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FINRA's scandalous litany of failures and its efforts to redefine the true fiduciary standard out of existence

Our one-man think tank continues his scathing indictment of the SRO's disingenuous and downright fraudulent practices

Wednesday, July 17, 2013 – 3:10 AM by Guest Columnist Ron Rhoades
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Ron Rhoades: Shouldn't the phrase: 'member, FINRA' be viewed like the warnings on cigarette packages -- i.e., as a consumer warning sign?

Dina’s Note: In this third installment of a remarkable four-part series, Ron Rhoades continues to make — passionately — his case against FINRA, detailing what he sees as its crimes and misdemeanors against the advisory profession, a true fiduciary standard and, by extension, against U.S. investors and the health of the economy. See: Why FINRA’s power grab for RIAs needs to be stopped to avert the death of the profession, Part 1). Stay tuned for the last chapter in which Ron, having diagnosed the malady prescribes the cure: the establishment of a professional regulatory organization that will keep the interests of the public paramount.

“Americans are angry at Wall Street, and rightly so. First the financial industry plunged us into economic crisis, then it was bailed out at taxpayer expense. And now, with the economy still deeply depressed, the industry is paying itself gigantic bonuses. If you aren’t outraged, you haven’t been paying attention.” Paul Krugman, “Rewarding Bad Actors”, The New York Times, Aug. 3, 2009

Here we stand, more than seven decades after the creation of what is now the Financial Industry Regulatory Authority Inc., and we see that it has resisted nearly every attempt to raise the standards of conduct for its members above the low standard of suitability. The organization has completely neglected its mission to protect consumers, and instead has fostered conflict-ridden business practices and the lax regulation of its members. To observe these failures one need only view this litany of failures by FINRA. See: The suitability standard, defined. (See: An in-depth analysis of FINRA’s attempted takeover of RIAs and why the group should be disbanded, Part 2)

FINRA’s opposition to broker vs. dealer segregation

The 1936 Securities Market study recommended a complete separation of the functions of broker and dealer. Another study by the SEC conducted later that year also recommended further study of the possibility of separation of broker and dealer functions, with the SEC conceding “that some of the abuses in the securities industry are the direct result of the combination of broker and dealer functions: namely, the inducement of brokerage customers to buy the securities which the broker-dealer had underwritten or in which he has a trading position; the persuasion of a customer to sell good securities in order to buy securities in which the dealer has an interest and the difficulty for the unsophisticated customer in distinguishing between the two functions and their implications.” However, under intense pressure from FINRA and its member firms, this separation of function was never achieved. See: Ron Rhoades is a lawyer and RIA with no back-down; the VA industry is finding that out in a hurry.

Troubles continue today for even sophisticated investors in protecting themselves when dealing with brokers who also act as dealers. There is an inherent conflict of interest in functioning as both a dealer (and trading for its own account, as well) and as a broker; one need only recall the recent sale by Goldman Sachs & Co. Inc. to its customers of mortgage-backed securities it manufactured, while simultaneously making bets that these securities would fail. Goldman Sachs executives’ recent testimony to Congress revealed the confusion customers of the firm faced, as these executives professed that the firm acted in the “best interests” of their customers as a broker, yet also defended their ability to manufacture and sell “sh***ty products.” See: No eff-ing way: Goldman professionals can’t email profanely?.

(Goldman Sachs chief executive Lloyd Blankfein, in his prewritten statement to the U.S. Senate before hearings on April 26, 2010, denied any wrongdoing by his firm. “We have been a client-centered firm for 140 years, and if our clients believe that we don’t deserve their trust, we cannot survive,” he said. “We certainly did not bet against our clients.” Yet Sen. Carl Levin, D-Mich., chairman of the Senate Homeland Securities and Government Affairs Permanent Subcommittee on Investigations, pointed out an e-mail in which execs described one of their failing investments as a “shi**ty deal.” See: Goldman Sachs settles to make its scandal die, and Congress passes financial services reform. What does it mean for RIAs? Not much, yet..)

Early in the 1940s, shortly after its formation, FINRA (then the National Association of Securities Dealers) hailed its achievement in preventing the possible mandated split of “dealer” (including investment underwriting) functions from the functions of a broker (i.e., undertaking trades as an agent). “Mr. Wallace H. Fulton, in his address on the 20th anniversary of the NASD, considered the successful combating of the segregation proposals as one of the chief achievements of the NASD.”

This author believes that FINRA’s actions to preserve the existence of brokerage and dealer functions within the same firm is not an achievement, but one of FINRA’s colossal failures and a cause for many of the ills that pervade U.S. financial services today.

FINRA defended price-fixing by its member firms

NASD/FINRA failed to prevent — and even defended — the price-fixing activities of its market-making member firms in the mid-1990s. Former SEC Chairman Arthur Levitt stated that the evidence showed FINRA “did not fulfill its most basic responsibilities” and concluded that by FINRA’s failure “American investors — large and small, sophisticated and inexperienced, institutional and individual — all were hurt by these practices.” Levitt further stated that FINRA was “the cop on the beat” that “simply looked the other way.”

FINRA abets fraudulent use of titles and descriptors

FINRA continues to permit its members and their registered representatives to use the titles “financial consultant,” “financial advisor,” and “wealth manager.” Yet, these terms infer a relationship based upon trust and confidence, when such relationship of trust and confidence is later denied by the broker-dealer and its registered representative.

