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Protecting the Profits

I'm continually amazed at what a strange organization FINRA is. The organization (Company? No. Regulatory body? Not quite. Lobbying arm for Wall Street? Closer. Standard setting body? If so, then the standards are low.) has released its 2014 financial report, with net income (I think that would mean profit if it were a corporation) of $129 million. The revenues include $132.6 million in fines, which suggests that the operating margin can be completely explained by disciplinary actions against bad actors among the member firms.

FINRA reports that it “rebated” $20 million to its member firms for the second year in a row. These windfall profits, coming from the fines assessed against some of these very members, are being kindly returned in the form of rebates.

Meanwhile, the firm, although tax-exempt, pays its executives Wall Street-like salaries that are far in excess of what public sector or regulatory employees would earn: $2.89 million to CEO Richard Ketchum, $1.29 million to chief financial officer Todd Diganci; $1.2 million to chief information officer Steven Randich; $1.17 million to chief legal officer Robert Colby; $1.1 million to VP for regulatory operations Susan Axelrod; $1.057 million to executive VP for enforcement Bradley Bennett; and $1.02 million to executive VP for market regulation Thomas Gira. These are the people who were forbidden by the member firms from instituting the CARDS program that would have monitored brokers' client activity in real time. That kind of submission doesn't come cheap.

The report (you can find it here: tells us that FINRA's mission is to “protect investors and keep the markets fair.” The annual report talks about different successful monitoring efforts using technology, which, the organization says, “is particularly important since some market participants are increasingly dispersing their activity across trading venues in an effort to mask improper trading schemes.” We are told about a trader who was manipulating the prices of options, and new rulemaking on high-frequency trading among brokers trading for Wall Street's own accounts. Algorithmic trading strategies should be closely monitored, and the organization hopes to gain better insight into the lack of pre-trade transparency in the fixed income markets. The organization is constantly assessing rules.

When you read this self-congratulatory memorandum, you can almost forget that there is a much easier solution to protecting the public. Thousands of fee-only and dually-registered advisors wouldn't even think of slyly inserting their own trades in between the trades of investors or mutual funds and the potential buyers and sellers-and therefore don't have to have somebody “regulate” this activity that contributes nothing to our economy. Fee-compensated advisors have no incentive to manipulate the prices of options, because they aren't employed by a large firm that pays them an enormous bonus if they score big at the expense of people on the other side of a trade. If you don't earn commissions, you aren't motivated to sell bonds at enormous hidden markups.

Where am I going with this? I'm wondering what would happen if those bloated salaries were eliminated, the regulatory operations were transferred to the SEC, the fines were used to offset SEC costs of operations, and brokerage firms were banned from predatory trading activities altogether, eliminating the costly supervision of things that do nothing to benefit customers. FINRA's mission is to protect a fundamentally predatory Wall Street revenue model by making it seem as if these predatory activities are appropriately regulated-a nonprofit, if you will, that was created to protect the excessive profits that flow to non-fiduciary organizations who see their customers as ripe for the plucking. It's as if an industry were formed to rob houses, and then, to deflect the inevitable criticism, the industry put in place a massive bureaucracy whose mission was to make sure that only appropriate house-robbing activities took place, with fines and monitoring activities-supported, in part, by some of the profits from robbing the houses in the first place, but also by fines when the members went too far in activities that should never have been permitted in the first place.

There was a time when I thought that this problem would go away. I predicted that the profession would evolve to a fee-compensated revenue model, and cheekily wrote that the last advisor who was regulated by FINRA should turn out the lights on the way out the door. Now I believe the predatory model isn't going anywhere-even though I think, for the benefit of our economic system, it should.