End the Politics of Wall Street Regulation: Decentralize FINRA and the SEC. -
December 5, 2011 / Bill Singer, Contributor
On November 15, 2011, I delivered the afternoon Keynote Speech at the Fall Symposium of the National Association of Independent Broker Dealers (NAIBD). The topic of my remarks was “The Failed Partnership between Wall Street’s Regulated and Regulators.”
Frankly, I found the moment an awkward one. For much of the last decade from my perch in what was referred to as the NASD Dissident/NASD Reform/NASD Dissident-Reform Movement (and now known by the preamble of FINRA), I have banged heads with NAIBD. That my shadow crossed over the threshold of one of that organization’s events was as much as surprise to me as a likely uncomfortable shock for some in attendance.
On the other hand, it is only from the clash of ideas in the marketplace that innovation emerges, and as readers of my columns know, I love robust debate and a frank, blunt exchange of ideas — provided it’s civil and done in the spirit of testing one’s core beliefs with openness to a change of opinion and position.
Below is the version of my remarks as contained in the script that I used during my speech. As with any lawyer, I edited as I went along — some things were left out and some things were expanded. Nonetheless, as raw and honest as is possible, here’s what I said:
Good afternoon. As you’ve likely figured out from the promotional material for today’s program and from that introduction, my name is Bill Singer. Yes, I know, I’m much older and shorter in person. Frankly, it’s not that big a mystery. The photo that I use for my websites and for my Forbes and Registered Rep magazine columns is about ten years old.
TOPIC OF SPEECH
As the program notes indicate, I’ve chosen a cheery, upbeat topic for my speech: The failed partnership between Wall Street’s regulated and regulators. My intent is that my remarks be received in a constructive manner, but I warn you – these are difficult times and I have no desire to be mistaken for a cheerleader or a face-painted fan in the stands. For some two decades, I’ve been on the field, tackling and getting tackled, and I’ve seen enough penalty flags thrown to last a lifetime. So, put on your pads, strap on your helmet. The Halftime Show is over.
THE LONG DECLINE
At its high water mark around 1999, there were nearly 6,000 member firms in what we used to refer to as the NASD member firm community. By 2006, after the Tech Wreck, after 9/11, and after the IPO scandals, the NASD membership was down to about 5,000 firms. Then came The Great Recession, Stanford, Madoff, Bear Stearns, Lehmann, AIG, TARP, and, life as we knew it pretty much ended. Last I looked, the newfangled FINRA membership is about 4,500. How much devastation is that? Do the simple maths, for every 6 of you sitting here today, imagine that in another decade about one or two of you will be gone.
Today, FINRA is a house divided against itself. We have arrived at this abomination not by accident but by what I view as the social engineering done to reinvent FINRA as an organization of financial superstores and large regional firms – and this has been accomplished to the detriment of FINRA’s Small Firm community and with the complicity of larger member firms; former and present NASD/FINRA board members, executives; and more than a handful of industry cronies.
Pursuant to Article I of FINRA’s By-Laws, FINRA’s Board has been intentionally divided into three separate constituencies:
• Large Firms employing 500 or more registered persons
• Mid-Size Firms employing 151 to 499 registered persons
• Small Firms employing a maximum of 150 registered persons.
Using that small, middle, and large firm formula, the FINRA Board is now a gerrymandered disgrace of 22 members, those seats:
FINRA’s May 3, 2011 Election Notice informed us that there were 4,189 small firms and 173 Large Firms.
I find those numbers intriguing.
There is over 24 times the number of small firms as there are large firms. Small firms represent about 90% of FINRA’s 4,500 members. So, how many votes on FINRA’s Board do the 4,189 small firms have? Three votes – the same number of votes as 173 large firms. Given that there are 24 times as many small FINRA member firms as large ones, the small firms should have 72 votes versus the large firm’s 3.
Then there’s that ticklish fact that 90% of FINRA’s member firms are small firms. As such, given that there are 22 Board seats, the small firms should have something like 20. Instead, the small firm community has only 3 seats.