FINRA has the ability to combat fraud by its member broker-dealer firms and their registered representatives. Securities Exchange Act Section 15A(b)(6) requires that the rules of an association be designed to promote just and equitable principles of trade. FINRA satisfies this statutory requirement in part through FINRA Rule 2010, which reads: “A member, in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.”

The SEC has held that FINRA’s authority under Rule 2010 relating to “just and equitable principles of trade” permits FINRA to sanction member firms and associated persons for a variety of unlawful or unethical activities, including those that do not implicate “securities.”

Additionally, Securities Exchange Act Section 15© prohibits any broker-dealer firm from effecting any transaction in or inducing or attempting to induce the purchase or sale of any security by means of any manipulative, deceptive or other fraudulent device or contrivance. Under this prohibition, broker-dealers are precluded from making material omissions or misrepresentations and from any act, practice, or course of business that constitutes a manipulative, deceptive, or other fraudulent device or contrivance. (Emphases added.,)

This year Gil Weinreich, editor of Research magazine, quoted Boston-based Dalbar Inc.'s CEO, Lou Harvey. as stating: “Imagine, for example, if anyone could describe themselves as 'doctor’ or 'attorney’ but the real ones were 'fiduciary doctor’ and 'fiduciary attorney’...” The article goes on to state: “The heart of Harvey’s proposal is to restrict the use of the word 'advisor’ (or 'adviser’) to fiduciaries alone, leading to prosecution for non-fiduciaries using that label.”

At the fi360 Annual Conference in April 2013, Skip Schweiss, president of TD Ameritrade Trust Co., pointed out Lou Harvey’s suggestion during a panel discussion in which this author participated. Schweiss also suggested that anyone calling himself or herself a “financial advisor” or “financial consultant” be held to the fiduciary standard of conduct.

The view that one holding out as an advisor should be governed by the fiduciary standard of conduct finds recent support in academic literature: “The relationship between a customer and the financial practitioner should govern the nature of their mutual ethical obligations. Where the fundamental nature of the relationship is one in which customer depends on the practitioner to craft solutions for the customer’s financial problems, the ethical standard should be a fiduciary one that the advice is in the best interest of the customer. To do otherwise — to give biased advice with the aura of advice in the customer’s best interest — is fraud. This standard should apply regardless of whether the advice givers call themselves advisors, advisers, brokers, consultants, managers or planners.“ [Emphasis added.]

There exists authority, as well, on the inappropriate use of titles, from the SEC itself. Very early on the SEC took a hard line on representations made by brokers. In its 1940 annual report, it noted: “If the transaction is in reality an arm’s-length transaction between the securities house and its customer, then the securities house is not subject to a fiduciary duty. However, the necessity for a transaction to be really at arm’s-length in order to escape fiduciary obligations has been well stated by the U.S. Court of Appeals for the District of Columbia [Circuit] in a recently decided case: '[T]he old line should be held fast which marks off the obligation of confidence and conscience from the temptation induced by self-interest. He who would deal at arm’s length must stand at arm’s length. And he must do so openly as an adversary, not disguised as confidant and protector. He cannot commingle his trusteeship with merchandizing on his own account…'” [Emphasis added.]

Additionally, in its 1963 comprehensive report on the securities industry, the SEC stated that it had “held that where a relationship of trust and confidence has been developed between a broker-dealer and his customer so that the customer relies on his advice, a fiduciary relationship exists, imposing a particular duty to act in the customer’s best interests and to disclose any interest the broker-dealer may have in transactions he effects for his customer …[B-D advertising] may create an atmosphere of trust and confidence, encouraging full reliance on broker-dealers and their registered representatives as professional advisers in situations where such reliance is not merited, and obscuring the merchandising aspects of the retail securities business ... Where the relationship between the customer and broker is such that the former relies in whole or in part on the advice and recommendations of the latter, the salesman is, in effect, an investment adviser, and some of the aspects of a fiduciary relationship arise between the parties.”. [Emphasis added.]

The fact that misrepresentations of one’s status amounts to fraud is reflected in a recent regulatory action filed by the Illinois attorney general in an action seeking civil penalties against Mr. Richard Lee Van Dyke, Jr. (a.k.a. “Dick Van Dyke”), a seller of fixed indexed annuities. Mr. Van Dyke is alleged to have stated in advertising: “If you want a successful financial plan, you need a financial advisor you can really trust … He believes in principles like full disclosure and transparency and he doesn’t sell investments on commission which means he’s on your side so you get to reach your goals first before he does. When’s the last time an investment advisor put you first?”

The basis of the complaint is a violation of Illinois’ Consumer Fraud and Deceptive Business Practices Act. The attorney general’s complaint notes: “The representations cited above, on which defendants intend consumers will rely, as well as others on defendants’ website, lead consumers to believe defendant Dick Van Dyke is an objective, knowledgeable and unbiased financial services expert for consumers facing retirement, when in fact he is an insurance salesman.”

As a result of regulatory missteps by FINRA over many decades, substantial consumer confusion now abounds as to the standard of conduct consumers can expect from their providers of investment advice. In large part this is due to the improper use of titles by registered representatives, which, as discussed above, rises in the view of many to the level of intentional misrepresentation (i.e., fraud). Yet FINRA does nothing to prevent such fraud from occurring. See: An RIA that paid the price for falling for the Bayou scam speaks out.

