Sunday, July 28, 2013

A 4-Part Series: Why FINRA Should Be Disbanded, and How Personal Financial Advisors Might Move Toward a True Profession

FINRA SHOULD BE DISMANTLED. Here's an overview of why ...

1942: A Dismal Year for Individual Investors - Due to FINRA. In the year following the commencement of World War II, when all Americans had their attention diverted to the enormous threats from abroad, FINRA (formerly known as the National Association of Securities Dealers, or NASD) adopted rules of conduct for its member. Strangely missing from such rules was a fiduciary standard of conduct for brokers (i.e., registered representatives of broker-dealer firms) when providing personalized investment advice, despite the fact that courts and even FINRA (NASD) itself had acknowledged the existence of such a duty. Over seven decades have passed, and FINRA has compounded its error 1000-fold, for it has yet to rectify this agregious error.

Is the Term "Best Interests" Being Co-opted by FINRA? Even worse, FINRA's Dec. 2012 NTM regarding its "revised" suitability standard stated that brokers must act in the "best interests" of their customers. Sounds like a fiduciary standard! Indeed, as stated by one recent federal court decision: "The federal fiduciary standard requires that an investment adviser act in the 'best interest' of its advisory client." Belmont vs. MB Investment Partners, Inc.708 F.3d 470; 2013 U.S. App. LEXIS 3732; Fed. Sec. L. Rep. (CCH) P97,297 (2013) (citing other previous federal court decisions). Yet, FINRA only uses the term "best interests" in its explanation of its suitability rule, without any reference the the fact that acting in the best interests of a customer is a long-standard, though short-hand, method of explaining the fiduciary duty of loyalty.

Nor is this "best interests" standard enforced with any level of diligence by FINRA, as would be expected from a competent regulator. Of course, enforcement of its rules is required by the Maloney Act, which requires that FINRA possess rules governing business ethics which must provide that the members "shall be appropriately disciplined ... by expulsion, suspension, limitation of activities, functions, and operations, fine, censure, being suspended or barred from being associated with a member, or any other fitting sanction."

This also begs some question? Is it an attempt to co-opt the term "best interests" and redefine it as something other than fiduciary? Is this an attempt by FINRA to hold out to the public that its members act under a fiduciary duty of loyalty, when most deny the existence of such duties? Worse yet, is this intentional misrepresentation on FINRA's behalf?

FINRA's Omissions and Mistakes: Pernicious, Widespread Effects.  The result of FINRA's mistakes? We have possessed over seven decades of operation under a financial services system in which certain business practices should have been outlawed, or at least substantially constrained. Consumer distrust of Wall Street is at an all-time high, leading to lower participation in the capital markets by individual investors. This, in turn, increases the costs of capital for American business.

Additionally, there exists substantial deviation of the returns of the capital markets away from individual investors, with returns instead fueling excessive compensation for Wall Street's investment bankers and brokers. This exorbitant consumption of the profits of American business, by Wall Street, which has grown to over 35% of the corporate profits.

In the years ahead, the result will likely be less financial security of our fellow Americans, reduced capital formation, and stagnant economic growth in the U.S. In addition, higher tax rates for both individual Americans and corporations will result, as the government shoulders an increased burden of caring for those retirees with inadequate personal resources.

What Can be Done? What are the Solutions?

In a four-part series of articles at, I explore the huge problem which FINRA poses, and suggest possible solutions.

I suggest FINRA be disbanded, and that a new, true "Professional Regulatory Organization" assume its market conduct functions.

Of course, other possible solutions are possible. For example, the SEC has the power to adopt rules for FINRA's members to follow, and has the power to sanction FINRA for not enforcing its own rules. In addition, it might be possible to establish a competitive regulatory organization, for investment advisers (and possibly some brokers, as well), which could create a framework for a "rush to the top" as far as standards of conduct are concerned. Competition can be a good thing, if the competition is correctly structured.