Alas, life isn’t always fair and FINRA has often been a testament to that fact. A self-regulatory organization that was founded by smaller, dynamic firms has abandoned its founding members and now caters to the needs of a minority of larger firms. Instead of truly proportional representation and input at your self-regulatory organization, small firms are marginalized. Worse, you lack the tools to undo that bias because the SRO that you helped create, support, and grow views you as a nuisance rather than its lifeblood.
During the Great Depression, Will Rogers said that “If stupidity got us into this mess, then why can’t stupidity get us out of it?” In recent years, I have looked at Wall Street and often wondered the same thing. The heart and soul of FINRA, you members with fewer than 150 registered persons have sat by as your influence and input was diminished by regulations and regulators seeking to tear down your business. FINRA, a Too-Big-To-Work self regulator paved over the empty space you left behind and built a Wall Street landscape with towering Too-Big-To-Fail financial supermarkets. Sadly, the reconstruction was flawed, the contractors and their materials shoddy, and that lovely new Wall Street is now falling apart at the seams.
The small fry, the little guy, the mom-and-pops – you all watched for too many years as larger broker-dealers who could afford to employ former NASD, FINRA, and SEC attorneys and examiners expanded with seeming ease. It took you, a smaller firm, months to get your Membership Agreement amended to allow for another branch or more brokers or a new product line – but that big firm nearby, the one with the TV ads and the former FINRA exec or the former SEC administrator, well, geez, they just seemed to send in their wish-list and, voila, in a snap they got what they wanted.
Then of course was the explosion in FINRA fines – fines for this, fines for that, fines for inadvertent mistakes, fines for things that no firm used to get fined for. What is the rationale, what is even the point of fining a registered person or a member firm when he, she, or it makes an inadvertent error? As if, what? – That dollar-sign enforcement has been such a success in recent years?
You small fry get charged with violating Rule X and FINRA wants a $20,000 fine. A large firm with thousands of brokers gets hit with violating the same Rule X and FINRA wants the same $20,000 fine. To some, that flat rate of fines seems fair. However, to those of us in the small firm end of things, we see through that charade and realize it is only a façade of fairness.
First off, the too-big-to-fail FINRA member firm that failed and is now part of a too-big-to-fail bank holding company, never actually pays those $20,000 fines out of its own pocket – no, if that member is a publicly traded company, the fine is actually paid by the public shareholders. All of which fosters a mind-set at larger firms that since the bucks don’t actually come out of some human being’s pockets – hell.
Then there’s that other aspect of the one-size-fits-all fines. The $20,000 fine FINRA takes in an AWC from a big boy doing hundreds of millions in revenue doesn’t have quite the same sting as that same $20,000 fine coming out of the bank account of the small FINRA member doing $1 million a year. For the big boys, it’s the cost of a day’s worth of toilet paper, for you, its a few months rent.
Meanwhile, the cost of daily compliance weighs heavy upon your shoulders. With every new regulatory initiative comes more paperwork. And with that paperwork comes the need to hire more non-producing folks. And as all the one-size-fits-all regulations pile up, well, you’re paying someone to essentially sit at a desk filling out forms that affirm that you’re not doing anything that even needed to have the form filled out. You’re paying someone to check off “not applicable” or “does not apply.”
Meaningful reform is never achieved by simply issuing more rules or imposing higher fines. What are required are more intelligent and workable rules and a system of fines designed to achieve the same impact upon large firms as with small. Moreover, without the willing participation of those regulated, any regulatory regime is destined to fail as an army of unwanted occupation rather than a partner in maintaining fair and honest markets.
FINRA is a monopoly that aspires to the properties of a gas, which as you may recall from High School chemistry, can expand to fill virtually any size container. Lately, FINRA hasn’t seen a violation that it didn’t want to impose a fine or a suspension for. And speaking of expanding gas, FINRA now eagerly eyes the registered investment advisory sector. Just what the small firm broker-dealer community needs. Your three Board seats will go to two. Your needs will be further buried under a larger stack of papers in some in-box.