FINRA permits the use of the fraudulent term 'fee-based’

As knowledgeable consumers became more aware that true fiduciary advisors, with few conflicts of interest, were available, Wall Street redoubled its efforts to obfuscate and confuse consumers, in a valiant but ill-advised attempt to preserve its archaic business model.

The past few decades have seen a small but now significant rise in the number of fee-only financial advisors, such as those who are members of the National Association of Personal Financial Advisors — NAPFA — and/or those advisors who are members of the Garrett Planning Network Inc. These personal financial advisors eschew all commissions and material third-party compensation paid by product manufacturers (including 12(b)-1 fees). Instead, they choose to accept reasonable fees paid directly by the clients. See: One-Man Think Tank: The fiduciary standard may sink Wall Street’s advisors-on-yachts. Should we care?.

In this manner, they avoid many of the conflicts of interest found in Wall Street’s large broker-dealer firms. These independent, fee-only and fiduciary financial advisors act solely as the client’s representative, researching and then choosing far-lower-cost investments and investment products (and insurance products) for their clients.

Fee-only advisers continue to thrive within their own small universe of clients. Yet attracting tens of thousands more advisors to the “fee-only” trusted advisor space has been difficult. Why? The reasonable compensation these fee-only advisers receive is insufficient to fund promotional efforts sufficient in quantity to counter the huge marketing budgets of the broker-dealer firms. Wall Street’s marketing machine, fueled by the high diversion of returns from individual investors, is extremely powerful.

For example, in recent years Wall Street’s promotional machine has further confused consumers (and even advisors) by adopting the term “fee-based” to refer to advisors who receive both fees (paid by clients) and commissions (through product sales). Originally the term “fee-based” referred to fee-based brokerage accounts, which by virtue of a 2007 U.S. Court of Appeals decision were shut down. Following that decision, Wall Street firms embraced using the term “fee-based” to refer not to a type of account, but rather to many (if not most) of its dual registrants. See: 5 Reasons why the hybrid RIA model may be a bigger deal than ever.

FINRA failed to step in to warn that the use of “fee-based” to describe an advisor (as opposed to an account), where the advisor was also receiving commission-based compensation, is inherently misleading. While a dual registrant might accurately portray herself or himself as “commission-and-fee-based” or “fee-and-commission-based” (depending upon which form of compensation received was predominate), the exclusion of the word “commission” from the term “fee-based” is nothing more than an omission designed to mislead individual investors. since the term “fee-based advisor” is intended to obfuscate, confuse, and lead to greater business, the necessary intent requisite for actual fraud likely exists through the use of the term, at least in most instances.

In essence, the use of common or similar titles, and the high fees received by those operating under a conflict-ridden standard of conduct (which in turn funds Wall Street’s marketing efforts) results in the inability by consumers to distinguish higher-quality advisors from lower-quality advisors, leading to pernicious effects upon both consumers and true professionals alike. Of course, such insidious results are adored by Wall Street, as its preserves the archaic, conflict-ridden business model which extracts high levels of rent from individual investors and, indeed, from our economy.

Still today, FINRA, the regulator of its broker-dealer firm members, does nothing to stop this continued obfuscation by its member firms.

FINRA fails to oversee derivatives

FINRA failed to seek appropriate supervision of derivatives created and sold by its members, a regulatory oversight which was a substantial cause of the 2008-'09 Great Recession from which America still suffers today. FINRA has yet to be held accountable for these many failures to protect the public interest and the financial crisis caused by its failure to regulate its member firms.

A January 2010 report by the Alliance for Economic Stability, regarding NASD/FINRA’s failure, among others, to assure proper supervision of the over-the-counter derivatives market, detailed two other specific major failures by the SRO:

First, FINRA had the most expansive jurisdiction of any regulator. It can request whatever information it sees fit about its members’ business affairs or even personal affairs, without the same constraints of due process imposed upon government agencies. As such, it could have initiated investigations into the activities surrounding mortgage-backed securities. It failed to do so.

Second, FINRA failed to take any disciplinary action against Joseph Cassano from American International Group Inc.'s financial products division. Even if Cassano did not willfully intend to act as recklessly as he did, his behavior nonetheless shows a gross negligence that has had an impact upon the world financial system whose cost is beyond estimation. See: Larry Roth has AIG playing offense again in the advisor game.

According to the AES’ report, “The reason for FINRA not taking steps to address its apparent deficiencies is that FINRA serves to benefit the interests of its members. FINRA worked for the interests of its members to the detriment of the public in the price-fixing in the OTC stock market; it did the same in the OTC derivatives market; FINRA continues to do so now by not addressing its mistakes and toughening its rules.”

The Alliance for Economic Security concluded, in a Jan. 4, 2010, proposal for new FINRA rules, that “FINRA is not a reliable regulatory authority.”

The stock analyst conflict of interest scandals

FINRA failed to prohibit the promulgation of stock analyst conflicts of interests, leading to the many scandals of nearly a decade ago. Only actions by state securities regulators (finally joined by the SEC), resulting in a 2003 landmark settlement with 10 of the nation’s top broker-dealers, forced these Wall Street firms to address conflicts of interest between their equity research analysts and investment bankers.

