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What FINRA's CEO shuffle reveals about its waning viability as the self-funded fox guarding the investor henhouse

As Richard Ketchum departs amid fulsome praise, FINRA's failed bid to make RIAs 'rules based' combined with member unrest leave the SRO in deep dilemma mode

Thursday, August 25, 2016 – 9:41 PM by Natalie Carpenter
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Après moi le déluge? Outgoing FINRA chief Rick Ketchum engineered a bold bid for RIA oversight but leaves a flailing organization.

Brooke’s Note: Will history be kind to Richard Ketchum for the way he spent his seven years as head of FINRA — complete with a lovely oil painting him hung in a prominent spot in the Wall Street Hall of Fame? Possibly. After all, he took the organization from circa 2009 humiliation to some form of 2016 swagger. But there seems to be an equally good chance that his painting will be hung fondly by RIAs in their Hall of Fame. What we see in this article is Ketchum’s accomplishment of putting out fires with dignified aplomb. But we also see that he eschewed the kind of real change at the Financial Industry Regulatory Authority that stockbrokers need to arm themselves against the onslaught of registered investment advisors. See: FINRA shifts an unwelcome spotlight away from itself — by training it on the brokers it oversees. He spent a lot of cannon balls, like Napoleon pushing into a Siberian expanse, in mounting a counteroffensive against RIAs by trying to become their cop. See: Is FINRA oversight of RIAs a fait accompli? It’s starting to feel that way. Eyes fixed on the RIA prize, and perhaps besotted by his staggering compensation package, Ketchum may have neglected his loyal base of broker-dealers to the point where the internal divisions of the organization dwarf external ones. FINRA’s response to all this thus far is … nada. Questions from RIABiz about its continued existence — or whether it will exist at all — go unanswered. Not a word from FINRA PR, Ketchum or the two people replacing him. Robert Cook, who takes over his day-to-day duties as CEO, is a real mystery man — albeit with good inside-the-beltway-type credentials. It was Cook’s appearance that got Natalie Carpenter digging into this topic in the first place — one that resulted in a big sand pit.

As Richard Ketchum winds down his seven-year tenure as CEO and chairman of the Financial Industry Regulatory Authority Inc., his legacy is more than secure — it positively glows. Whether it glows like sunshine or a nuclear meltdown is open for debate.

“There is no one in the industry I have more respect for than Rick Ketchum,” says Pat Armstrong, current governor of the Securities Traders Association Inc. and former executive floor governor of the NYSE. “He is what people in the business aspire to be. He’s been the one person to pick up the pieces in this incredibly complex environment during one of the most challenging times in finance. He’s the guy who’ll be reading messages on his cell phone during a meeting and not miss a single word. I believe they had to find two people to do his job. He’s that good.” See: Rick Ketchum reveals plan for advisor oversight at FSI conference.

Bradley Bondi of Cahill Gordon & Reindel LLP chimes in: “Rick is extremely knowledgeable about the industry and legal matters. He’s thoughtful, personable. He cuts right to the chase. At that level, you have to be decisive. He has a gift of getting to the bottom of issues with diplomacy.”

And Lewis Lowenfels, a prominent securities lawyer and co-author of the seven-volume legal treatise Bromberg & Lowenfels on Securities Fraud, offers an attorney’s highest recommendation: “Rick has done a very good job. He’s very practical in his approach — not theoretical. He’s tough, but fair. I wouldn’t mind if he were a judge for one of my cases.”

On offense

Yet despite near universal praise for Ketchum’s righting of FINRA’s storm-ravaged ship and sailing it into calmer waters, the bifurcated leadership team that will succeed him inherits an organization with deep-rooted problems newly exacerbated by the DOL’s fiduciary rule, not to mention some still-mutinous member firms who see the SRO as more concerned with appearing to crack down on misdeeds than in protecting their interests.

Ketchum took the helm of FINRA in 2009 when the SRO was at its nadir, having failed to protect the public from a thrashing at the hands of the industry it regulates. He was well paid for his efforts, earning a total of $2.9 million in compensation and benefits in 2014, up from $2.6 million in 2013. (Ketchum was among seven top FINRA executives who earned more than $1 million that year.) See: Is FINRA oversight a fait accompli? It’s starting to feel that way.

Observers wonder if Robert Cook's SEC CV will serve him well as FINRA's new chairman. Observers wonder if Robert Cook’s SEC
CV will serve him well as
FINRA’s new chairman.

Not content with reclaiming FINRA’s business-as-usual bearings, Ketchum went on the offensive, making a bold play for oversight of $3.5-trillion of RIA assets under management and the 30,000-odd investment advisors who oversee them. See: How many RIAs are there? No, seriously, how many?

