New legislation introduced by Rep. Spencer Bacchus and Rep. Carolyn McCarthy to anoint a self-regulatory organization for RIAs has sparked the predictable firestorm of attacks and counter-attacks between RIAs and brokerage firms. Compounding the controversy is the fact that brokerage organizations like the Securities Industry And Financial Markets Association and the Financial Services Institute has endorsed Finra as the logical alternative to be that SRO.
Many RIAs and brokerage executives alike think that Finra has failed to do an adequate job of regulating the brokerage business. Although they are flush with cash, instances of ethical conflicts within the agency keep cropping up.
Only this past month, Finra board member Joel Blumenschein was fined $30,000 and suspended from working at his firm for failure to supervise his reps at Freedom Investors Corp. Yet when we last checked, Blumenschein remains on the Finra board even though he is temporarily barred from his firm. Talk about stewardship.
[Five days after I posted this, Blumenschein did in fact resign of his own volition. Still, the fact that he says the decision was his and his alone might raise questions in some quarters about Finra's governance procedures.]
More than three years after Bernard Madoff's Ponzi scheme collapsed, RIAs and brokerage executives continue to cite him as a reason why Finra should-or shouldn't-be named an SRO. Madoff served as vice chairman of Finra's predecessor organization, the National Association of Securities Dealers.
Both sides enjoy tarring each other with the Madoff name but the fact is that he managed to drive a truck through some of the holes that existed between RIA and broker-dealer regulation. Hundreds of other Ponzi schemes in both the RIA and brokerage universe have unraveled since Madoff's and, as both sides are quick to point out, most consumers don't know the difference between a fiduciary and suitability standard.
Estimates on what it would cost Finra to take over RIA regulation vary from $150 million to $500 million a year. Most of that money would be spent on hiring 900 examiners, according to one report.
Where the brokerage industry has a fair point is that SEC-regulated RIAs, for the most part, are examined far less frequently than B-Ds. If Finra did hire 900 examiners, it would give them about one examiner for every 16 to 18 RIA firms.
Sounds like a sufficient number to examine RIA firms every other year. But according to people who know, the SEC already has one examiner for every 20 RIAs.
According to regulatory experts like MarketCounsel's Brian Hamburger, about one-third of those examiners spend their time inspecting brokerage firms, not RIAs. The brokerage business is Finra's primary responsibility yet apparently the SEC doesn't have a great deal of confidence in that SRO.
Still, if you run the math, it would appear that an SEC examiner inspects two or three RIAs a year. So something isn't right. Hamburger and others told me six months ago it is in no way clear that the SEC doesn't already have the resources for each examiner to inspect the vast majority of RIAs every other year.
So say what you will about Finra, but the SEC doesn't appear to be a very shrewd allocator of its human resources. Furthermore, there is the productivity issue. Several years ago, the SEC fired several employees for spending most of their seven-hour days in the office-during the middle of the financial crisis-watching Internet pornography on their computers. Though these porn-loving bureaucrats were fired, it raises questions about what type of people are attracted to government. Even though history was unfolding in front of their faces, the events of the moment held no interest for them.
It's hard not to be cynical about both agencies.