The Financial Industry Regulatory Authority (FINRA): An Explanation

What Is the Financial Industry Regulatory Authority (FINRA)?

The Financial Industry Regulatory Authority (FINRA) is an independent, nongovernmental organization that writes and enforces the rules governing registered brokers and broker-dealer firms in the United States.

Its stated mission is “to safeguard the investing public against fraud and bad practices.” It is considered a self-regulatory organization.12

FINRA was created as the result of the consolidation of the National Association of Securities Dealers (NASD) and the member regulation, enforcement, and arbitration operations of the New York Stock Exchange (NYSE) in 2007. The consolidation was meant to do away with overlapping or redundant regulation and reduce the cost and complexity of compliance.

Understanding FINRA

Oversight Role

The Financial Industry Regulatory Authority (FINRA) is the single largest independent regulatory body for securities firms operating in the United States. It oversees more than 3,400 brokerage firms, 152,000 branch offices, and nearly 617,550 registered securities representatives, as of 2020.4 FINRA has 19 offices across the United States and approximately 3,600 employees.5

FINRA regulates the trading of equities, corporate bonds, securities futures, and options. It has also been authorized by Congress to protect the interests of investors.6

In addition to overseeing securities firms and their brokers, FINRA administers the qualifying exams that securities professionals must pass to sell securities or supervise others who do. Those include, for example, the Series 7 General Securities Representative Qualification Examination and the Series 3 National Commodities Futures Examination.7

Rules Enforcement

In its enforcement capacity, FINRA has the power to take disciplinary actions against registered individuals or firms that violate its rules.

In 2020, it initiated 808 disciplinary actions, levied fines totaling $57 million, and ordered restitution of $25.2 million to investors. It also expelled two member firms and suspended another two, while barring 246 individuals from the securities business and suspending another 375.4

Also in 2020, it referred 970 fraud and insider trading cases to the Securities and Exchange Commission (SEC) and other government agencies for prosecution.4

For investors who are shopping for a broker or want to check up on their current one, FINRA maintains BrokerCheck, a searchable database of brokers, investment advisors, and financial advisors. BrokerCheck includes certifications, education, and any enforcement actions.8 It draws from FINRA’s Central Registration Depository (CRD) database, which contains the records of individuals and firms in the securities business in the United States.9

Benefits of FINRA

FINRA’s main benefit for investors is protection from potential abuses and unethical conduct within the financial industry. FINRA resources (such as the aforementioned BrokerCheck) allow investors to determine if someone claiming to be a broker is actually a member in good standing.

By banning brokers who violate its rules of conduct, FINRA stops many financial crimes from taking place.

FINRA’s commitment to, and responsibility for, these functions was made clear by the combining of the NASD and the NYSE’s regulation operations into one organization.

The SEC approved the consolidation of these two organizations in July 2007. In announcing its formation, FINRA described a broad mandate that included responsibility for “rule writing, firm examination, enforcement and arbitration and mediation functions, along with all functions that were previously overseen solely by NASD, including market regulation under contract for Nasdaq, the American Stock Exchange, the International Securities Exchange, and the Chicago Climate Exchange.”10

The American Stock Exchange was acquired by the NYSE in 2008. The NYSE was acquired five years later by the Intercontinental Exchange (ICE). The Chicago Climate Exchange, a market for trading greenhouse gas emissions allowances, was shut down after the purchase by ICE of its parent company Climate Exchange Plc in 2010.1112

 

Criticism of FINRA

FINRA faces much of the same type of criticism that is often applied to any self-regulatory organization. Critics, such as Senator Warren of Massachusetts and Senator Cotton of Arkansas, claim that FINRA does not do enough to protect investors.13

In particular, an academic study by Egan, Matvos, and Seru showed that there were issues with repeat offenders. It found that financial advisors with past histories of misconduct were several times more likely to commit offenses in the future.14 FINRA may have been too restrained in exercising its powers.

The general criticism of self-regulatory agencies such as FINRA is that they do just enough to maintain the public’s trust. In this view, self-regulatory agencies have an inherent conflict of interest.

While members are interested in keeping the public’s trust, that interest only goes so far. Members need to weed out the worst offenders, but they don’t want the spotlight on themselves.

For example, it might be possible to rank all members for integrity. Yet, that would necessarily result in about half of all members being ranked as below-average. Unsurprisingly, self-regulatory agencies rarely rank their members.