However, FINRA’s rule making in this area continued to stall. A 2012 report by the Government Accountability Office found that “FINRA has not yet finalized its 2008 proposal designed to consolidate the SRO research analyst rules and implement recommendations made by NASD and NYSE staff in 2005 … FINRA staff, as well as most market participants and observers we interviewed, acknowledged that additional rule making is needed to protect investors, particularly retail investors. In that regard, until FINRA adopts a fixed-income research rule, investors continue to face a potential risk.”

FINRA’s opposition to a true fiduciary standard

Unlike the aloof stance expected of a regulatory organization, NASD/FINRA engaged in a decade-long advocacy promoting fee-based brokerage accounts without subjecting its members to the fiduciary standard of conduct required under the Advisers Act.

Indeed, in an April 4, 2005, comment letter to the SEC, Mary L. Schapiro and Elisse B. Walter, then vice chairman and president and executive vice president, respectively, of regulatory policy and oversight, FINRA even argued that its conduct rules were superior to broad fiduciary duties, stating:

“[T]he contours of an adviser’s 'fiduciary duty’ are imprecise and indeterminate. Indeed, these contours have been developed unevenly over time, and much of what the [Financial Planning Association] describes as an adviser’s fiduciary duty is more implied than expressed. This general, implied duty simply cannot afford retail investors with the same level of protection as the explicit regulatory standards governing the conduct of business as a broker-dealer, which are developed after extensive public comment and commission approval. In clearly articulating the obligations of a broker-dealer, SEC and NASD rules provide much better assurance that brokerage customers will be protected.” (Please …!) See: Obama makes 'really unfortunate’ appointment of Elisse Walter as new SEC chairman.

FINRA’s leading role in the financial crisis of 2008-'09

In 2008-'09, a massive financial crisis shook the United States and the world. Mortgage-backed securities created from toxic mortgages — the “shi**y products,” as Sen. Levin famously demeaned them in the Goldman Sachs hearings in April 2010 — became increasingly devalued. Wall Street’s investment banks made billions packaging toxic mortgages into pooled MBS investment vehicles, then selling them to unsuspecting investors — both institutional investors and individual consumers.

It is well-documented that the largest and most powerful FINRA members worked in the late 1990s to ensure that the over-the-counter derivatives market would be kept out of the purview of government agencies. Counter-party risk rose even further due to the prevalence of credit default swaps, the holdings of trillions of dollars of which made capital in the investment banks impossible to accurately judge, and credit markets froze.

As the financial crisis and its resulting Great Recession continued, hundreds of largely innocent community banks were seized. The larger investment banks, most with large broker-dealer organizations, were bailed out by Congress — and subsequently thrived and further expanded their already huge market share of the banking sector of the economy.

The cause of the financial crisis lay squarely in the hands of one regulator — the Financial Industry Regulatory Authority Inc., formed in 2007 by the merger of the NASD and the enforcement arm of the New York Stock Exchange.

At its core, FINRA was charged with the regulation of brokers and dealers, and their related business activities. Yet FINRA, being a membership organization heavily influenced by the same large Wall Street firms which it also regulated, largely ignored the mounting risks to America’s economic vitality and failed to regulate the market-making activities of its member broker-dealer firms. FINRA’s failure to perform its direct oversight duty led to the spectacular and costly collapse of two of its larger members, including the largest bankruptcy in U.S. history.

As the Alliance for Economic Stability, a nonpartisan economic policy organization dedicated to promoting a fair financial marketplace, subsequently observed: “FINRA, as an SRO, has the closest relationship with and most direct scrutiny of Wall Street investment banks. When these investment banks initiated discussions on policy regarding OTC derivatives in 1994, FINRA [then NASD] was in the best position among regulators to intercede and assure appropriate supervision. FINRA failed to do this, even after recommendations for oversight from the [General Accounting Office].”

The AES also noted that despite its expansive powers over broker-dealers, “FINRA failed to oversee the risks posed by OTC derivatives, though all transactions were carried out through FINRA member broker-dealers or their affiliates.”

Finally, the AES observed: “FINRA has shown itself to be inept at properly addressing gross negligence done by its members, even when that negligence impacts the entire world economy.”

FINRA’s role in the Madoff scandal

An internal report found that FINRA didn’t fully probe Bernard Madoff’s firm (despite inspecting it annually). When FINRA officials initially denied any wrongdoing in the failure to detect Madoff’s Ponzi scheme, John C. Coffee, a securities law scholar, said in his testimony before the Senate Banking Committee that “Madoff’s brokerage business was by definition within … FINRA’s jurisdiction.” See: SEC details new 'Madoff fix’ custody rules.

Additionally, in an internal report FINRA admitted that it repeatedly failed to investigate tips about R. Allen Stanford’s alleged $7 billion fraud.

FINRA misleads Congress

FINRA lay largely silent in the two years following the financial crisis, and by means of its silence largely escaped congressional scrutiny for its key role in effecting the financial crisis. But then, in 2011 and 2012, FINRA began to lobby Congress extensively for an expansion of FINRA’s powers, under the pretense that such an expansion would have prevented Madoff’s massive Ponzi scheme. Yet many industry observers noted that it was FINRA’s own failures as a regulator which enabled Madoff’s Ponzi scheme to grow to such massive proportions.

