FINRA

In other posts, I’ve mentioned FINRA, with references to how they control various things that impact financial markets and stock trading.  While they have a great acronym that manages to flow into what almost seems like a real word, let’s break down those constituent letters into what FINRA actually does and what tools they offer the day to day investor.

When you lose the acronym, FINRA stands for the Financial Industry Regulatory Authority.  You see they play a little fast and loose with the “IN” portion of the acronym, which seems to work out, otherwise they’d be FIRA – and that just doesn’t have the same ring to it.  

Now, with a name like that, you might think of FINRA as a team of regulators with an office in Washington next to the FBI and SEC that reviews transactions and swoops in when something’s amiss.  But, FINRA is actually a private corporation that regulates brokers and exchange markets that register as members.  FINRA is an example of a self-regulatory organization – the idea being (apparently) that if member firms face strict oversight from within, then the government will not impose its own regulations.  So if you’re asking why any brokerage or exchange would join FINRA just to face scrutiny, this is why.  The theory goes that these powerful organizations would rather be subject to industry-specific oversight than that of the government.

Of course, the Securities and Exchange Commission (aka the SEC) is the ultimate regulator of the securities industry, meaning that it’s not like the US government allows the industry to operate like the wild west just because FINRA exists.  The SEC can and still very much does take action when there’s impropriety in the securities markets.  Typically, however, the SEC tends to focus more on securities transactions themselves, while FINRA deals with brokers and exchanges.  The SEC has formally agreed to its arrangement with FINRA, so the two can operate in symbiosis.

And not to mention that the US Department of Justice can prosecute securities-related crimes like securities fraud.  Just a note: while on tv, you’ll see people scared of getting arrested or put in jail by the SEC, the SEC doesn’t actually have criminal enforcement authority.  However, when the SEC finds criminal activities (which they often do), the case is referred to the criminal authorities who have the power to prosecute.  Now, if you’re getting hauled to prison for 10 years, it probably matters little to you which agency actually put you there…

Back to FINRA.  So what does FINRA do exactly?  

Some pretty important things for individual investors.  For one, FINRA regulates brokerage firms that trade equities, including many of the firms with which you probably place trades if you perform transactions through an online broker.  FINRA has the power to conduct reviews of their actions if there are any complaints and sanction member firms in the event of improper conduct.

Broker Check

Perhaps the most critical aspect of what FINRA does relates to individual brokers, so if you ever consider hiring a financial advisor or broker, now’s a good time to start paying attention.  FINRA governs the examination and licensing of securities brokers, meaning that anyone who executes trades on behalf of another must generally pass certain exams and receive a license from FINRA.  There are a litany of different exams that putative brokers can take, each of which has a different scope.  I won’t get into the details here, but suffice it to say that if you’re working with a broker, you should make sure that they’re properly licensed and registered to do what they’re telling you.

In that vein, FINRA maintains a comprehensive database of individuals and firms operating in the securities industry.  Each broker or firm is identifiable by their CRD number (or their name or location – to make it easier).  You can search them here:

https://brokercheck.finra.org/

FINRA broker check is a valuable source if you’re considering doing business with a broker.  It’ll tell you their registrations, work history, and background – which is all fine – but most importantly, tells you if they’ve been subject to any FINRA enforcement actions or been a party to any FINRA arbitration brought by one of their customers.

FINRA Arbitration

So here’s the scoop.  One thing you should know about working with brokers is that, assuming you’re working with a properly FINRA-licensed broker, if they engage in misconduct with your money, you (for the most part) are not able to sue them in court.  Rather, your agreement with the broker most likely contains a provision requiring that you bring any disputes to FINRA arbitration.

In case you don’t know, arbitration is a quasi-judicial forum in which you grant private individuals the right to issue a judgment concerning a legal dispute.  Instead of a judge and jury, you have an arbitration panel that makes the decision.  

FINRA’s arbitration process requires that industry professionals serve as arbitrators, so the apparent benefit is that you have people who are knowledgeable about the securities industry deciding your dispute.  The thing you have to know about arbitration, however, is that the decisions rendered are typically enforceable the same way as if you received a judgment in a court.  There are limited exceptions (talk to a lawyer about them), but generally speaking, if you get a judgment against a broker and they don’t pay, you can go to court, file the judgment, and enforce it the same way as if you had obtained the judgment in court.

Why might someone take a broker to arbitration?  Let’s start with one reason you can’t take a broker to arbitration.  You can’t just sue your broker because your investment portfolio lost market value – you still take the risk of market fluctuations even if someone else is helping you pick stocks.  FINRA arbitration is not insurance against losses.

Rather, there are two pretty fundamental claims people make in arbitration that are permissible.  One is what’s called “suitability,” which is a claim that your broker did not build a portfolio that was suitable for the risk tolerance you provided.  Whenever you fill out an application for a broker, it should ask you what your risk tolerance is.  If you say “conservative” or “slow growth” or “low risk,” that’s what the broker has to follow.  If they put you in overly risky positions that are inconsistent with your stated approach, and they end up losing money, you might have a suitability claim.

The second is called “churning,” which is where the broker engages in unnecessary transactions seemingly for the purpose of generating additional commissions.  (Now, if you self-invest in an online account, you can avoid this problem altogether…)  But, if you have a broker, they have to manage your account within reason, and if they’re drumming up extra fees, you can bring them to FINRA arbitration to recover the improperly-paid commissions and other related losses.  

There are plenty of other claims people can make against brokers, and this is why it’s important to verify your broker’s past through FINRA.  If customers prevail in arbitration, they can obtain a monetary award from the broker (and firm) compensating them for losses.  These judgments will show up on broker check, so it’s good to know if your (potential) broker has engaged in any of this conduct.  FINRA can also take enforcement action against brokers and firms, including by imposing temporary or permanent bans.

Unregistered Advisors

The other vital purpose of broker check is to see if someone purporting to give you financial advice is registered at all.  There are plenty of people out there calling themselves financial advisors who don’t actually register with FINRA, yet sell you “securities” products.  They’ll typically use an acquaintance to execute any trades for you, or they sell you investments that are themselves not properly registered.  Not everything has to be part of FINRA, but you should check the nature of anything you’re investing in to see whether it should, and therefore whether the “broker” must also be registered and properly licensed to sell it to you.

Be wary of anyone who’s not registered with FINRA.  Not to say that you shouldn’t trust them, but make sure you fully understand what you’re getting yourself into – and of course, don’t let them tell you they don’t need to be registered.  And if need be, you can report unregistered people engaging in securities transactions to FINRA, and FINRA can still take action against them.  If you incur a legally compensable loss due to an unregistered person, you may be able to sue them in court – but of course, any such decision should be discussed with a real lawyer.

FINRA does a great deal more than this, but this is probably what’s most relevant to the individual investor.  Remember to do your homework if you’re searching for an investment advisor / broker, etc. and use the resources FINRA provides as a starting point for due diligence.