History of the Financial Industry Regulatory Authority: Do Regulators Really Protect Investors?
To understand the history of the Financial Industry Regulatory Authority (“FINRA”) and the challenges facing investors, we must examine its origins. Before FINRA, there was the National Association of Securities Dealers, Inc. (the “NASD”).
This History of FINRA will cover:
- How the history of the NASD fostered FINRA’s close ties to the brokerage industry, and
- How this relationship impacts investor disputes in FINRA arbitration.
NASD and FINRA Timeline
Founded in 1939
The NASD was founded in 1939. In the wake of the Great Depression, the securities industry representatives recognized a need for regulation. They worked in cooperation with the U.S. Congress and the U.S. Securities and Exchange Commission (SEC) to create a self-regulatory organization with the authority to regulate the financial services industry. Today, all securities brokerage firms in the United States that transact business with the public are required to be a member of the NASD (now FINRA).
Congress established NASD with the following goals:
- Standardize the securities industry’s principles and practices
- Promote high standards of commercial honor
- Advance just and equitable principles of trade for the protection of investors
- Adopt and enforce rules of fair-trade
1971: NASD Introduces Automated System for Price Quotes
Before exchanges used electronic trading systems, investors called their stockbrokers to execute trade orders, which were then placed on a physical trading floor. Trading floors functioned much like auctions. In 1971, NASD automated the process of placing a trade. Electronic trades allowed for more efficient trading and tightened up the bid-ask-spread—the difference between how much a stock would sell for versus how much a buyer would pay for it. The automated system made it easier for brokers to ensure their investors got the best prices for their trades. Following this fully automated exchange, the competition among NASD, NYSE, and AMEX allowed the stock market to handle larger volumes of orders.
1987 Stock Market Crash
There was a dramatic increase in the size of the NASDAQ when NASD established a two-tiered system for ranking its 3,600 companies. The top tier was comprised of companies that met certain rigorous criteria. This top tier, known as the NASDAQ National Market list, was widely circulated. The second tier comprised companies that did not meet these strict criteria. It was called the NASDAQ SmallCap Market and appeared in fewer newspapers.
This tiering system was not enough to prevent the fallout from the stock market crash of 1987, also known as “Black Monday.” The crash resulted in 4,000 complaints from investors and necessitated major regulatory overhauls. It revealed a major fault in stock market exchanges, which cleared different types of securities transactions at different times. After the crash, financial products had to standardize their clearing timelines.
2007: Formation of the Financial Industry Regulatory Authority
In 2007, the NASD and the NYSE Member Regulation combined to form FINRA. FINRA would conduct the regulatory oversight of more than 5,000 securities firms and 666,0000 registered representatives. Mary Schapiro, the CEO of FINRA in 2007, stated, “With investor protection and market integrity as our overarching objectives, FINRA will be an investor-focused and more streamlined regulator that is better suited to the complexity and competitiveness of today’s global capital markets.”
How FINRA Fails Investors — and How a FINRA Lawyer Can Help
FINRA is a self-regulatory organization that is funded by the brokerage industry. Broker-dealers must abide by FINRA rules, and member firms must pay an annual fee to FINRA. The size of the firm determines the amount of the fee. This fee may create a conflict of interest. Because the largest brokerage firms pay the most to FINRA, it is not in FINRA’s monetary interest to expel large firms, no matter how egregious their misconduct might be.
FINRA Arbitration: Does It Really Protect Investors?
FINRA arbitration allows investors to recover losses for investors who were harmed by stockbroker fraud or misconduct. Arbitration is an alternative to lawsuits and is legally binding against financial professionals governed by FINRA, who agree to submit to FINRA’s rules and regulations as part of their professional certification. Although the goal of FINRA arbitration is to help investors recoup their losses and receive compensation, the system does not always work in investors’ favor.
In 2021, only 31% of cases resulted in a FINRA award for investors. This is only a mild decrease from the statistics before the pandemic. However, many cases settle before an award—59% of caes ended with an investor settlement in 2021. Investors should not let the number of FINRA awards discourage them from pursuing arbitration.
FINRA arbitration does not always live up to its stated aim to serve as a “neutral” resource for resolving disputes. Studies have suggested that FINRA arbitration panels are more likely to side with stockbrokers than investors. One study suggests that this may be because many FINRA arbitration panel members have worked in the financial industry.
Critics have also suggested that FINRA does not have the strongest motivations to eliminate stockbroker misconduct. If FINRA sufficiently discouraged brokers from engaging in misconduct, the regulator would no longer have a purpose. Unsurprisingly, FINRA often fails to sufficiently discourage misconduct. 44 % of stockbrokers fired for misconduct find work within a year, suggesting that brokerage firms may not be concerned about the repercussions of future misconduct.
While FINRA has established the new Rule 4111 as part of a stated effort to highlight firms with a history of misconduct, they refuse to publish lists of firms that consistently employ brokers with records of misconduct. In 2017, Reuters published a list of brokerage firms with high concentrations of brokers with disciplinary histories.
Kurta Law Can Help
Industry insiders may have a leg up on the FINRA arbitration process. In a recent civil case, a Georgia judge found that a lawyer for Wells Fargo manipulated the process of selecting arbitrators to decide a FINRA arbitration case. Remember: The brokerage firm will have legal representation. Without a securities lawyer, you could be at a disadvantage.
Unfortunately, it is still largely up to investors to fight for their rights, through either FINRA arbitration or mediation. Contacting a FINRA lawyer is an excellent first step toward recovery. You can recover money lost due to broker misconduct, but you may need help to navigate the challenging process of FINRA Arbitration.