Effective self-regulation requires balancing industry interests and client interests.
The first securities industry regulator in the United States was the industry itself. By 1817, the US securities markets had grown large, complex, and unruly. So the brokers who had been trading securities on Wall Street decided to form what would become the New York Stock Exchange (NYSE) in 1863.
As their first regulatory act, they drew up a formal constitution, establishing rules for members to follow. Today, such self-regulation is considered central to the integrity of the US financial markets, and the bodies that police themselves are known as self-regulatory organizations (SROs).
While regulation may have been born of self-interest, today the law requires exchanges to regulate themselves or delegate regulation to another SRO, such as FINRA, the Financial Industry Regulatory Authority. Brokerage firms and their employees who buy and sell securities are also regulated though FINRA, the nation’s largest SRO.
While SROs have evolved over the years, their purpose remains much the same: setting and enforcing industry standards. They work in tandem with the states and the SEC and CFTC, cooperating in investigations and helping support the government’s regulatory goals of protecting investor rights and keeping the markets efficient, fair, and honest.
SROs at a glance
SROs are independent, nonprofit organizations — not government entities — that are authorized by Congress and overseen by the federal regulator for the industry in which they operate. For example, the SEC must approve FINRA rules and those written by NYSE Regulation before they can take effect.
An SRO is funded by membership dues and assessment fees, or, when it oversees an exchange, by the exchange. All US broker-dealers and the registered representatives who work for them must be members of FINRA. Similarly, most introducing brokers (IBs), futures commission merchants (FCMs), commodity trading advisers (CTAs), and others who are registered with the CFTC and have discretion over customer accounts must be members of NFA, the National Futures Association. It’s the SRO for the derivatives industry.
There are no SROs, however, for other groups of financial professionals, including registered investment advisers (RIAs), financial planners, and insurance brokers.
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The Logic of self-regulation
Besides the most obvious reason — that the law requires it — the securities industry has its own reasons for regulating itself.
For one thing, when a firm acts dishonestly, it may cast a shadow on honest firms as well. So it’s in the interest of honest firms to keep a close eye on unfair practices. Furthermore, self-regulatory bodies have the power to enforce standards that can make business more efficient — such as establishing a centralized reporting system for trades, or developing a single, standard licensing examination for brokers.
Practically speaking, self-regulation may be less expensive and more efficient than government regulation. But ultimately the strongest reason for self-regulation is that it makes the public more confident about the securities markets. That means more money flowing into investments — and more profits for the securities industry.
FINRA in action
FINRA wears many hats. It tests and licenses registered representatives — better known as stockbrokers — and operates the Central Registration Depository (CRD) to collect and store qualification, employment, and disclosure information about both brokers and the broker-dealer firms that employ them.
The regulator makes and enforces rules that govern the actions of brokers and broker-dealers, including the requirement for complete disclosure about any investment product being offered to a client. Individuals or firms that don’t comply with the rules can be fined, suspended, or barred from the securities industry. They can also be required to make restitution to investors who have experienced losses as a result of misconduct, such as recommending an unsuitable product or committing overt fraud. Some cases are referred to the SEC or the Department of Justice and may result in civil or criminal litigation.
FINRA gathers trading data to identify potential problems in US markets and increase market transparency. Among the things it seeks is evidence of insider trading, front-running, or other market manipulation. It also reviews all marketing and advertising materials its members use to protect investors from misleading or false information.
In addition, the regulator provides in-depth financial education and oversees mediation and arbitration of industry disputes, including those between investors and their brokers or brokerage firms.
Regulators on the inside
Firms in the securities industry also have internal self-regulation: their compliance departments. Among the tasks of a corporate compliance department are to review sales material and other documents that the company generates, investigate customer complaints, and take disciplinary action against company employees if necessary. By using in-house enforcement, companies hope to stay on the right side of the law — and to avoid the cost, inconvenience, and damage to their reputations that a full outside regulatory investigation may bring.
A look at NFA
Like FINRA, NFA establishes rules, sets high professional standards for its members, and holds them accountable for their actions. Investor protection is a major focus, with particular attention to the way customer funds are handled. The NFA also seeks to assist investors in making informed decisions by providing publications about the futures industry, including its unique risks.
The regulator monitors its members’ business and financial activities, conducts regular examinations, as FINRA does, to confirm compliance with its requirements, and works to keep markets fair and orderly. Also like FINRA, NFA maintains mediation and arbitration programs to resolve disputes. Investors can check an individual or firm’s registration and disciplinary history using the BASIC. BASIC is an acronym for Background Affiliation Status Information Center.
To back up its authority, the NFA has the right to discipline members and may refer cases to the CFTC or a law-enforcement agency for prosecution.
What Is A Self-regulation Organization (SRO)? by Inna Rosputnia
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