GAO: SEC Should Increase FINRA Oversight

June 3rd, 2012
in econ_news

Econintersect:  The Government Accountability Office has issued a report that is critical of the operation of FINRA (Financial Industry Regulatory Authority), a SEC-seal-3-120pxfinra-sign-120pxsecurities industry self-regulatory organization.  The report specifically reviews weaknesses in the SEC (Securities and Exchange Commission) oversight of FINRA.

FINRA has responded by saying that the oversight received is already strong, but acknowledged it could be doing more to review its operations.  From Investment News:

FINRA believes the report demonstrates the broad and robust oversight the SEC provides to our operations, with annual or continuous review of our core regulatory programs,” Finra said in a statement. “We agree with GAO's recommendation that a retrospective review of FINRA rules could be valuable, and we'll work with the SEC to implement such a process.”

Follow up:

The GAO report comes as FINRA is in the midst of ramping up a campaign to become the regulator of registered investment advisors, who have previously been overseen by the SEC.  Republicans in the House have been proposing legislation to enable that.  An editorial comment by GEI News referred to the proposal as one for “the fox to watch the hen house.”

Some of the specific areas covered by the GAO report:

  • Some areas of FINRA activity receive limited or no oversight.
  • Some areas of activity reviewed are examined less frequently than planned.
  • There are no retrospective reviews of FINRA rules to determine effectiveness.
  • Governance and executive compensation have not been reviewed.

Here is the entire summary of the report from the GAO press release:

What GAO Found

Historically, the Securities and Exchange Commission’s (SEC) oversight of the Financial Industry Regulatory Authority’s (FINRA) programs and operations varied, with some programs and operations receiving regular oversight and others receiving limited or no oversight. Through its inspection process, SEC conducted routine and special inspections of various aspects of FINRA regulatory programs, including examinations, surveillance, and enforcement programs. SEC has also conducted routine inspections of FINRA’s advertising and arbitration programs but not as frequently as it had planned. SEC has also regularly reviewed FINRA proposed rule changes that are subject to SEC approval to determine consistency with the Securities Exchange Act of 1934 and related rules and regulations. However, neither SEC nor FINRA conducts retrospective reviews of FINRA’s rules. GAO and others have reported on the usefulness of retrospective reviews as they allow agencies to assess the effectiveness of their rules, and some federal financial regulators, including SEC, have begun pursuing plans to conduct retrospective reviews of their rules in light of a recent executive order that encourages independent regulatory agencies to do so. By not conducting these reviews, FINRA may be missing an opportunity to systematically assess whether its rules are achieving their intended purpose and take appropriate action, such as maintaining rules that are effective and modifying or repealing rules that are ineffective or burdensome. Further, by not reviewing what steps FINRA takes in reviewing its existing rules, SEC may not capture sufficient information to form an opinion about FINRA’s efforts to review its rules. Further, SEC has conducted limited or no oversight of other aspects of FINRA’s operations, such as governance and executive compensation. According to SEC, these operations were not historically considered due to competing priorities and resource constraints. Specifically, SEC officials said that SEC focused its resources on FINRA’s regulatory departments, which were perceived as programs that have the greatest impact on investors.

SEC is in the process of enhancing and expanding its oversight of FINRA using a more risk-based approach. To assess the risks facing FINRA, SEC has collected a substantial amount of information on FINRA’s regulatory programs and operations, including for programs and operations of FINRA for which it has not previously conducted oversight. SEC has analyzed the information it collected, and, according to SEC staff, will use this information as it implements its enhanced risk-based oversight of FINRA later this year. SEC has followed some elements GAO has previously found to be important in a risk-management framework, but officials have not articulated or documented how they will implement all of the elements, such as considering alternative oversight approaches and monitoring the effectiveness of its oversight. Incorporating these other elements will better position SEC to prioritize evolving and varying risks, evaluate alternatives, and monitor its oversight efforts. Without such elements, SEC may be missing opportunities to take a more comprehensive, risk-based approach in overseeing FINRA.

Why GAO Did This Study

SEC oversees FINRA, which is charged with regulatory oversight of all securities broker-dealers conducting business with the public in the United States. In light of recent events in the financial markets, SEC and FINRA have faced questions about their oversight roles. The Dodd-Frank Wall Street Reform and Consumer Protection Act required GAO to study SEC’s oversight of national securities associations registered under section 15A of the Securities Exchange Act of 1934, a provision which applies only to FINRA. This report examines (1) how SEC has conducted oversight of FINRA, including FINRA rule proposals and the effectiveness of its rules, and (2) how SEC plans to enhance its oversight of FINRA. To address these objectives, GAO reviewed SEC documentation, policies and procedures for inspections of FINRA and reviews of FINRA rule proposals; reviewed documentation on SEC’s plans for enhanced FINRA oversight; and interviewed SEC and FINRA officials.

What GAO Recommends

SEC should encourage FINRA to conduct retrospective reviews of its rules and establish a process for examining FINRA’s reviews, and SEC should follow all elements of a risk-management framework in developing its future oversight plans. SEC generally agreed with GAO’s recommendations.

For more information, contact A. Nicole Clowers at (202) 512-8678 or

John Lounsbury


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