Ketchum cleverly prosecuted the initiative by contrasting his organization’s self-funding structure and its sheer bandwidth when it comes to administering regulatory exams with the SEC’s paltry budget — one that relies on tax dollars stintingly bestowed by Congress — and its examiners’ stretched-to-the-limit capabilities. See: Most RIAs prefer to pay money for SEC exams now than pay in blood later under an SRO.

Too bad a cop?

The threat level for RIAs was high — especially considering the ever-growing Wall Street outflows flowing into the RIA channel. Success would have ushered in an era of heads-I-win-tails-you-lose regulatory jurisdiction for FINRA, perhaps extending its tenuous existence indefinitely. See: One-Man Think Tank: Six reasons that FINRA should be dismantled.

FINRA eventually admitted tacit defeat on the RIA oversight front after being perceived by RIAs as too-militant a law-and-order regulator — but also by its own membership. See: FINRA’s regulatory white flag may be a pause before it plays white knight to SEC’s cash-starved damsel.

“I fear that FINRA has lost its identity as an SRO. Rather than the entity that was created decades ago, which was strictly the securities industry quietly policing itself, with no publicity, no fanfare, no worries about how it would be perceived by others. FINRA today is extremely enforcement oriented, loudly extolling the number of cases it brings [and] the fines [it imposes],” said Alan Wolper, a partner with Ulmer & Berne LLP, in a recent RIABiz article about BrokerCheck, FINRA’s report card on broker-dealers. See: FINRA shifts an unwelcome spotlight away from itself — by training it on the brokers it oversees.

He continued: “The biggest challenge that these gentleman face is finding a way to strike a reasonable balance between the tough cop-on-the-beat [image] it yearns to convey and an industry association that actually helps its members.”

Split decision

The two men who will serve as Ketchum’s replacements, who approach the task with vastly differing backgrounds and mindsets, embody FINRA’s occluded mission.

Robert W. Cook, most recently a partner at Cleary Gottlieb Steen & Hamilton LLP, and formerly the SEC’s director of trading & markets, was named incoming CEO of FINRA in June. A month later, Jack Brennan, former CEO of The Vanguard Group and currently lead FINRA governor, was named FINRA’s chairman. See: What Vanguard’s hire of a sizzling Wall Streeter reveals about Bill McNabb’s determination to avoid the whiff of stale passivity.

This two-heads-are-better-than-one strategy has garnered mixed reviews.

“Splitting the roles of CEO and chairman will probably prove to be very wise,” says Bondi. “Bob Cook is a smart, technical lawyer. By contrast, Brennan is an industry leader that revolutionized the industry.”

But Tim Welsh, president of Nexus Strategy a Larkspur, Calif. consultancy, speaks for those who see the move as a sign of befogged vision.

“There is a clear lack of leadership at FINRA. If you know what you are doing, you hire someone and move on. If you don’t, you hedge bets with two hires,” he says. “With the pending DOL Fiduciary rule lingering, this is the biggest period of uncertainty that we’ve ever seen. FINRA is overseeing a dying world. Its only incentive is to slow down regulation.” See: The short scoop on Wall Street’s claim that the DOL rule is too long.

Andrew Stoltman, principal of Stoltman Law Offices and current PIABA (Public Investors Arbitration Bar Association) secretary, sees the move as prudent. “Splitting the role is a good development,” he says. But the former stockbroker has some doubts about Cook himself. “He’s a blank slate. That’s the good news. But, his background in private practice, defending market participants, is a major concern.”

Into the cold

Tim Welsh: FINRA is overseeing a dying world. Its only incentive is to slow down regulation. Tim Welsh: FINRA is overseeing a
dying world. Its only incentive is
to slow down regulation.

Cook’s SEC tenure spanned a critical period for the agency, one that saw implementation of enhanced risk controls for broker-dealers, securities exchanges and markets, clearing agencies and FINRA. Cook also oversaw the consolidation of the audit trail of the May 2010 Flash Crash. See: How leery RIAs should be of a flash crash and how much the SEC’s new report advances our understanding.

The challenge for Cook will be taking his knowledge of the SEC’s culture and translating it to FINRA’s — an organization with 3,600 employees that levied close to $200 million in fines and restitution in 2015 and processes, on average, 50 billion transactions every day.

Bondi is confident that FINRA has the wherewithal to support Cook during the transition period. “Bob Cook is walking into an organization that has a lot of veteran leadership. He’s not coming into this cold. People underestimate how well skilled leadership is at FINRA. It is a well-run machine.”

Brennan, the other half of the new leadership team, comes to FINRA from Malvern, Pa.-based Vanguard with a mindset steeped in good corporate governance and honest accounting. He’s been lead governor at FINRA since 2011. See: Regulatory Wire: Is it game-over for the fiduciary standard this year? Advocates say, maybe not.

Twenty questions

More controversially, Brennan, a member of the NASD board starting in 2007, oversaw the consolidation of NASD and NYSE’s members into FINRA that year.

