The SEC needs better metrics, accountability and communication as part of its frequent examinations and inspections of FINRA, according to a government watchdog agency.
As the only entity overseeing the self-regulatory organization, the SEC reviewed FINRA at least 69 times in the past three fiscal years across 10 different areas of its operations spelled out under the Dodd-Frank Act and the Securities Exchange Act, the U.S. Government Accountability Office found in a Dec. 15
With authority over 3,400 firms and 620,000 brokers, FINRA’s operations carry significant importance for wealth managers paying membership fees and managing compliance and regulatory matters. The SEC last filed its own enforcement
“Ensuring that FINRA carries out its responsibility is really critical to the SEC's mission,” said Michael Clements, the GAO’s director of financial markets and community investment and the lead author of the report. “What we're saying here is, there are a few opportunities for the SEC to leverage the info that it is getting from these exams to help improve its oversight of FINRA.”
Representatives for FINRA declined to comment on the report, referring inquiries to the SEC. Representatives for the SEC didn’t respond to requests for comment.
The relationship between the two entities revolves around the “peculiarities of the SRO model,” according to Michael Canning, the former director of policy and government affairs for the North American Securities Administrators Association and founder of regulatory consulting firm The LXR Group. As a private entity, FINRA doesn’t face the same obligations as the SEC or state regulators such as due process and adhering to case law precedent in its actions, he said.
“On the one hand, they're under the oversight of the SEC and they're expected to collaborate with other regulators like the states and the SEC's Enforcement Division,” Canning said. “If they're perceived as being the arm of the state, an arm of a state actor, then a court can say, ‘You've got to follow the rules of other regulators.’”
The GAO’s study covered inspection and examination case file materials from the past three years, including scoping memos about the subject of the reviews, correspondence between the SEC and FINRA and documents about any SEC follow-up on the findings. The SEC’s supervision of FINRA primarily comes through the rulemaking approval process at its Division of Trading and Markets and the regular probes of the Division of Examinations. The SEC deemed material about “the number and type of findings and associated corrective actions” from the first version of the GAO report to be “confidential supervisory information,” according to the study. The GAO removed parts of the July version of the report from the publicly available study.
“This public report omits certain information related to the (1) subjects of SEC’s inspections and examinations of FINRA, (2) findings of these reviews, and (3) corrective actions proposed by FINRA in response to these findings,” according to the report. “Although the information provided in this report is more limited, it generally addresses the same objectives and uses the same methodology as the sensitive report.”
Still, the watchdog agency criticized the SEC for using “task-oriented” metrics in its examinations of FINRA rather than measuring its effectiveness. For example, the agency counts how many meetings with stakeholders FINRA has held but doesn’t assess the results of the meetings and how they fit into the SEC’s goals. The agency checks whether FINRA has completed the processing of tips, complaints and referrals but doesn’t evaluate its performance.
“According to the officials, there are few specific rules in the federal securities laws prescribing how FINRA must oversee brokers-dealers,” the report said. “Although some outcome-oriented performance measures may have known limitations, they also may provide more useful information than measures that do not reflect leading practices and therefore may be ineffective at monitoring performance.”
In the same vein, the GAO took the agency to task for not having a system in place to monitor deficiencies from the examinations and the actions taken by FINRA to address them, nor a procedure for identifying the most significant findings. Instead of systems, the SEC uses “informal” approaches such as a manually updated spreadsheet about the deficiencies and corrective actions and examiners deploying “professional judgment to determine the relative importance of the findings” and how to share the information, according to the report.
As part of its response to the GAO’s report, the SEC pledged to review its existing performance metrics and develop “additional measures, as necessary, that reflect leading practices.” In addition, it vowed to create a formal process for keeping tabs on the deficiencies and “for assessing the importance of and communicating findings,” according to the study.
