Finra

What Is FINRA?

FINRA, the Financial Industry Regulatory Authority, is a private, independent self-regulatory organization (SRO) that oversees brokerage firms and their associated persons in the United States. Its primary mission falls under the broader category of financial regulation, aiming to protect investors by ensuring the U.S. securities industry operates fairly and honestly. FINRA achieves this by writing and enforcing rules, examining firms for compliance, and providing arbitration and mediation services for dispute resolution. It acts as the frontline regulator for the approximately 3,400 brokerage firms and over 600,000 registered securities representatives doing business with the public in the U.S..

History and Origin

The foundation of FINRA lies in a long history of self-regulation within the U.S. securities industry. For more than two centuries, private membership organizations have set rules for their members and held them accountable for misconduct²⁷. Following the stock market crash of 1929 and the subsequent Great Depression, the U.S. Congress established the Securities and Exchange Commission (SEC) in 1934 to oversee the securities industry. However, the SEC did not replace the existing self-regulatory functions of exchanges. Instead, it required exchanges to register and operate under its supervision²⁶.

In 1938, the Maloney Act was passed to better regulate off-exchange trading, leading to the creation of national securities associations registered with the SEC. FINRA's direct predecessor, the National Association of Securities Dealers (NASD), was officially registered with the SEC in 1939²⁵. The NASD was responsible for regulating the over-the-counter market and licensing financial professionals. In 2007, FINRA was formed through the consolidation of NASD and the member regulation, enforcement, and arbitration operations of the New York Stock Exchange (NYSE)²³, ²⁴. This merger aimed to streamline regulatory processes and create a more unified oversight body for the securities industry²². More information on FINRA's establishment and evolution can be found on its official history page.²¹

Key Takeaways

• FINRA is the largest independent self-regulatory organization (SRO) for all securities firms operating in the U.S.
• Its core mission is to protect investors and maintain market integrity by ensuring fair and honest operations within the securities industry.
• FINRA is responsible for writing rules, examining firms for compliance, licensing financial professionals, and resolving disputes through arbitration and mediation.
• Although independent, FINRA operates under the robust oversight of the Securities and Exchange Commission (SEC).
• FINRA's regulatory activities contribute to investor confidence and the overall stability of the capital markets.

Interpreting FINRA's Role

FINRA's role is crucial for the functioning and trustworthiness of the U.S. financial markets. It acts as an intermediary layer of regulation between the federal government (primarily the SEC) and individual broker-dealers. Its enforcement actions, rule-making, and oversight of professionals directly influence how firms conduct business and how securities are traded. By setting and enforcing standards, FINRA aims to reduce fraud, prevent manipulative practices, and ensure that investors receive fair treatment and appropriate disclosures. The existence of an independent SRO like FINRA underscores the concept of cooperative regulation, where industry expertise is leveraged for effective oversight while remaining subject to government supervision.

Hypothetical Example

Imagine an individual, Sarah, who invests her savings with a financial advisor at a brokerage firm. After a few years, Sarah notices significant losses in her investment portfolio that she believes were due to unsuitable recommendations and excessive trading by her advisor. Sarah attempts to resolve the issue directly with the firm but is unsuccessful.

In this scenario, FINRA provides a mechanism for Sarah to seek resolution. She can initiate a FINRA arbitration or mediation claim against the brokerage firm and her advisor. FINRA's Dispute Resolution Services facilitate this process, providing a forum for investors to present their cases to impartial arbitrators or mediators. If the arbitrators find in Sarah's favor, they can award her damages, including the return of lost funds. This process offers investors a way to address grievances with their financial professionals outside of traditional court litigation, often proving more efficient and cost-effective.