“The benefits of one unified regulator are substantial and wide-ranging, with the most significant being: An end to dual regulation,” wrote Mary Schapiro, who was NASD’s chairman and CEO, at the time. “We’re eliminating two sets of rules governing NYSE and NASD broker-dealer conduct, and along with them all the overlaps, conflicts and duplicative costs.” See: Regulatory Wire: CREW report criticizes the SEC and blasts its chairman, Mary L. Schapiro, for being slow to fight fraud.

Member feedback from the time period, however, paints a more troubled portrait of the consolidation. Several lawsuits followed with accusations of fraud abounding. A former FINRA lawyer, who asked not to be identified, says small-member firms became suspicious of NASD’s investment pool after Schapiro refunded a $35,000-per-member firm “surplus,” a move that many characterized as buying votes. See: Non-partisan watchdog group writes a scathing letter about FINRA.

That source further says that angered small-member firms eventually got 20 questions placed on the 2012 FINRA Annual Governors election ballot, all of which passed. The source says Ketchum’s off-the-record response effectively was, “This is not binding. We are not doing it.”

Ongoing revolt

Member complaints continue to this day, specifically that one of FINRA’s primary roles — to facilitate compliance so member firms can remain violation-free — has been long forgotten as regulators respond more readily to headline-making violation crackdowns.

“I have been saying for years that the environment we occupy started with the research analyst cases,” says Wolper. “The only regulator anywhere who was doing anything was Eliot Spitzer, back when he was attorney general of New York. That embarrassed NASD [at the time] and the SEC. Follow that up with conspicuous whiffs on Madoff and Stanford, and you end up with a massive overreaction by the regulators — that has yet to abate — in their drive to avoid further embarrassment.”

Wolper continues: “My clients bitch and bitch about it, but I tell them no one cares. They threaten to complain to their congressmen, and I tell them no politician, whether local, state or federal, is going to argue in favor of reducing regulation of the financial industry ….The only way to resolve this is through FINRA itself, through the district committees — [which are] powerless, but they do have the ears of FINRA management — the [National Adjudicatory Council] and the Board. I get it that the latter two either already have or will soon have a majority non-industry composition, but if the industry members are vocal enough, change is theoretically possible. Theoretically.”

Armstrong has a slightly different take on FINRA’s relationships with its “small fish” members.

“Small independent broker dealers today are challenged to keep up with the pace of new regulation. They are held to the same standards as the large bulge-bracket firms, with smaller resources at their disposal. Rick Ketchum heard these complaints years ago and he initiated informal settings for independents to voice their unique concerns. This was the only time in my career a regulator made an effort to level the playing field,” he says.

World turned upside down

Alan Wolper: if the industry members are vocal enough, change is theoretically possible. Theoretically. Alan Wolper: if the industry members
are vocal enough, change is theoretically
possible. Theoretically.

Yet, with the upcoming enactment of the DOL rule looming over the industry and the provisions of the Dodd-Frank legislation still playing out, change may not need arrive via the market-regulation relationship. In fact, deferring a such a fix may speed the reform process.

“Market structure is upside down,” says Welsh, referring to Dodd-Frank’s requirement that the SEC assess the need for, as well as implement, a uniform federal fiduciary standard for providing financial advice (expected to come in October of this year) and also the DOL’s separate definition of fiduciary standard as it relates to ERISA accounts. See: Part II: Tick, tick … How FINRA tramples on 'settled’ principles of the Supreme Court, and even Adam Smith, in its sanctification of two-hatted advice.

His solution: “Just make it all a fiduciary standard. That lowers the need for SROs. A good example of that is the 401(k) world. You add a 'best interest contract exemption’ to the fiduciary standard, then sue advisors if it goes wrong and lower costs at the same time.” See: Why exactly DOL’s latest action is so shocking to so many brokers — and even ERISA lawyers — despite years of warnings.

Still, FINRA’s greatest foe seems more internal than external. The member base FINRA oversees is shrinking — from 2011 to June 2016, membership shrank 12%. Their 2015 annual report shows total revenues down year over year.

So, if legislation does away with the sales model, what will become of FINRA’s department of member regulation and sales practice? If the large arbitration system FINRA oversees is euthanized by prohibition of mandatory arbitration clauses, akin to the rules proposed by the CFPB, where does that leave FINRA’s department of dispute resolution and parts of the enforcement department? With a shrinking member base, can the SEC assume the regulatory and enforcement arms of FINRA?

Or, will large member firms, who appear to stand to benefit the most from “business as usual” at FINRA, use their power to fight for the status quo?
See: Wall Street thriller 'Margin Call’ is a cautionary tale — even for RIAs.

Editor’s note: Watch for an upcoming article that will delve into questions of where FINRA is headed as internal and external forces chew away its comfort zone.



April 14, 2018 — 3:56 AM
Just smart enough to convey your ignorance.

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