SEC makes stealth FINRA oversight changes

The SEC is heeding a government watchdog’s calls to beef up its oversight of FINRA, but it’s doing so behind closed doors. 

The Wall Street regulator, which is FINRA’s only supervisory agency, “generally agreed” with recommendations from the Government Accountability Office last December to improve its formal scrutiny of FINRA, which oversees brokers. According to a report from the GAO last month, the SEC is tightening its FINRA reviews' focus on “performance measures,” “deficiencies” and “corrective actions.” The SEC, according to the report, is also pledging to improve communication between the agencies about the examinations.

The GAO conducts triennial reviews of the SEC's oversight of FINRA as required by Dodd-Frank, the 2010 law that sought to restore stability to Wall Street following the financial crisis and mortgage meltdown. FINRA drew criticism that it was too close to the securities industry and didn’t do enough to root out schemers like Bernie Madoff. It has also come under scrutiny for its arbitration forum. While FINRA is supervised by the SEC, it’s generally a self-regulator. It generated $1.3 billion in operating revenue in 2021. 

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The SEC allowed the GAO’s prior reports on its oversight of FINRA under Dodd-Frank, in 2012, 2015 and 2018, to be fully public. But with its current report, the SEC “determined that some of this information was confidential supervisory information.” The SEC ordered the GAO to omit certain details from the public version of the report that it issued in December, five months after the “restricted” edition that’s shielded from public review. 

Last January, Financial Planning submitted a request to the SEC and the GAO for the “restricted” version under the Freedom of Information Act. The GAO declined the request a couple of weeks later.

In its denial, the GAO said the report was “designated as containing ‘controlled unclassified information’ by [the SEC].” The GAO defined that information as related to facts “obtained from various agencies or private firms in such a way that increases the visibility of particularly sensitive information or reveals internal control weaknesses or methodology.” 

In a July 6 letter to FP, the SEC also classified the report as restricted and containing “confidential supervisory information.” Wall Street’s regulator added that making the study public “could reasonably be expected to disclose techniques, guidelines, and criteria used in connection with the staff’s review of records and thereby undermine the enforcement of the federal securities laws.” 

Representatives for the SEC didn’t respond to requests for comment.

Asked about the GAO’s recommendations, FINRA spokesman Ray Pellecchia said in an email that FINRA “has taken a number of significant steps to strengthen investor protection and adapt to changing markets and industry practices” since the events of the meme stock selloff in early 2021. 

Pellecchia added that FINRA has been “implementing a new rule that improves our ability to monitor the liquidity risk of members with the largest customer and counterparty exposures.” The body “has also sought comments on member firm practices involving complex products, options and short sales.” 

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The SEC placed “modernizing the U.S. financial regulatory system” on its “High Risk List” in 2009, and five other key focus areas for the watchdog “also have direct implications” to SEC operations, according to the incremental update on the GAO’s recommendations. 

What’s publicly known is that the SEC conducted 69 examinations of FINRA between fiscal years 2018 and 2020. The public version of the GAO report in December faulted the SEC for a dearth of “outcome-oriented” data and “useful information for decision-making,” among other areas discussed in the review.

To some regulatory experts, the secrecy about the report’s details doesn’t seem right. 

“As is always the case, when you empower a government agency to classify information, or to designate information confidential, that can be used more broadly than necessary to obfuscate and prevent the public from accessing information that the public or the industry should have a right to review and understand and make judgments about,” said Michael Canning, the former director of policy and government affairs for the North American Securities Administrators Association and founder of consulting firm The LXR Group.

The watchdog’s June 17 update cited the latest status on the “priority” adjustments to the SEC’s exams of FINRA. First, performance metrics with enhanced tracking of the outcomes of the exams would “provide greater assurance that FINRA is carrying out its regulatory responsibilities and that SEC is meeting its mission, including protecting investors and maintaining efficient markets,” it said. 

Second, bulked-up procedures to monitor deficiencies and corrective actions would “provide [the] SEC with reasonable assurance that it is gaining key information about the state of risk in its oversight of FINRA and the extent to which identified risks have been appropriately mitigated,” it said. 

Third, it said, specific identification of the most important findings of the exams and coordination among the two regulators about them would help the SEC “gain reasonable assurance that it has correctly and consistently identified and communicated its most important findings internally and to FINRA.”

The report didn’t provide an expected timeline for the SEC to carry out the recommendations.

The watchdog follows up with government agencies, which include the SEC, “at minimum on a yearly basis, sometimes more frequently,” to check on the progress, said Michael Clements, the GAO’s director of Financial Markets and Community Investment. He added that the SEC “had some actions underway; they need to simply finish those actions to satisfy the recommendations.”