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Resources
Who's
Looking Out For Investors?
by
Michael Schmidt, CFA
In
the financial services industry, consumers pay a fee for a service
and expect a certain level of security in return. When an investor
pays a broker to handle his or her accounts, the broker is obligated
to act in that investor's best interests. This obligation is
not only moral, but also arises from the rules set forth by
the industry's various regulatory agencies. The problem is that
if an account is mishandled, most consumers have no idea where
to turn until it's too late.
Examples of mishandling range from churning to suitability to
fraud. Churning is an unethical practice employed by some brokers
to increase their commissions by excessively trading in a client's
account. Suitability relates to the types of investments
chosen for the account and whether they are appropriate for
a particular investor, while fraud can encompass a wide range
of behaviors with varying levels of severity.
So who is looking out for the average investor? Is it
the Financial Industry Regulatory Authority (FINRA), the state
regulatory agencies, the Securities and Exchange Commission
(SEC), the Office of the Comptroller of the Currency (OCC) or
the Federal Reserve Board (FRB)? The answer is all of the above,
but each in its own way. Read on to learn more.
FINRA
For most consumers, FINRA, the agency
that governs business between brokers, dealers and the investing
public, is the first line of defense in the event of a problem
associated with an investment account.
When an investor opens an account at a U.S.-based brokerage
firm, the fine print in the lengthy account-opening document
typically stipulates that consumers give up their rights to
pursue the brokerage company in a venue outside arbitration.
Under FINRA's rules, however, the consumer maintains the right
to pursue arbitration. As a result, the lion's share of consumer
complaints against brokerages is fielded by FINRA and is usually
arbitrations.
Arbitrations are basically court-like settings where judges
are replaced by a panel of peers. Cases are presented by claimants
(plaintiffs), with or without their attorneys, and are defended
by respondents (defendants), who typically have attorneys.
The process begins by filing a claim with FINRA, which
then notifies all parties involved that proceedings have begun.
Arbitration is designed to be simple in order to accommodate
the average consumer lacking legal expertise and allow him or
her to file a claim without the need to hire an attorney. The
forms are written in plain language so as not to discourage
someone from filing.
However, while the initial filing can be processed without an
attorney, it is widely suggested that the claimant (plaintiff)
hire an attorney as he or she will encounter a barrage of deep-pocketed
legal defense maneuvers once the claim is filed. There is no
shortage of legal services available for claimants, and many
attorneys will take cases on contingency, especially if there
is a large potential settlement and what they feel is a good
chance of winning.
While the arbitration process is effective and orderly,
consumers pursuing a case should be prepared for the same time
lags they would experience with a typical state or federal court
case. The filing process can take up to one year and proceedings
after the initial filing can take years.
Because the process can take a significant amount of time
and resources, it is highly recommended that consumers that
have been treated unfairly exhaust all measures for handling
grievances directly with their broker or investment manager
prior to filing a complaint with FINRA.
State Regulatory Agencies
While FINRA fields the majority of complaints
from investors, there are other lines of defense with overlapping
powers. For instance, each state has its own regulatory agency
to police the in-state activities of the securities industry.
While a state's regional jurisdiction is defined by its own
state lines, its professional jurisdiction varies.
Typically, the state polices a variety of financial services
providers ranging from credit unions to broker dealers. State
agencies also cover investment advisors that fall below the
requirement for filing with the SEC
(less than $25 million under management). Here, the coverage
that state agencies provide is similar to the SEC's
duties of licensing, filing and auditing. Regulatory overlap
is usually avoided as registered investment advisors only register
under one agency or the other.
The state typically gets involved early in an investigation
and then cooperates with the SEC
as the investigation deepens. While effective, the state agencies
are not usually as well staffed as FINRA or the SEC and have
to cover a larger caseload per investigator.
The SEC
The glue that holds the investor protection
system together is the SEC, which arose from the ashes of the
1929 stock market crash and was crafted around the Securities
Act of 1933 and the Securities Exchange Act of 1934. The
SEC governs the self-regulatory organizations (SROs) that reach
down to the consumer, and its jurisdiction is far reaching,
covering four main divisions:
- corporate
finance
- market
regulation
- investment
management
- enforcement
The SEC's
responsibilities have become ever more challenging with the advent
of computer-based crimes and the increasing complexity of financial
products and transactions, but its primary purpose is still to
protect the individual investor by watching over the investment
management industry and ensuring that public companies provide
sufficient financial and other information to the public to allow
investors to make informed decisions.
With the new challenges in the marketplace, there has been
a call to increase the flexibility of the SEC's power. However,
despite years of discussions about consolidating regulatory bodies
or appointing a finance czar, there are no concrete plans in the
pipeline.
The OCC and the Fed
There are two other regulatory bodies spoken
of frequently, the less common Comptroller of the Currency
(OCC) and the famous (or infamous) Federal Reserve Board (FRB).
While both of these bodies are very active in watching out for
investors, their activities are focused on banking and financial
services at a higher level, and their involvement in individual
cases is rare.
Conclusion
Each of these regulatory bodies looks
out for investors in its own way, and each has its specific duties
with some overlap. The regulatory organizations have become increasingly
sophisticated to accommodate increasingly complex investment transactions
and products, but are challenged each year as new issues arise.
These organizations are designed to protect consumers, so if you
have a problem that you aren't able to resolve directly with your
broker, take advantage. Remember, just like your local police,
the regulatory agencies won't know about any issues unless you
contact them.
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