As FINRA balloons to thousands of employees and far too many over-compensated executives, the SRO loses its flexibility and becomes even slower to adapt to new challenges. The once vibrant partnership between the regulated and the regulator that was envisioned when the Maloney Act created self-regulatory organizations nearly three-quarters of a century ago — that partnership is dead. And in its place is an ossified, inflexible, ineffective and often incompetent bureaucracy that sees the majority of its membership – you, the 90% — as adversaries.
Through the prism of a rose-colored lens that softens the view of larger firms, FINRA sees unavoidable human error at large firms as an inadvertent mistake; but that same miscue at a small firm seems to get tagged as wilful fraud or negligence. The formal regulatory Complaint against the small firm that names the CEO, the FINOP, and the CCO is often in marked contrast to the Complaint against the large firm which assumes that organization is run by robots.
FINRA is no longer about regulation. It is a bureaucracy that has managed to morph into the same creature as virtually all agencies that are based in Washington, DC.
SOVIET COMMAND AND CONTROL
A generation ago, much of America’s regulatory and law enforcement operated on what I call the American model of a localized command and control structure. Frankly, it’s always been the best way to manage warfare, government, regulation, and criminal prosecutions. Local police precincts, local FBI offices, local US Attorney’s offices – you work a neighbourhood beat, you get a feel for your turf.
Over recent decades the American way of governing, regulating, and prosecuting has been displaced by what can only be called an old Soviet system of centralized command and control. It’s a cancer that has spread throughout our society. It’s the belief that some career bureaucrat nestled away from the real world in the political corridors of Washington, DC knows better than those yahoos who live and work in the bounties. And talk to the government workers and regulators who are in the local outposts — you will hear their complaints how they’ve lost control and flexibility, how it now takes weeks to get their paperwork reviewed in Washington, DC by some make-work artist. Off the record, in a hushed whisper, they will tell you that things were better when there was more localized control.
It should come as no surprise, then, that I am not here today to praise FINRA but to bury it. I don’t hate FINRA. I hate what it has become because I know what it can be.
But let’s not reinvent history simply to bolster my thesis. Few things in life are unblemished. No regulator or business should aspire to sainthood – it is not a practical business plan. FINRA’s predecessor, the old NASD, was not without its faults. It was the soil from which penny stock hucksters grew and from which the price-fixing of NASDAQ by the market making community was nurtured. And many of the complaints that I raise about biased regulators and ineffective regulations are always raised by regulated entities and have been raised not merely for years or decades but for generations.
So, no, let’s not pretend that when FINRA was the smaller NASD it was better –NASD had its faults, some of which were severe. And let’s not pretend that somehow being small automatically imbues a member firm with decency and compliant behaviour, it does not.
For all its warts, the old NASD offered an alternative to the stodgy New York Stock Exchange. In the old NASD community we had the vibrancy of NASDAQ rather than the increasingly outdated specialist system of the antiquated Floor. The old NASD community was driven by smaller firms with a vision and more oriented to the retail investor than their NYSE counterparts. Notably, the old NASD was built on District Offices and District Committees planted in regions around the country; whereas, NYSE remained a monolithic presence literally on Wall Street.
But that was then and this is now – and now, we must deal with the fact that NASD was hijacked by regulators and members not interested in offering an alternative to the New York Stock Exchange but in seeking to emulate it. In the end, the NYSE is a wasting asset that failed to adapt to the new realities of the marketplace and is in danger of becoming increasingly irrelevant. And that is what FINRA chose as its model. And that is why we are falling down the same slippery slope.
A SOLUTION: DIVIDE AND CONQUER
I propose that FINRA be dissolved as it is presently constituted and that we replace this unwieldy bureaucracy with three new broker-dealer self-regulatory organizations:
• One for firms with up to 150 registered persons;
• One for firms with between 151 and 499 registered persons, and
• One for firms with 500 or more registered persons.
