Finra moves forward after 360 appraisal

Robert Cook discusses the challenges facing the broker regulator, ranging from retooling its exam program for Reg BI to supporting small firms and increasing its transparency

Oct 12, 2019 @ 6:00 am

By Mark Schoeff Jr.

Over the last three years, Robert W. Cook has led the Financial Industry Regulatory Authority Inc. in an extensive self-examination to create a better brokerage industry regulator.

The former securities lawyer and head of the Securities and Exchange Commission's Division of Trading and Markets launched the Finra 360 initiative within months of becoming Finra's president and chief executive in August 2016. It has resulted in streamlining some operations and shedding more light on Finra's governance and finances.

But Mr. Cook, 54, faces many challenges as he enters his fourth year at Finra's helm.

Small brokerages are complaining that the regulatory burdens imposed by Finra rules could drive many of them out of business. Investor advocates are pushing Finra to address brokers who have long disciplinary histories and keep popping up at new firms, and Finra is under fire for certain aspects of its arbitration system.

Additionally, after more than a decade of enforcing the broker suitability standard, Finra will soon have to ensure its members comply with Regulation Best Interest, which the SEC approved over the summer.

Mr. Cook sat down with InvestmentNews reporter Mark Schoeff Jr. in Finra's Washington, D.C., office earlier this month to discuss Reg BI and other challenges, and how his rural Vermont background — including farm school from seventh to ninth grades, and oxen training in high school — inspired him even before he attained both bachelor's and law degrees from Harvard University and a master's degree from the London School of Economics.

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Mark Schoeff Jr.: How big of a change will Regulation BI be for Finra's mission?

Robert Cook: It's entirely consistent with Finra's mission. We will now be examining for compliance with Reg BI as opposed to Finra's suitability rule. It is a significant amount of work for us to retool our exam program, to develop examination modules around Reg BI, to train our examiners, to determine the scope of the exams over time. The good news is that it's the SEC's rule, and we're collaborating closely with them, including working with their examination team to think about how we approach the task of overseeing compliance in a consistent, coordinated way.

MS: Will the advent of Reg BI bring the end to the current suitability standard of care that brokers have adhered to since 2012?

RC: This is one of the additional areas we're focused on, what happens with some of our rules in light of Reg BI? Suitability is clearly one we're going to be thinking about, whether it needs to be modified or partially repealed to the extent that it is now incorporated into Reg BI. We would need to file a proposed rule change through the SEC.

MS: For Reg BI, a principles-based rule, there's no road map for how you mitigate conflicts. There's also no definition of 'best interest,' so what will you expect from brokers on Reg BI?

RC: The important thing to emphasize here is that it's an SEC rule. The expectations created by the rule and the interpretations under it will come from the SEC. That's different from our suitability rule that we've sort of owned the interpretation of. We need to work closely with the SEC to understand its views on what the rule requires. We're not sitting in a position where we can give you interpretations of what the requirements are of Reg BI.

MS: In SEC Chairman Jay Clayton's view, Reg BI is bringing the investment adviser and broker standards of conduct closer together. Since you'll have to enforce Reg BI, would you like to extend your oversight to investment advisers as well?

RC: Reg BI and the related interpretations and guidance around the adviser rule are bringing the two channels of advice closer together. But our mission, our statutory obligation, is with respect to the brokerage side. There may be opportunities for closer coordination with the SEC about how you look at firms holistically given the very point you've focused on. There can be challenges for us or for the SEC in looking at only one side. But that said, we're still very focused on just our mission and executing on our mission of overseeing brokers.

MS: What has been the major accomplishments of Finra 360 so far?

RC: One of the most important changes resulting from Finra 360 has been to help this organization focus on how to embrace continuous improvement and to continue to innovate and continue to leverage technology to do our job better. The combination of our enforcement groups was a significant one. Looking forward, there's a major effort to transform our examination and risk monitoring group. There's a lot more to come.

MS: What changes will we see to the exam program?

RC: We've talked at a high level about the overall approach there, which is to continue to ensure that our examination program is risk-based and that we're allocating our resources to areas of greatest risk to investors. One of the ways that we think we can help achieve that is by developing a national program that is organized around the business models of the firms we regulate and not necessarily around our rulebook.

MS: What differences will brokerages see on exams?

RC: There should be greater coordination of the exam cycle program. So rather than having an exam by this group, and then one by this other group because they cover different aspects of the business, it would have one integrated exam that covers all aspects of your business on the single exam. Ideally, we will hear more often that examiners come in and asked questions that they would ask themselves if they were examining themselves.

MS: In Finra 360, you put a lot of emphasis on small firms, yet they still say they face big regulatory burdens that are driving some of them out of business. How are you addressing those concerns?

