access to the market was expanding, and money was flying. At the time, there was regulation, but not like there is today.
Brokers and broker-dealers could opt into National Association of Securities Dealers (NASD) Regulation or New York Stock Exchange (NYSE) Regulation — the two voluntary regulatory authorities at the time — but no regulation was mandatory. This greatly reduced the efficacy these regulatory bodies had in maintaining a fair market.
As a result, fraud was commonplace. Underinformed investors were being defrauded by their brokers and broker-dealers, losing significant amounts of money in the process.
In combination with the subprime mortgage debacle, the rampant fraud of the day led to a loss of faith in the stock market and the great financial recession of 2008.
The leaders of the NASD and NYSE regulatory authorities saw the issue coming and were determined to make a difference. To do so, the two organizations proposed a merger.
A larger regulatory authority with oversight of more brokers and broker-dealers would surely cut down on fraud and excessive or harmful investment activities in the market. On July 30, 2007, the SEC approved the combination of these two voluntary regulatory authorities, creating FINRA as it’s known today.
Upon its formation, FINRA became a nongovernment regulatory organization with oversight of 5,000 firms, 666,000 registered representatives, and 3,000 employees, making it the largest nongovernmental regulatory organization in the United States.
Unfortunately, its formation was too late to prevent the financial crisis and the Great Recession that began unfolding in late 2007. Damage done years prior would lead the U.S. and the rest of the world’s developed nations down a path of extreme economic hardship.
Penalties Imposed by FINRA
FINRA is not an extension of the U.S. government, but it has many powers that allow it to regulate effectively.
Although FINRA cannot file charges against fraudsters, the regulatory authority has referred more than 800 fraud and insider trading cases to the SEC and other agencies for litigation and prosecution.
And FINRA does far more than just suggest that charges be filed against fraudsters.
In its history of just over a decade, FINRA has brought 854 disciplinary actions against registered brokers and firms for unethical behavior. These actions have involved the authority levying more than $39 million in fines and orders to pay nearly $28 million in restitution back to harmed investors.
FINRA also has the ability to damage the career opportunities of wrongdoers. In order to be a broker or broker-dealer in the United States, you must register with FINRA.
However, if you have a checkered past in the securities industry, FINRA will deny your registration, making it impossible to work as a financial advisor for a broker or to open a brokerage or broker-dealer.
Moreover, FINRA can also ban executives from holding C-suite positions at any publicly traded company. So, it’s fair to say that fraudsters who cross FINRA’s lines will likely pay for their actions for years to come — both financially and professionally.
How FINRA Differs From the SEC
There are a few key differences between FINRA and the SEC that are important to understand. These include:
- FINRA Is Part of the United States Government. The SEC is an arm of the federal government; FINRA is not. As a result, the SEC has the ability to regulate the investing actions of any investor, publicly traded company, or professional financial service provider in the United States. Conversely, FINRA only has the ability to regulate its members.
- FINRA Is Under the Purview of the SEC. The SEC is the top investing authority in the United States. As a result, FINRA is under the purview of the SEC, not the other way around.
- FINRA Regulates Brokers and Broker-Dealers. FINRA and the SEC differ greatly in the types of offenses they look for to maintain a fair and equitable market. FINRA is specifically interested in brokers, broker-dealers, and publicly traded companies. In other words, the regulatory authority only tracks those who have the ability to sell shares of securities to the public. The SEC is charged with regulating all market activity. However, because of the help provided by FINRA, the SEC is most focused on individual and institutional investors.
By balancing responsibilities between FINRA and the SEC, the two regulatory authorities have made the securities market a far safer place for your investing dollars to be.
How to Report Misconduct to FINRA
Although FINRA actively oversees activity in the stock market, no single authority has the ability to see everything that happens in the market at all times.
It makes the job of regulatory authorities more effective when the investing public takes part in regulation. You can do your part by reporting any misconduct you come across in your investing activities.
If you believe that a broker, broker-dealer, or publicly traded company is spreading misleading information in an attempt to sell shares or taking part in any other fraudulent activity, you can report this activity in the following ways:
- File an Online Complaint. FINRA makes it easy to inform them of wrongdoing on their website. FINRA’s website explains the steps to take in order to file a complaint.
- Call FINRA Directly. If you would rather speak to a human being, you can call FINRA’s Whistleblower Tip Line directly with your complaint at 866-963-4672 in the U.S. or +1-646-315-7293 outside the U.S.
If you’re considering making a complaint to FINRA, there are a couple of steps that you should take first:
- Contact the Other Party. Prior to submitting your complaint to FINRA, you should always give the broker, broker-dealer, or publicly traded company an opportunity to defend their position. So, call the party that the complaint is about to see if there is a misunderstanding that can be resolved with a simple conversation. This helps to keep unnecessary cases that clutter the system out of the complaints log.
- Read the Complaint Brochure. FINRA offers a brochure about its investor complaints program. Before making a complaint, it’s a good idea to read this brochure to ensure that your complaint is valid and that you understand how the process works.
If FINRA and the SEC did not exist, the stock market would still be the Wild West. History has shown that voluntarily regulated systems and systems without regulation simply do not work.
Although the SEC alone has made a huge difference since the days of the Great Depression, the addition of FINRA in the early 2000s has made the United States equities market a far safer place to invest.
While you invest, keep in mind that FINRA and the SEC are most effective at keeping your money safe when the investing community gets involved.
So, if you see any wrongdoing by a broker, broker-dealer, or publicly traded company, don’t hesitate to follow the appropriate steps to bring the potential fraud to the attention of FINRA — or to the SEC if the fraud is an act by an individual or institutional investor.