Practical Applications

FINRA's influence extends across numerous aspects of the financial industry:

• Licensing and Qualification: FINRA develops and administers qualification examinations, such as the Series 7 and Series 66, which individuals must pass to become licensed financial advisors and registered representatives. This ensures a baseline level of knowledge and competency within the industry.
• Market Oversight: FINRA actively monitors trading activities across various markets to detect and prevent abuses like insider trading, market manipulation, and spoofing.
• Rulemaking: FINRA writes and updates rules governing the conduct of its member firms, covering areas such as advertising, sales practices (including Regulation Best Interest (Reg BI)), and financial responsibility²⁰.
• Enforcement: FINRA investigates potential violations of its rules and federal securities laws, imposing disciplinary actions, fines, and ordering restitution for harmed investors¹⁹. These actions range from censures to barring individuals from the industry.
• Dispute Resolution: FINRA operates the largest securities dispute resolution forum in the United States, providing a neutral forum for resolving disputes between investors and brokerage firms¹⁸. In 2023, FINRA reported a notable increase in arbitration case filings, with 3,382 new cases, including 1,891 customer-initiated claims.¹⁶, ¹⁷

For more detailed information on FINRA's dispute resolution statistics, interested parties can visit FINRA's official website.¹⁵

Limitations and Criticisms

While FINRA plays a vital role in protecting investors and maintaining market integrity, it has faced criticisms and acknowledged limitations. One recurring critique centers on its status as a self-regulatory organization. Critics sometimes question whether an industry-funded entity can be sufficiently aggressive in policing its own members, especially concerning enforcement actions. Reports indicate a decline in the number of enforcement actions taken by FINRA in recent years, leading some to question its effectiveness, despite an increase in total fines collected¹³, ¹⁴. FINRA, however, asserts that it has improved rules to deter "bad actors" and prioritizes cases involving repeat offenders and significant customer harm¹².

Another area of discussion involves the perceived shift in FINRA's approach to enforcement, with some observers noting a "kinder, gentler" stance since 2016, emphasizing guidance over punishment for minor violations¹¹. Furthermore, FINRA's constitutional status and enforcement authority have been challenged in court, raising questions about the inherent tension between industry autonomy and public interest in self-regulation¹⁰. While FINRA's BrokerCheck tool provides valuable information for investors to research financial professionals, some studies suggest that investors may benefit from even more non-public information about brokers' potential for harm⁹.

FINRA vs. Securities and Exchange Commission (SEC)

While both FINRA and the Securities and Exchange Commission (SEC) are critical to financial regulation in the U.S., they operate with distinct roles and levels of authority. The SEC is a U.S. government agency established by Congress with broad oversight powers over the entire securities industry. Its primary objectives include protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation. The SEC enforces federal securities laws, oversees corporate disclosures, and regulates stock exchanges, investment advisers, and other market participants.

In contrast, FINRA is a private, not-for-profit corporation that functions as a self-regulatory organization (SRO). It is overseen by the SEC, meaning the SEC approves FINRA's rules and conducts regular inspections of FINRA's operations⁶, ⁷, ⁸. FINRA's scope is narrower than the SEC's, focusing specifically on regulating broker-dealers and registered representatives who deal directly with the investing public. Essentially, the SEC sets the broad framework of federal securities law and regulations, while FINRA writes and enforces more detailed rules of conduct for its member firms and individuals, often handling day-to-day compliance and disciplinary matters within the brokerage industry⁵. The SEC also acts as the first level of appeal for actions brought by FINRA.

FAQs

Q: Is FINRA a government agency?
A: No, FINRA is not a government agency. It is a private, independent self-regulatory organization (SRO) that operates under the oversight of the U.S. Securities and Exchange Commission (SEC).⁴

Q: What does FINRA do to protect investors?
A: FINRA protects investors by writing and enforcing rules that govern brokerage firms and financial professionals, examining firms for compliance with these rules, monitoring market activity for abuses, providing tools like BrokerCheck to research professionals, and offering a forum for dispute resolution through arbitration and mediation.², ³

Q: How can I check if my financial advisor is regulated by FINRA?
A: You can check the background and disciplinary history of your financial advisor and their firm using FINRA's free online tool, BrokerCheck. This tool provides important information to help you make informed decisions about who to do business with.

Q: What types of issues does FINRA handle in disputes?
A: FINRA's dispute resolution services handle a wide range of issues between investors and brokerage firms or their associated persons, including allegations of unsuitable investments, misrepresentation, unauthorized trading, breach of fiduciary duty, and violations of Blue Sky Laws.¹

Q: Does FINRA only regulate stockbrokers?
A: While FINRA primarily regulates registered representatives and brokerage firms involved in the sale of securities, its oversight covers a broad range of activities and professionals within the securities industry. This includes those dealing with various investment products and services offered by its member firms.