I submit that three autonomous SROs with their own Boards, their own staffs, their own members, and their own rules is a quick, easy, and effective first-step in fixing the broken regulatory regime on Wall Street. Overnight, we could end the age of one-size-fits-all regulation. Simply breaking up FINRA into its three constituencies would get us back to neighbourhood policing and permit each of FINRA’s three broker-dealer segments to create rule books tailored to their needs and the realities of their business.
Restoring trust and confidence in the fairness of our industry’s regulation would likely rebuild the fractured partnership between the regulated and the regulator. It would eliminate the internecine warfare inherent in this glorified trade organization of FINRA that regulates three differently sized factions according to rules that are too often premised upon a zero-sum game. As presently structured, FINRA regulates in a manner that results in what is good for large firms is bad for small ones, and vice versa. You got round and square pegs but only round holes – and that’s stripping a lot of edges off small firms when FINRA tries to pound you into one-size-fits-all regulation.
2006 JOB OPENING
How did we arrive at our present predicament with a broken regulatory partnership and a patronizing self-regulatory organization? We stand here today trying to deal with the mess that is FINRA because of decisions made a few years ago – and that five or ten years from now, we will be deeper into the muck because of decisions that FINRA makes today and that you failed to correct.
By way of example, let me turn the clock back about five years to a September 15, 2006, when NASD posted a job on its Career Opportunities website. More than anything, this posting typifies how we got into this mess. The September 2006 job opening was for a Director of the NASD’s new Office of Member Relations. What I want you to focus on is the nature of the job duties. So as to not be accused of making up some of the tortured language in that notice, let me quote directly from the job posting:
MAJOR PURPOSE OF JOB:
The Director, Member Relations, assists the Vice President of Member Relations with all aspects of the department’s operations.
As with all bureaucracies, we start off with the simple premise that the more titles there are in a department, the more important the department sounds. So in the heady days of 2006, NASD was advertising for a Director of Member Relations whose job involved assisting NASD’s Vice President of Member Relations. And we all know how this cascades out of control. The Director soon needs a Deputy Director, and that leads to an Assistant Deputy Director, who needs a Deputy Assistant Director, and, of course, once you get to that point, you absolutely must hire an Assistant Director to the Deputy Assistant Director. Of course, when you call any of these folks you get voicemail telling you to press 1 to continue in English.
Further on in the job posting, NASD explains that among the operations that this new Director of Member Relations will perform is to facilitate effective feedback loops between member firms and NASD departments to affect positive change. God Bless Washington, DC and all that bureaucracies and little bureaucrats it has spawned. When I see prose such “facilitate effective feedback loops,” I immediately know what’s going on. Someone is desperate to make a simple task sound very important and complicated. For god sakes, who the hell talks like that? Certainly no one who has run a small broker-dealer on a daily basis speaks like that. Feedback loops – fruit loops, what’s the difference and why are we even hiring someone at your expense to perform such a job? Speaking of performing that job, here’s another nugget from that 2006 NASD Job Posting:
ESSENTIAL JOB FUNCTIONS:
The Director serves as ambassador to member firms. An ambassador?
Okay, so even five years ago our self regulator grudgingly admitted that it viewed its members as foreign entities — not really partners in self-regulation. Of course, I thought that in diplomatic relations, countries exchanged Ambassadors. Where is the ambassador from the small firm community in all of this? And there’s more. The NASD Job Notice stated that among the tasks for this new job would be:
• Key message development, including identification of key themes to deliver as well as general talking points for NASD senior management . . .