FINRA acknowledged that “Mr. Madoff engaged in deceptive and manipulative conduct for an extended period of time….” FINRA even acknowledged that during the 20 years before the Madoff scheme was revealed, “FINRA (or its predecessor, NASD) conducted regular exams of Madoff’s broker-dealer operations at least every other year.” Yet, instead of acknowledging its key failures, FINRA instead asserted that it “regulates broker-dealers, but not investment advisers,” and asserted that it could not have detected Madoff’s massive fraud.

But many industry observers note that FINRA’s own failures were largely responsible for enabling Madoff to perpetuate his fraud. As Coffee testified before Congress: “Prior to 2006, Madoff Securities was only a broker-dealer and not a registered investment adviser. Thus, during this period, I see no reason that FINRA (or at that time NASD) should have abstained from examining and monitoring the advisory side of Madoff Securities. This side was never formally separated in a different subsidiary; nor was it even geographically remote.”

Coffee continued: “Madoff Securities had no right or privilege to resist any inspection by NASD (or later FINRA) or to fail to provide information on the ground that its investment advisory business was exempt from NASD oversight. If it resisted on this ground, the NASD and FINRA had full power to discipline it severely. NASD Rule 8210 makes it clear beyond argument that NASD can require a member firm to permit NASD to inspect its books, records and accounts, and to provide other information. As NASD further advised its members in its Notice to Members 00-18 (March 2000): 'Implicit in Rule 8210 is the idea that the NASD establishes and controls the conditions under which the information is provided and the examinations are conducted.’”

Furthermore, as noted in the AES report: “In addition to Coffee’s testimony, Peter J. Chepucavage, general counsel at Plexus Consulting Group LLC; Pete Michaels, partner at Michaels Ward & Rabinovitz LLP; and Samuel Y. Edgerton, partner at Edgerton and Weaver LLP; all of whom are competent to opine on FINRA’s jurisdiction, have made statements concluding that FINRA had jurisdiction over Madoff.”

Over the 20-year span of its multiple examinations, all NASD/FINRA had to do was to ask Bernie Madoff one of two simple questions, which should have been discerned from even a cursory review of Madoff Securities’ operations: “Why is Madoff Securities not also registered as an investment adviser?” and “Where are all of the trades you state you make as an investment adviser?” (These trades didn’t show up in the records of Madoff Securities’ clearing arm, as would be expected.) See: Four questions that financial advisors and clients need to ask in a post-Madoff, post-meltdown era.

Even though Bernie Madoff’s investment scheme was uncovered in the year after Madoff Securities finally registered with the SEC as an investment adviser, Rep. Spencer Bachus (R-Ala.) bemoaned the “lack of oversight [of investment advisers] particularly in the aftermath of the Madoff scandal” in proposing a bill to effect FINRA’s power grab over investment advisers. In so doing, he perpetuated FINRA’s inappropriate characterization of the Madoff scandal as a “regulatory gap” — rather than, as so many experts have in essence opined, a colossal failure by FINRA itself. See: Why Bachus’ SRO-that-must-not-be-named would prove a tyrant to RIAs.

Many more scandals at FINRA’s doorstep

Through its lax regulatory practices and oversight, NASD/FINRA failed to prevent a number of other often-repeated industrywide scandals that have plagued the broker-dealer industry over the last decade — from the insider trading scandals to penny stocks, limited partnerships, sales of unsuitable mutual fund share classes and inappropriate sales of auction-rate securities. See: The New York Times exposes JPMorgan’s brokers, yet again.

FINRA’s fines support its members

When FINRA does act against its member firms, the fines it imposed on them are paid to FINRA — to fund FINRA’s activities itself. In essence, its member firms indirectly benefit from their own fines, which serve to lower the annual fees the firms pay for their “self-regulation.”

FINRA lied to the SEC

In 2011 the SEC stated that FINRA provided “altered documents” during SEC inspections. According to the SEC’s order, the production of the altered documents by FINRA’s Kansas City district office was the third instance during an eight-year period in which an employee of FINRA or its predecessor, NASD, provided altered or misleading documents to the SEC. The SEC ordered FINRA to hire an independent consultant and “undertake other remedial measures to improve its policies, procedures and training for producing documents during SEC inspections.”

FINRA refuses to share with state regulators

FINRA continues to largely refuse to share information with state securities regulators, important government authorities in protecting consumer interests and in the successful identification and prevention of fraud.

FINRA wants B-Ds to regulate their competition

FINRA, a “self-regulatory organization” for broker-dealer firms, essentially proposes that broker-dealer firms would regulate their competition — independent registered investment advisory firms. It’s like drug companies being given control over the regulation of physicians. Only here, investment product manufacturers and their distributors would take over the regulation of fee-only independent financial advisors. It does not take a rocket scientist to realize that the role of the independent financial advisor would be diminished, through regulation, in favor of the product-sales-driven broker-dealer firms.

FINRA’s proposal does not expand, but rather destroys, the concept of “self-regulation.” In this instance, independent small financial advisors would be regulated not by their own professional leaders, but rather by the conflict-ridden large Wall Street broker-dealer firms with which they compete. See: RIAs flood Capitol Hill with protests against a SRO-FINRA future on the day of the Bachus Bill hearing.