Here is a copy of the editors' preliminary notes, as well as a link to the entire article.
    • "Dina’s Note: Ron Rhoades returns to RIABiz with a four-part series that updates and expands An in-depth analysis of FINRA’s attempted takeover of RIAs and why the group should be disbanded, Part 2, originally published by RIABiz on May 31, 2012. In this first installment, Rhoades explores the effect lack of trust will have on the capital markets and our economy. In future installments, Rhoades will delve into the history of the regulation of brokers; FINRA’s early — and more recent — failures to protect the investing public; and, finally, discuss options for reform, including the creation of a true profession for financial and investment advisors."
    • "Brooke’s Note: The free enterprise system is no more compartmentalized than any other system. If one part is sick, damaged or tainted, it is only a matter of time before it affects the body whole. The recognition of that immutable natural law is, in effect, what Ron Rhoades draws our attention to in this column. Is it farfetched to think that a kink in the economic hose in as critical a point as the one where capital flows back from the consumers to companies and governments — i.e. though financial advisors as guided by their regulators — would be like a low-level virus for the grander economy? A good think tank made up of of several cross-disciplinary academics could work that one out. Fortunately for us, Ron is it. See: Part One: Investment Advisers: Is our path toward, or away, from a true profession?"
    • "Brooke’s Note: The plot thickens. In this second — absorbing — combination of history and fiduciary bible thumping, Ron Rhoades tells the life story to date of FINRA from its infancy in 1939, when it was called NASD, to its idealistic adolescence and then, well then it’s pretty much downhill, according to our fiercely partisan and erudite one-man think tank. Along the way, there’s a crusading New Deal senator, gripping courtroom drama and a whole lot more. Simply put, for anyone with a dog in this hunt, it’s a good read. For more, check Part 1: Why keeping FINRA from ruling RIAs is critical to these firms, the investor — and even the U.S. economy — and stay tuned for Part 3, which delves more deeply into FINRA’s misdeeds."
  • July 17, 2013 (Part 3 of 4): FINRA's scandalous litany of failures. In which our one-man think tank offers a scathing indictment of the broker-dealers' SRO (Part 3 of a four-part series).  READ the article at
    • "Dina’s Note: To recap: In part 1 (See: Why FINRA’s power grab for RIAs needs to be stopped to avert the death of the profession, Part 1) and part 2 (See: An in-depth analysis of FINRA’s attempted takeover of RIAs and why the group should be disbanded, Part 2) of this remarkable series, Ron Rhoades reviewed FINRA’s early history, including its failure to adopt rules that applied the fiduciary standard of conduct to brokers who provided personalized investment advice, and the limited protections offered to investors under the 'failed standard' of 'suitability.' In this installment, Ron explores FINRA’s long history of failure, and its continued opposition to providing protections to the investing public under the fiduciary standard of conduct."
    • Dina’s note: In this final installment of this four-part series, Ron Rhoades outlines a vision for a true profession of investment and financial advisors, through the creation of a professional regulatory organization that will protect the investor, not Wall Street interests. The last refuge of the criticized is to say: Well, then what would you do? With this article, Ron has preemptively struck down that line of counterattack.
Thank you to Brooke Southall and Dina Hampton at RIABiz for publishing these articles. - Ron

Ron A. Rhoades, JD, CFP® serves as Asst. Professor and Program Coordinator for the Financial Planning Program at Alfred State College, Alfred, New York. He currently serves as Chair of the Steering Committee for The Committee for the Fiduciary Standard, and he frequently speaks at conferences and in presentations to policy makers in Washington, DC on the fiduciary standard. In 2013, Ron was named one of NAPFA's "30 Most Influential" persons in NAPFA's 30-year history. He is an academic member of NAPFA and of the Financial Planning Association. Ron Rhoades is the author of several books and many articles on topics relating to investments and financial planning. He received the "Tamar Frankel Fiduciary of the Year" award in 2011, and also was named as one of the "Top 25 Most Influential" by Investment Advisor magazine in 2011.

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If you are a consumer interested in learning more about financial and investment advisory services from Ron Rhoades, JD, CFP® and his fee-only investment advisory firm, ScholarFi, Inc. - please e-mail, or call Cathy Rhoades, Director of Client Services, at 607-247-5008.

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