RC: The focus on small firms is important to me. Small business is a driver of job creation. Sometimes they're very involved in innovation. In some cases, they're providing financial services to people or communities who might not otherwise have access to those services. Our focus has been to try to be sensitive to the position of small firms when we are engaged in rule-making or retrospective rule reviews. On the other side, there's also a unique opportunity Finra has to help support compliance by small firms [through] the exam findings report to the small-firm helpline. We've started a small-firm report that we do every couple of months. We pick some issue that small firms are interested in, and we hold a conference call for them … with experts from Finra.

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MS: You've tried to introduce more transparency into the board's workings, yet it still meets behind closed doors and the report we get is the one Finra writes.

RC: As a result of the engagement notice, we got a number of suggestions about our governance. There's a lot more transparency now about who's on the board, what the committees are. The idea of opening up the board to have a public meeting was one of the ideas considered. At this time, I'm not expecting the board to go in that direction. As you can imagine, there are a variety of considerations to think about there, including wanting to preserve and enhance a robust, candid dialogue among the members of the board about issues. Even if you were inclined to have a public meeting, you'd have to do a lot of it in private anyway. There are a lot of issues that would not be appropriate to discuss in public.

MS: In 2019, expenses are going to exceed revenue again. So far, you've been able to hold fees flat by drawing from the reserves. When are fees going to rise again?

RC: They certainly will rise again at some point. The [board] decision was made that we will reduce our level of reserves down from the level where they are now [approximately $1.7 billion]. The only way to reduce your level of reserves is to have multiple years where we're showing a loss. We have a structural imbalance now between our revenue and expenses. We will continue to draw down the reserves until the reserves hit a level that the board thinks is the appropriate level. By that time, [we will] introduce new fees to support the mission. Remember, any fees we increase would have to go through a rule-filing process with the SEC.

MS: How are you addressing the problem of brokers with disciplinary histories reemerging at new firms?

RC: We've had a high-risk broker examination program for a number of years. We continue to develop and expand that. We've been trying to supplement that over the last few years with Phase I [by] enhancing the firms' and Finra's supervision of individual brokers. Some of those initiatives involve new rules. We expect to be bringing them before the SEC for filing.

Phase II is Rule 4111, which is focused on firms that have a high concentration of brokers with a regulatory history or their own regulatory events. This is a new approach based significantly on extensive data analytics. If this rule gets adopted in the form proposed, in terms of identifying firms, we will be reviewing regularly whether the filters are the right filters to capture the right firms.

MS: Congress just passed the FAIR Act, which would end mandatory arbitration in brokerage contracts. Is the Finra arbitration system under threat from Capitol Hill?

RC: We're obviously interested in these legislative developments because of the potential impact on our dispute resolution services. Just to be clear, Finra does not mandate arbitration unless the investor wants it. We don't have the legal authority to prevent mandatory arbitration clauses. The authority to try to restrict mandatory predispute arbitration agreements has really been delegated to the SEC under Dodd-Frank. Any reconsideration of that is appropriately done by the SEC or Congress.

MS: Where are we on expungement reform?

RC: We continue to work to improve the expungement process. What we want to ensure is that there's an appropriate process to make sure customers — investors — have access to information that's relevant to them about their financial advisers' prior experience, but, on the other hand, to give financial professionals the opportunity to address any incorrect or inaccurate information. The board decided [at its Sept. 24-26 meeting] to move forward with a proposal that had been issued in 2017 to create a special roster of arbitrators with specific training and other qualifications who would be the ones to hear expungement requests in certain circumstances.

MS: Finra 360 is about listening to your members. But you're also supposed to regulate them. How do you listen to your members without being captured by them?

RC: I think it's a reasonable question and, obviously, one we have to be on guard for. On the one hand, it is sort of our obligation to be listening to members. That is why our governance structure was set up the way it was. We also need to make sure that we're, at the end of the day, doing what is best for investors. And, I can tell you, everyone here at Finra, that is in their DNA. That is the filter we put everything through, whether it comes from one side or another: Is it going to make us better at protecting investors? The additional level of scrutiny to make sure we're doing that comes from, one, our majority-public board and, two, very extensive oversight from the SEC.

MS: What is it from your Vermont childhood that informs what you do every day at Finra?

RC: I had the opportunity to grow up in an environment where there was a very strong community, a strong work ethic and a strong sense of service to the community and helping out others. I grew up with a lot of people who had limited means, and there were lots of opportunities for all of us to be helping each other. I was attracted by the mission of protecting investors, of being of service to others. I think that's in some ways inspired by the type of community I grew up in.

I go back whenever I can to spend time with them because it reminds me of my roots. They keep me honest. If I get too big for my britches, they let me know pretty quickly.

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