And since these large broker-dealers and their regulator, FINRA, would love to stem the flow of their customers and their employees from expensive product-sales-oriented broker-dealers to lower-total-fee-and-cost fiduciary, fee-only registered investment advisers, there is no doubt that regulation after regulation would be adopted to make it onerous for investment advisers to survive, much less thrive. Consumers would be forced back into the hands of profit-driven, conflict-ridden Wall Street firms.

FINRA seeks to impose an additional layer of costs and bureaucracy on registered investment advisers, who have been directly overseen by the SEC for more than seven decades. Even if FINRA’s own estimates of the additional costs of its regulation were believable, the small businesses which make up the core of the registered investment advisory community would pay thousands and thousands of dollars a year in additional fees. These fees would be the death knell for many of the small professional firms that seek to provide low-cost investment and financial advice to their clients. The remaining firms would have to raise their fees to their clients substantially to pay the increased registration fees and the attendant compliance costs. Consumers of modest means, such as the young couple starting a family, or the single mother struggling to save and invest for her future retirement needs and the educational futures of her children, would be unable to afford to pay these resulting higher costs. See: FINRA comes up with cost projections for its SRO and the CFP Board blasts them.

FINRA, long opposed to the application of a true fiduciary standard, seeks to redefine the true fiduciary standard out of existence

FINRA and its members seek to redefine the highest standard of conduct under the law — the fiduciary standard — as a much lower “new federal fiduciary standard.” In essence, they want the low standard of conduct for their members to be one in which conflicts of interest are not avoided — or even brought out into the open.

All Wall Street desires to occur, in connection with the SEC’s current Dodd-Frank Act Section 913 rule-making efforts, is the imposition of “casual disclosures” such as: “The interests of my firm may not be the same as yours.” Of course, such disclosures don’t adequately inform the consumer. Nor are casual disclosures even remotely close to a true fiduciary standard. See: How 10 top groups define 'fiduciary’.

Moreover, Wall Street firms are keenly aware of the large body of academic research which reveals that even robust disclosures are ineffective in protecting the interests of individual investors in today’s highly complex modern financial world. That’s why a true fiduciary standard which requires keeping the best interests of the client paramount even after disclosures are undertaken — long opposed by FINRA — is so important to consumers.

The failed 'suitability doctrine’ continues to permit 's***y’ products to be sold to individual consumers

The failed doctrine called “suitability” would continue to permit broker-dealer firms to manufacture and sell to their customers “sh****y products” such as securities stuffed with junk mortgages.

Broker-dealer firms desire to escape these higher standards by controlling FINRA and the continued development of standards — not only for themselves, but also for the trusted investment advisory profession, which is their competition. For more than seven decades FINRA and its predecessor, NASD, have resisted efforts to raise the standard of conduct of its broker-dealer members above the failed, horrendously low standard of “suitability.” FINRA desires to preserve this failed standard, which offers little protection for the customers of broker-dealers and instead preserves the high profits of broker-dealer firms.

FINRA attempts to redefine 'best interests’

FINRA recently appeared to embrace the duty of a broker to act in the “best interests” of its customers, similar to the language contained in Section 913 of the Dodd-Frank Act. Does this recent pronouncement by FINRA herald a fiduciary duty, imposed by FINRA, upon brokers? After all, it has been stated that, “The centerpiece of the fiduciary duty is the requirement that investment advisers act in the best interest of their clients.”

FINRA’s member firms fear that the phrase “best interests” represents may not be in accord with current broker-dealer business practices, although FINRA has stated that its member’s business practices are still permitted. In essence, FINRA touts that its members are required to act in the “best interests” of their customers, yet does little to give true meaning to, or enforce, that standard. In fact, FINRA’s understanding of its own “best interests” standard — based upon mere disclosure of conflicts of interest and not requiring full disclosure of compensation received by the broker-dealer and/or its registered representative (certainly a material fact which should be disclosed) — is not in accord with consumer or advisor understanding of the fiduciary standard of conduct, nor in accord with recent judicial pronouncements, not only under the Advisers Act but also in other contexts applying the “best interests” standard in fiduciary law.

In fact, FINRA recently stated in a letter to the SEC that it believed “it would be a mistake to … impose the investment adviser standard of care and other requirements of the Advisers Act to broker-dealers,” seemingly setting the stage for defining a “fiduciary standard” which is anything but the real thing.

This all begs the question. Shouldn’t the phrase: “Member, FINRA”, be viewed like the warnings on cigarette packages — i.e., as a consumer warning sign?

Consolidating power in FINRA over all investment business would give Wall Street increased control over America’s economy FINRA would continue as the most powerful organization affecting nearly all aspects of the securities industry. Yet it is an organization whose failure to achieve the purposes for which it was created makes it highly questionable whether it should even continue.

Individual Americans denied affordable, trusted advice

Individual Americans — all of whom deserve trusted, independent advice — would be denied the protections of the true fiduciary standard and access to professional investment advice — a woeful prospect for the future economic security of all Americans — and America itself. In the words of Jonathan R. Macey in his 2002 white paper, “[E]ffective financial planning is important to the success of a free-market economy. If people do not make careful, rational decisions about how to self-regulate the patterns of consumption and savings and investment over their life cycles, government will have to step in to save people from the consequences of their poor planning.”

FINRA’s dishonesty — even with respect to its own name

FINRA has been dishonest.