How nice. This newfangled ambassador would be hired to also focus on identifying “key themes” to deliver. I’m not exactly sure where they were proposing to deliver these key themes but, hey, I’m cranky to begin with. Look, we all know why NASD wanted to hire this Director and why FINRA continues to fill such silly positions. They wanted this Director to be the NASD’s snow blower. And the snow job is to give you in the small firm community the touchy-feely impression that someone’s listening, someone cares, and someone is working behind the scenes to implement changes in your favour. Yeah, right. FINRA still doesn’t get it. We in the small firm community are not children or idiots. We can see through FINRA’s spin and doubletalk. Not only did NASD publish this nonsense of a job opening – for all to read – but they clearly didn’t realize or care how insulting it was. I mean, seriously, is senior management at our industry’s self-regulatory so out of touch with the members it regulates that NASD needed to hire someone to generate “general talking points for NASD senior management?” Senior executives at NASD and now FINRA can’t figure out what’s appropriate to discuss when addressing industry groups? Hey, anyone ever hear of old-fashioned sincerity? Finally, there’s this nonsense - Other Responsibilities:
The Director is also responsible for:
• Preparing, reviewing, monitoring, and providing guidance on written communications to members, including messaging priorities, tone, and delivery mechanism.
• Oversight of tone and messaging delivered at standing and district committee meetings. . .
Did NASD really need to hire an executive to worry about messaging priorities, tone, and delivery mechanism?
Worse, the Director will also have “oversight of tone and messaging delivered at standing and district committee meetings. . .” Funny, I just can’t find any reference to developing “sincere content” or to timely responding to complaints from the industry. I also note that despite this job being for the Director of a member relations department; there is nary a word about delivering messages from the industry to NASD. Frankly, that was the legacy and remains the inheritance of FINRA. Why does that matter? Because past is prologue, and this bureaucratic mind-set is what has brought us to the brink of disaster in 2011 and, if not reversed, will take us over the edge. If you’re going to get rid of the weeds on your lawn, you have to pull them out by the roots.
SEC REPORT Lest I be accused of unfairly singling out FINRA, let me also shine a dim light on the Securities and Exchange Commission, which recently posted on its website a very impressive document titled:
Report on the Implementation of SEC Organizational Reform Recommendations / As Required by Section 967 of the Dodd–Frank Wall Street Reform and Consumer Protection Act
I was planning on waiting for the DVD release of the Report but figured that I would plow through the 25-page document. For starters, literally, we are informed in the preamble of the Report that:
“The Dodd–Frank Act directed the U.S. Securities and Exchange Commission (SEC) to engage an independent consultant to conduct a broad and independent assessment of the SEC’s internal operations, structure, funding, and the agency’s relationship with Self-Regulating Organizations (SROs)”. And y’all wonder why the regulation of Wall Street seems clueless and impotent? I’m absolutely thrilled to learn that it took the SEC only six months to develop the “necessary program management and oversight infrastructure.” Program management and oversight infrastructure? I sort of understand infrastructure as taking the form of a bridge, a tunnel — something made with concrete and steel. How does that all get transformed into some managerial and oversight function? Did we at least get a highway overpass to the new managerial and oversight function? Can we directly drive from the SEC to FINRA?
Hey, be thankful, it only took six months to develop that necessary program infrastructure thingamajig. Now what — a bridge to nowhere? Amazingly, the SEC apparently anticipated my sarcasm because it pre-emptively noted in the Report:
Over the next six months, significant work will have been done within each work stream to analyze the Boston Consulting Group’s (BCG) recommendations and recommend what, if any, actions should be taken.
You like that “work stream” thing? Maybe the SEC will caught up its work stream with a paddle? Okay, that seems reasonable. Let me see if I got this.
First, you got your six months to develop the infrastructure chemically.
Second, you got another six months to analyze the consultant’s recommendations before you actually do anything with that infrastructure that’s now rusting away.
Then, whew, let me catch my breath here – then, after that year of heavy-duty developing and analyzing, the SEC will probably get around to recommending “what, if any, actions should be taken.”
Six months here. Six months there. Why at this rate we could easily waste an entire year just ruminating rather than doing something about anything. Of course, that is what passes for government these days, right? And that’s also what passes for regulation. Finally, what does the SEC propose to with the second six months of post-infrastructure analysis? Well, here it is from the horse’s, umm, mouth. The SEC is apparently prepared to: