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One-Man Think Tank: Six reasons that FINRA should be dismantled

Insuperable issue: Each FINRA firm has an equity interest in FINRA - and would be entitled to a slice of its billion-dollar war chest

Wednesday, July 14, 2010 – 5:10 AM by Ron Rhoades, Columnist
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Ron Rhoades: It is time for FINRA to be dismantled.

1. Many RIAs desire more frequent inspections by the SEC or their state regulator. Why? To stop fraud before it grows too big. Regardless of whether the SEC and/or FINRA was at fault in failing to stop Madoff, Stanford, and other recently discovered frauds early on, the uncovering of massive fraud destroys investors’ trust in the capital markets, generally, and trust by investors in all financial advisors. A robust inspection regime is – despite FINRA’s assertions to the contrary – actually requested by RIAs. Hence the general RIA community support for increased funding of the SEC.

2. FINRA has long sought to oppose the application of the fiduciary standard to the investment advisory activities of BDs. See FINRA’s comment letters on the BD fee based accounts rule (authored by 2 now SEC commissioners). See also FINRA’s efforts to expand the 'solely incidental’ phrase meaning to the point where the BD exemption absorbs the rule (SEC September 2007 proposed 'two hats’ rule).

3. FINRA now seeks to falsely 'embrace’ the fiduciary standard, in hopes of watering it down. Witness FINRA’s support of a new 'universal standard of care’ – which, as I wrote in an April column, lacks any justification. FINRA fails to submit any good reason why the current fiduciary standard should be abandoned in favor of a standard which – although touted as a 'new federal fiduciary standard’ – is anything but.

4. At its core, FINRA’s members are BD firms – and its governing board is dominated by them. A fiduciary standard will not survive if administered by an organization representing commercial interests. It takes the leadership and courage of individuals – professionals – who don’t answer to the profit motives of a wirehouse firm’s shareholders – to enable a fiduciary standard to remain true and, to paraphrase Justice Cardoza, not be 'denigrated’ over time by the emergence or expansion or 'particular exceptions.’ (A recent example – FINRA’s support for the principal trading expansion temporary rule).

5. Despite the Maloney Act’s expressed desire that BD firm standards evolve over time to the highest levels, the profit interests of investment banks and BD firms have kept the main standard of conduct registered representatives possess with respect to their customers at the very low level of suitability (in which caveat emptor still applies in the arms-length relationship) – for seven decades.

6. A principles-based fiduciary regime does not require the myriad of specific rules FINRA is used to promulgating.

Could FINRA change? Could its members become individuals – not firms? (A necessary first step.) No – because each FINRA firm has an equity interest in FINRA – and would be entitled to a slice of FINRA’s billion-dollar war chest (built largely from fines imposed upon its member firms – which should have flowed to the public coffers under a rational regulatory regime, instead of indirectly benefiting the very firms fined.)

More importantly, the FINRA culture would be nearly impossible to change. As evidence of this, many fee-only RIAs I have spoken to have hired former registered representatives, but then dismissed them. Why? Because what 'best interests’ means to a true fiduciary – always adopting the client’s ends as your own – is a concept few former product salespeople can grasp. Similarly, it would be nearly impossible to instill a fiduciary culture into FINRA.

(Unfortunately, the SEC staff largely adopts the FINRA view of fiduciary duties – i.e., do almost anything you want to the client as long as you disclose the existence of a conflict. True fiduciaries know that the fiduciary duty of loyalty means acting as the client’s trusted advisor and representative – and that regardless of disclosure of a conflict of interest, no client would ever truly provide INFORMED consent if the proposed action was not the best choice available to the client.)


FINRA is viewed as evil by many RIAs, as it had long sought to have BDs perform the same functions as RIAs, but under a lesser standard of conduct. Economist George Akerloff won a Nobel Prize for the economic theory which demonstrates that this is a bad idea … if FINRA is successful, consumers will turn to financial advisors less and less. Unable to distinguish a good advisor from one not governed by the highest standard of conduct under the law, consumers will ignore financial advisors altogether. There is already substantial evidence this is occurring.

The solution is for all investment and financial advisors to be held to the highest standard of conduct …. one which robustly enforced by a regulator which understands the standard and seeks to constantly maintain and enhance the standard, not diminish it.

The challenge for the RIA and financial planning community is to find a way to come together and present, in unified fashion, an alternative to FINRA oversight – either robust SEC and state securities regulator direct oversight of all BDs and RIAs and their representatives, or aided in some fashion by a Professional Regulatory Organization (PRO) whose individual members embrace the true fiduciary standard.

In my view, FINRA should not possess any role in the regulation or oversight of the market conduct of RIAs, BDs, stock analysts, etc. We have just seen what happened – greed-driven industry practices fostered by FINRA’s role in protecting the profits of it’s own member firms, leading to this Great Recession. It is time for FINRA to be dismantled, and for its rule making and oversight functions to be transferred to an organization which embraces the highest standard of conduct under the law – the bona fide fiduciary standard- for those entrusted with other people’s money.

Stephen Winks

Stephen Winks

July 14, 2010 — 11:51 AM

Absolutely Brillant! Ron has definitively made the arguement for advisory services regulation which precludes FINRA governance.

Who could disagree?


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