Find out why investors cannot count on regulators like FINRA for financial protection and how the NY Times exposed FINRA's Broker Check.
finra (Financial Industry
Regulatory Authority)
FINRA, the over-ambitiously named Financial Industry Regulatory Authority spends millions in advertising to establish itself as a friend and protector of American investors. As you watch the commercials and look at the print ads, please remember that the organizations that comprise its membership are brokerage firms.
It is true that FINRA has an enforcement arm that investigates alleged violations of FINRA rules. But, that is much less protection than FINRA’s name may imply. The protection it does provide will almost always come too late to save your nest egg. Like investigations by the SEC and state securities regulators, most FINRA investigations are commenced either by a customer complaint or the discovery of stockbroker misconduct. Of course, by the time either of those things has happened someone, maybe you, has already lost a lot of money. When that happens, FINRA's "investor protection" face changes to reveal the true nature of the organization.
When a FINRA member loses your life savings or your parents’ life savings, you cannot take that brokerage firm or the individual broker to court. You signed away your Constitutional right to do so when you signed an account agreement with a FINRA member. Instead you are forced, in your action against a FINRA member, into an arbitration system run by FINRA. One of the three arbitrators who decides that arbitration action will be currently employed in the securities industry, most likely by a FINRA member. If this sounds like having to take a dispute against your health insurance company to an arbitration system run by a trade group for HMOs, you understand perfectly.
FINRA Broker Check
Beware especially of FINRA’s Broker Check function, which to a limited degree allows you to check the background of your broker or a broker you are thinking of using. When you request a FINRA Broker Check report, you want a comprehensive report on the background of your broker or prospective broker. You want to know if he or she has ever been accused of mistreating a customer. FINRA won’t tell you that.
FINRA’s report may lead you to believe that the broker you are investigating has a clean record, when nothing could be further from the truth. That broker may have been the subject of one or more customer claims. The claim may have alleged unauthorized trading, or churning, or high pressure sales tactics, or even fraud. The broker’s firm may have had to pay out hundreds of thousands of dollars to make the claim go away. And yet the claim will likely not appear on the broker’s record.
Investor's Watchdog maintains a whitewash profile of stockbrokers
with "clean" FINRA records who are not as innocent as they look.
Why? Until very recently, it has been common practice to allow a broker to negotiate, as a condition of settlement, for the removal of the claim from his or her official record. That removal does not mean that the broker was innocent. It may mean only that the brokerage firm thought it worth the price to keep his record clean so that he can continue to attract customers.
The bottom line is that FINRA’s expungement practice up to this point has rendered its free Broker Check worthless. In fact, Broker Check is worth less than what you pay for it, because it may lead investors to believe that a broker with a troubling history is free from customer complaints.
Investor's Watchdog recently ran an Investor’s Watchdog BrokerSnapshot® report on a stockbroker with a major worldwide brokerage firm. The FINRA Broker Check report showed that she had a clean record — not a single customer complaint. In fact, the broker had 10 customer complaints in the Investor’s Watchdog database. That is not unusual. IW maintains a whitewash profile of brokers with "clean" FINRA records who actually have one or more customer complaints in the database. The file is thick.
Clean vs. Whitewashed
Many successful brokers have been in the business for decades. They remember the hyper inflation of the 1970s and the stock market crash of 1987. A broker who has been in the business that long and has survived every bear market without a single customer complaint has earned a solid reputation for good customer care. However, you cannot find out from FINRA whether the broker you are using or considering is such a broker.
Again, FINRA’s report does not include actions that the broker has negotiated to have removed from his official record. His firm knows that a clean record is important. If he is a big producer, the firm may have paid off every abused customer who ever filed a claim, getting as a condition of settlement the customer’s consent to have the complaint removed from the broker’s official record. So if you want to know how many abused customers have there been, FINRA won’t tell you. That can't be repeated enough.
Recently, Investor's Watchdog ran a background search on a broker in Boca Raton, Florida. Although her FINRA report is clean, she is not. IW found five separate arbitration actions against her, with damages totaling $4.9 million, with allegations including unauthorized trading and fraud. She is wearing five coats of whitewash. FINRA won’t tell you that.
Your Broker's Mentor
FINRA often won’t give you a complete employment history on a broker. Why is that important? A broker trained at Stratton Oakmont and a broker trained at A.G. Edwards are likley two very different animals. For that matter, FINRA won’t tell you that Stratton Oakmont was one of the most infamous brokerage firms in the history of the securities industry. Read Jordan Belfort’s memoir The Wolf of Wall Street if you want the details. Beware, though — it is rated NC-17. He tells it like he lived it. Unless you ask someone who knows that a broker received his early training at a firm notorious for customer abuse, how would you know? FINRA won’t tell you.
Failing the Series 7 Exam
FINRA doesn’t give you details about a broker’s licensing exams. Why is that important? Those exams test a broker’s understanding of concepts designed to protect you. If he can’t pass the test, does he understand his obligation to you? Investor's Watchdog recently ran a background search on a broker who failed the basic Series 7 licensing exam three times before passing it with the lowest passing grade possible. At one point he gave up for 10 years before trying again. He also failed every other exam he ever took, ultimately just giving up on the supervisory exam. FINRA won’t tell you that.
FINRA's New Expungement Rule
A year ago FINRA approved an expungement rule that will make it tougher for brokers to whitewash their records. FINRA’s new rule will help things going forward, especially since the arbitration panel is required to consider the amount paid in settlement of a claim in making a decision on whether a request for expungement should be granted. Although this should cut down on expungements, it cannot address the two decades of expunged customer complaints that FINRA will never disclose to investors.
The rule will also make settlements of investor claims less likely. If the broker will not be able to expunge the complaint from his record, he may feel as if he “might as well go to trial” and try to secure a victory with the arbitration panel. This is even more likely because the broker is always playing on his home turf in FINRA arbitration, which also requires that consumers pay out of their pocket for the arbitrators to decide their case. A broker's chances of securing a victory when playing in front of his home crowd are, in the professional SEC experience of Investor's Watchdog, greater than if he were forced to face a judge and jury.
Granted, FINRA’s web site has good information on the basics of investing. For those seeking an education, it is not a bad site to visit. But don’t be fooled. In school we learned that “You are what you eat.” The corollary to that truth is, “You are who your members are.” Always remember that FINRA’s members are brokerage firms.
