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Government Study Says SEC Should Boost Oversight of FINRA

Joe Mont | June 1, 2012

The SEC should take steps to improve its oversight of the Financial Industry Regulatory Authority, says a report issued this week by the Government Accountability Office.

FINRA, an SRO (self-regulatory organization), is the only registered national securities association. It has regulatory oversight of all securities broker-dealers doing business with the public in the United States.

The Dodd-Frank Act required the GAO to review the SEC's oversight of national securities associations registered under section 15A of the Securities Exchange Act of 1934 (Exchange Act), a provision that solely applies to FINRA.

“For industry self-regulation to function effectively, the SEC must ensure that SROs are fulfilling their regulatory responsibilities,” the GAO report says. “ SEC oversees FINRA primarily by inspecting its operations and examination programs and reviewing its proposed rule changes. However, over the last few years, and specifically in light of recent events in the financial markets, SEC and FINRA have faced questions about their oversight roles. These questions include the fairness of FINRA's arbitration practices, the rules it crafts related to oversight of broker-dealers, the limited transparency in its investment practices and corporate governance, and SEC's ability to effectively oversee FINRA.”

“The SEC has a formal process for reviewing FINRA's proposed rule changes and has recently taken steps to strengthen its review process,” the report concluded. “However, neither FINRA nor SEC has a formal process for evaluating the effectiveness of FINRA's implemented rules.”

It adds that “although FINRA also publishes rules governing the securities markets, it is not required to conduct such reviews of its rules.”

“Given its role in regulation, FINRA proposes many rules and rule changes each year that can have an impact similar to rules proposed and implemented by SEC,” the report says. “By not conducting retrospective reviews, FINRA may be missing an opportunity to systematically assess whether its rules are achieving their intended purpose and take appropriate action, such as maintaining rules that are effective and modifying or repealing rules that are ineffective or burdensome.

The SEC is in the process of “enhancing and expanding its oversight of FINRA, using a more risk-based approach,” the GAO found.

“The risks posed by the individual programs and operations could vary and therefore warrant different levels of oversight,” the report says. “Moreover, the FINRA programs and operations identified in Section 964 may not encompass all current and future risks, such as FINRA becoming an SRO for investment advisers. Incorporating these other elements of the risk management framework will better position SEC to identify and prioritize evolving risks, evaluate alternatives and monitor its oversight efforts. Without such elements, SEC may be missing opportunities to take a more comprehensive, risk-based approach in overseeing FINRA.”