In the financial services industry, consumers pay a fee for a service and expect a certain level of security in return. When an investor pays a broker to handle his or her accounts, the broker is obligated to act in that investor's best interests. This obligation is not only moral, but also arises from the rules set forth by the industry's various regulatory agencies. The problem is that if an account is mishandled, most consumers have no idea where to turn until it's too late.
Examples of mishandling range from churning to suitability to fraud. Churning is an unethical practice employed by some brokers to increase their commissions by excessively trading in a client's account. Suitability relates to the types of investments chosen for the account and whether they are appropriate for a particular investor, while fraud can encompass a wide range of behaviors with varying levels of severity.
So who is looking out for the average investor?
Is it the Financial Industry Regulatory Authority (FINRA), the state regulatory agencies, the Securities and Exchange Commission (SEC), the Office of the Comptroller of the Currency (OCC) or the Federal Reserve Board (FRB)? The answer is all of the above, but each in its own way. Read on to learn more.
FINRAFor most consumers, FINRA, the agency that governs business between brokers, dealers and the investing public, is the first line of defense in the event of a problem associated with an investment account.
When an investor opens an account at a U.S.-based brokerage firm, the fine print in the lengthy account-opening document typically stipulates that consumers give up their rights to pursue the brokerage company in a venue outside arbitration. Under FINRA's rules, however, the consumer maintains the right to pursue arbitration. As a result, the lion's share of consumer complaints against brokerages is fielded by FINRA and is usually arbitrations.
Arbitrations are basically court-like settings where judges are replaced by a panel of peers. Cases are presented by claimants (plaintiffs), with or without their attorneys, and are defended by respondents (defendants), who typically have attorneys.
The process begins by filing a claim with FINRA, which then notifies all parties involved that proceedings have begun. Arbitration is designed to be simple in order to accommodate the average consumer lacking legal expertise and allow him or her to file a claim without the need to hire an attorney. The forms are written in plain language so as not to discourage someone from filing.
However, while the initial filing can be processed without an attorney, it is widely suggested that the claimant (plaintiff) hire an attorney as he or she will encounter a barrage of deep-pocketed legal defense maneuvers once the claim is filed. There is no shortage of legal services available for claimants, and many attorneys will take cases on contingency, especially if there is a large potential settlement and what they feel is a good chance of winning.
While the arbitration process is effective and orderly, consumers pursuing a case should be prepared for the same time lags they would experience with a typical state or federal court case. The filing process can take up to one year and proceedings after the initial filing can take years.
Because the process can take a significant amount of time and resources, it is highly recommended that consumers that have been treated unfairly exhaust all measures for handling grievances directly with their broker or investment manager prior to filing a complaint with FINRA. (For further reading, see Investigating The Securities Police.)
State Regulatory AgenciesWhile FINRA fields the majority of complaints from investors, there are other lines of defense with overlapping powers. For instance, each state has its own regulatory agency to police the in-state activities of the securities industry. While a state's regional jurisdiction is defined by its own state lines, its professional jurisdiction varies.
Typically, the state polices a variety of financial services providers ranging from credit unions to broker dealers. State agencies also cover investment advisors that fall below the requirement for filing with the SEC (less than $25 million under management). Here, the coverage that state agencies provide is similar to the SEC's duties of licensing, filing and auditing. Regulatory overlap is usually avoided as registered investment advisors only register under one agency or the other.
The state typically gets involved early in an investigation and then cooperates with the SEC as the investigation deepens. While effective, the state agencies are not usually as well staffed as FINRA or the SEC and have to cover a larger caseload per investigator.
The SECThe glue that holds the investor protection system together is the SEC, which arose from the ashes of the 1929 stock market crash and was crafted around the Securities Act of 1933 and the Securities Exchange Act of 1934. The SEC governs the self-regulatory organizations (SROs) that reach down to the consumer, and its jurisdiction is far reaching, covering four main divisions:
corporate finance
market regulation
investment management
enforcement
The SEC's responsibilities have become ever more challenging with the advent of computer-based crimes and the increasing complexity of financial products and transactions, but its primary purpose is still to protect the individual investor by watching over the investment management industry and ensuring that public companies provide sufficient financial and other information to the public to allow investors to make informed decisions.
With the new challenges in the marketplace, there has been a call to increase the flexibility of the SEC's power. However, despite years of discussions about consolidating regulatory bodies or appointing a finance czar, there are no concrete plans in the pipeline. (Learn more about how this regulatory body protects the rights of investors in Policing The Securities Market: An Overview Of The SEC.)
The OCC and the FedThere are two other regulatory bodies spoken of frequently, the less common Comptroller of the Currency (OCC) and the famous (or infamous) Federal Reserve Board (FRB). While both of these bodies are very active in watching out for investors, their activities are focused on banking and financial services at a higher level, and their involvement in individual cases is rare.
Conclusion
Each of these regulatory bodies looks out for investors in its own way, and each has its specific duties with some overlap. The regulatory organizations have become increasingly sophisticated to accommodate increasingly complex investment transactions and products, but are challenged each year as new issues arise. These organizations are designed to protect consumers, so if you have a problem that you aren't able to resolve directly with your broker, take advantage. Remember, just like your local police, the regulatory agencies won't know about any issues unless you contact them.