In 2007, NASD and NYSE’s member regulation, enforcement and arbitration functions merged to form FINRA, the primary securities industry SRO responsible for overseeing broker-dealers. At the time of its formation, an objection was made by the FPA to FINRA’s all-encompassing name, “Financial Industry Regulatory Authority.” The FPA stated that the name implied that the self-regulatory organization would have jurisdiction over more than just the brokerage industry and hence was “misleading to the public.”

FINRA’s response? “I would need a degree in psychology to comment on the level of paranoia,” stated a FINRA spokesman. See: An in-depth analysis of FINRA’s attempted takeover of RIAs and why the group should be disbanded, Part 2.

Yet, despite its assertion, FINRA, beginning shortly thereafter and continuing to this day, has been lobbying for oversight over registered investment advisers, a direct contradiction to its earlier statements.

While one might seek to subscribe such action to a “change of heart” by FINRA, in September 2007 this author was approached by a FINRA vice president who admitted that not only had FINRA contemplated within the preceding year oversight of registered investment advisors, but that FINRA even had a committee explore the resources needed for such a task.

Not “paranoia.” Rather, a simple conclusion that FINRA cannot be trusted.

Next week: Part 4: Laying foundations for a true profession.

Ron Rhoades, JD, CFP® serves as chairman of the Steering Committee of The Committee for the Fiduciary Standard. He is an assistant professor of business law and financial planning at Alfred (N.Y.) State College.

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Mentioned in this article:

National Association of Personal Finance Advisors
Top Executive: Geof Brown, CAE

TD Ameritrade
Asset Custodian
Top Executive: Tom Nally

Financial Planning Association
Top Executive: Lauren S. Schadle, CAE, Executive Director and CEO

Garrett Planning Network
RIA Set-up Firm
Top Executive: Sheryl Garrett



June 25, 2014 — 10:55 PM

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September 12, 2013 — 8:19 PM

“The failed 'suitability doctrine’ continues to permit 's***y’ products to be sold to individual consumers.” Please explain how being a fiduciary will prevent this from happening. I am amazed at how people in this industry look at “fiduciary” as some kind of magic wand. Madoff was a fiduciary. Stanford was a fiduciary. How many other countless ponzi schemes were hidden under the cloak of the fiduciary standard?

I bet all of the victims of those fiduciary ponzi schemes would have much preferred to have had their investments at brokerages “under the horrendously low standard of suitability.”

Stephen Winks

Stephen Winks

September 12, 2013 — 10:34 PM


Advisors are not product focused, they are focused on comprehensive portfolio management and addressing and managing investment and administrative values on behalf of the client in the client’s best interest. Their compensation is derived from rendering advice not contingent on the consumer buying a product.

Pretty simple, fiduciaries always work for the client’s best interest not their own. This is not to say every recommendation works as intended, but it does say the recommendation was not influenced by self interest.


Dick Van Dyke

Dick Van Dyke

March 22, 2015 — 4:49 PM
Dick Van Dyke of Springfield, IL “Innocent”

Dick, Rebuts False Allegations of Fraud & Discusses his Innocence!

The first unanswered question and the one of several that beg to be answered are; since Dick’s clients are ALL satisfied and not seeking any form of relief why is the State of Illinois Securities Department levying a $353,000 dollar liability against Dick Van Dyke that does not compensate any “so called victims”?

Second question; why retroactively revoke Dick’s securities license when his clients in question are, non-securities, fixed index annuity only – satisfied insurance clients?

Third question; why is the State of Illinois Department of Securities claiming new jurisdictional authority over annuity insurance products that have been unambiguously excluded as a security for ninety years of IL legislative history?

Fourth question; why did the Illinois Department of Insurance (the agency with undisputed jurisdiction) settle amicably with no reference to fraud or dishonesty and accept that Dick admitted to no violations while allowing him to remain insurance licensed in good standing?

Fifth question; why did the Illinois Attorney Generals office settle amicably with no reference to fraud or dishonesty and accept that Dick denies any wrongdoing?

And Now – The Rest of The Story!

Until now, I (Dick Van Dyke), have remained mostly silent about the several cases filed by State of Illinois agencies against me. From the time these cases began almost four years ago, I have seen quite a twist of events. I now know that the Illinois Department of Securities (IDOS) initially acted on a complaint that had been filed against my firm by a competing financial advisor. It is significant that to my knowledge, there have been no client complaints nor any form of relief sought by clients even though the IDOS urged my clients to turn against me and accept as true the IDOS allegations. The same competitor – financial advisor entered complaints with The Illinois Department of Insurance (IDOI) and The Illinois Attorney General’s (IAG) office. All three State agencies as a result of my competitor’s complaints joined together against me while seeking huge penalties totaling about $500,000.00 in aggregate.

In a true twist of fate, David Lisnek, (DL) the competitor – financial advisor who originally initiated the State’s actions against me and also made the only complaints against me has since been arrested on felony charges, pleading guilty to stealing about $63,000 from an 84 year old woman. He is now on probation which is a matter of public record. Docket detail for David Lisnek case 2013-CF-001163, Illinois, Sangamon County records. Search under “Case Search” tab and then by name at the second link below.

DL Arrested: http://www.wandtv.com/story/24143455/man-arrested-for-allegedly-defrauding-senior DL Guilty Plea: http://records.sangamoncountycircuitclerk.org/sccc/NameSearch.sc DL Complaints against me: https://files.acrobat.com/a/preview/60c8346d-f3fe-4589-bbe4-469de529ef9b

I have now settled amicably with two of the above agencies. I refused to settle with IDOS.

The Illinois Attorney General’s (IAG) office initially made multiple allegations that my website contained inaccurate and deceptive information about my qualifications and the scope of my insurance business. The IAG settled with me by requiring a $5,000 voluntary contribution to a state education fund. My denial of any wrong doing ultimately was accepted and specifically addressed in the settlement. As a resolution to the IAG case, I agreed in the future to always construct my website and to conduct my financial practice in a manner that provides full disclosure of all material facts – which I maintain I have done at all times.

IAG Settlement: https://files.acrobat.com/a/preview/03dcf768-b5b3-49a6-a107-46973eb09fbf

The Department of Insurance (IDOI) case alleged that I had failed to prepare or accurately complete certain annuity disclosure forms for my clients and for the annuity policy issuing companies. Again, it is my understanding that none of my clients or any annuity policy issuer ever raised a complaint about these forms to the IDOI. While I originally thought that my completion of the particular annuity forms was completely accurate, I later learned that additional information should have been considered and referenced when these forms were submitted to the annuity policy issuer.

In recognition of what could be considered an error in completing these forms, I proposed a mutually agreed settlement to the IDOI. As a part of this settlement, I agreed to a $6,000 civil penalty. I also agreed to complete all future paperwork accurately and correct. I also agreed to obtain insurance carrier approvals when advertising their products – which I maintain I have done at all times.

IDOI Settlement: https://files.acrobat.com/a/preview/ef98f1ff-a9ab-4a3b-bc95-fc1c84da921b

However, I have consistently refused to accept any settlement offer from the Illinois Department of Securities (IDOS). Thus, I am still in a costly high stakes legal battle with them. Two key factors in my IDOS appeal involve: The IDOS lack of lawful jurisdiction – whether fixed index annuities are insurance products or securities; and the fact that the IDOS has no client complaints or any negative client testimony recorded against me.

I maintain that the IDOS has no lawful jurisdiction over my sale of annuity insurance products. The IDOS has falsely mischaracterized all of the fixed index annuity insurance products that I sold as securities while intentionally disallowing any consideration for the additional insurance benefits or monetary gain my clients obtained from their new annuities. The very statute that they have used to bring their administrative case against me specifically and unambiguously excludes insurance company annuities from being treated as a security under Illinois law.

My opinion: I am thankful that rational minds at the Illinois Department of Insurance and The Illinois Attorney General’s office finally prevailed to reconsider the facts of my case and settle fairly with me – having no further references to dishonesty or deceptive business practices.

I only wish more rational consideration would have prevailed from the beginning, sparing me from so much unfair negative press that has seriously harmed both my reputation and business. In addition, it could have saved me over $300,000 in legal fees, so far.

This, unfortunately, has been a David versus Goliath type of legal battle; given my limited financial resources compared to that of the State of Illinois’ almost inexhaustible legal resources.

Kindest Regards,
Dick Van Dyke



July 18, 2013 — 5:13 PM

Finally someone is telling the truth! Please keep writing, eventually enough people will read your articles and perhaps force our lawmakers hand. The last article on FINRA’s mandatory arbitration hit the nail on the head; I believe this is an extremely important issue, and many injustices are done in these hearings. You are doing a great service by publishing this information. Thank you!

Jim Hallett

Jim Hallett

July 17, 2013 — 8:45 PM

Mr. Rhodes, if there was a “Pulitzer” for investigative work in this area, you would have my vote!

By sticking to the facts, the truth wins. And, when the truth wins, the Public benefits. It is an honor and a privilege to serve in a fiduciary capacity.

bobby allison

bobby allison

July 18, 2013 — 5:53 PM

Very well done! Mr. Rhodes is correct. Furthermore, FINRA has allowed it’s clout to benifit powerful members of their CLUB to choke unwanted competitors in regional and local markets out of the industry. Many of the victims of these unprecented actions espoused the fiduciary business model. The SEC and FINRA completly blew the Stanford matter!

Stephen Winks

Stephen Winks

July 17, 2013 — 7:33 PM

What is so elloquent about Ron Rhoades brilliant insight into FINRA is he sticks to the facts, just the facts and lets them speak for themselves.

This type of observation takes thousands of hours and extraordinary indepth understanding which is uncommon in lay journalist, yet essential to addresing the loss of trust and confidence of the investing public.

FINRA and the SIFMA, formerly the National Association of Broker/Dealers and the Security Industry Assiociation, are trade associations which have been given extraordinary Federal self regulatory powers by Congress. The only problem is they both still act as industry trade associations rather than protectors of public trust in the consumer’s best interest. Those trade association duties were rendered secondary at best when the responsibilities of an SRO were assumed. As Ron Rhoades outlines, the best interests of the investing public have been consistently subordinated to the industry’s best interest.

FINRA and the SIFMA should only retain their SRO powers if they advance the best interest of the investing public. If they can not protect public trust, their SRO powers should be removed and they should continue as industry advocates. A new SRO that actually protects public trust and fiduciary standing in the consumer’s best interest (as Ron suggests) must emerge to resolve our present conflicted and unworkable regulatory regimen in the consumer’s best interest.


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