Remarks From the Financial Services Institute Advocacy Summit

Stephen Luparello

Vice Chair

Washington, DC

October 5, 2011

As prepared for delivery.

Good morning, and thank you, David [Bellaire], for that introduction and the invitation to speak today.

Before I begin, I would like to acknowledge the constructive relationship FINRA and FSI have enjoyed since the launch of FSI seven years ago. Our Chairman, Rick Ketchum, spoke at your OneVoice conference earlier this year, and I am pleased to have the chance to speak to you this morning here in Washington.

In recent years, our organizations have been engaged in conversation about a variety of regulatory issues, including those that I'm going to address today. The first topic is financial reform—specifically the discussion of authorizing one or more SROs for investment advisers and establishing a fiduciary duty for broker-dealers.

As FSI has advocated, authorizing an SRO to examine investment advisers is the most practical and effective way to close the regulatory gap in oversight between broker-dealers and investment advisers. FSI has strongly supported FINRA as that SRO, and we appreciate that support.

The second topic I'll update you on is our exam program, which we've continued to evolve in response to the many ongoing changes in regulation, the markets and at firms. We've recently implemented a more risk-based focus to our exams, and I'd like to walk you through our thinking on risk and what those changes mean to you. 

SRO for IAs

Let me return to the issue of an SRO for IAs. As you know, Dodd-Frank required the SEC to conduct a study on enhancing investment adviser examinations, which was released in January. The study clearly lays out that the SEC does not have the resources to examine investment advisers with adequate frequency and notes that one or more SROs for investment advisers can augment government oversight programs through more frequent examinations.

The gap in investment adviser oversight is a significant void in the protection of advisory clients and should be addressed as quickly as possible. As FINRA has consistently stated, we believe that investors deserve the same level of protection, regardless of whether they are dealing with a broker or investment adviser. 

For years, the SEC has had insufficient resources to devote to investment adviser examinations. For example, only 9 percent of SEC-registered investment advisers were examined in 2010. At that rate, the average registered adviser could expect to be examined less than once every 11 years. FINRA and the SEC, by contrast, examine about 55 percent of broker-dealers each year.

Congress is now considering how best to provide additional oversight of investment advisers, including authorizing one or more SROs to assist the SEC—the kind of structure that works very effectively in the broker-dealer space. Last month, a subcommittee of the House Financial Services Committee conducted a hearing on this topic and both Rick Ketchum and Bill Dwyer testified in support of an adviser SRO. Draft legislation by Chairman Bachus, which was circulated for the hearing, would establish the authority and set a framework of requirements for an adviser SRO. These requirements include provisions that would ensure that the SRO's regulatory program reflects the nature and diversity of the investment adviser industry. FINRA believes the draft is a thoughtful approach to addressing the critical need for increased adviser regulation.


I want to address concerns cited by some in the investment advisory community—especially those entities that are not affiliated with a broker-dealer—who have consistently opposed the SRO concept, and especially FINRA as that SRO.

They have mounted a campaign that is focused on the premise that the SEC should receive the necessary funding from Congress to comprehensively regulate investment advisers. The reality of that happening is unlikely.

Many advisers also fear that an SRO—particularly FINRA—would not be sufficiently sensitive to the different regulatory risks of advisers. Specifically, whenever the discussion moves to whether FINRA should be the SRO for investment advisers, the talking points in opposition are simple: FINRA is not qualified because it only regulates broker-dealers and therefore doesn't understand the differences between the two models. They believe IAs would be forced to live under a broker-dealer regime. That's simply wrong.

We agree that there are important differences between broker-dealers and investment advisers. Any entity that would be empowered to oversee IAs would need to recognize that and regulate accordingly—and FINRA most certainly would.

SRO Approach and Governance

Let me take a few moments to talk about how FINRA would oversee IAs if we became the SRO for some or all investment advisers. First, we would not force broker-dealer requirements on investment advisers. That would not be appropriate or in the public interest. Any IA SRO—FINRA or any other—would need to implement regulatory oversight that is tailored to the particular characteristics of the investment adviser business. We would examine for, and enforce compliance with, the Advisers Act and the SEC rules under that Act.

The primary regulatory structure for advisers should remain where it is today—under the fiduciary standard incorporated in the Advisers Act and related SEC rulemaking and interpretations, and from the developed body of state law. We believe that an SRO for advisers could be effective with limited rulemaking authority, the extent of which should be determined by Congress and the SEC. And SEC approval and oversight of any rule proposals would ensure that the SRO rules are appropriate for the adviser industry. 

Another criticism related to FINRA serving as an IA SRO is that our governance structure only reflects broker-dealer interests and does not have IA representation. As we wrote in our comment letter to the SEC—and as Rick stated in his testimony to the House subcommittee—if FINRA becomes the SRO for investment advisers, our governance structure must necessarily appropriately reflect investment advisers. This would be carried out most effectively by setting up a separate affiliate that would have a board comprised of majority public representatives, with members of the investment adviser industry allocated the remaining seats.

Leveraging Existing Infrastructure

Last, opponents to the SRO concept cite that FINRA staff lack the necessary expertise to regulate IAs. Here, at least, they have something of a point. We would need to hire additional staff, especially those with expertise and leadership in the adviser area, and implement a rigorous training program to make sure our existing examiner corps are up to speed on the differences.

That said, we're obviously not novices in designing and running examination programs. Given our experience, we are uniquely positioned to build a cost-effective SRO for investment advisers. While there would be some incremental cost to implementing an IA program, much of that cost is embedded in our existing infrastructure. We already have the district offices, the regulatory technology and the registration function through IARD. 


Let me spend a moment on a fiduciary standard of care, a subject that continues to be of particular interest to both FINRA and FSI.

While key details remain to be resolved, we know that the SEC study released in January accounts for the differences in the IA and BD channels, including the advice- versus commission-based relationships.

While it's not clear yet how any future proposals will evolve, FINRA believes the defining principle of fiduciary standard is simple: what's in the best interest of customers.

We have found under the present broker-dealer regulatory regime that too often we and the SEC have been forced to respond issue by issue, or violation by violation, rather than addressing problems more broadly and prospectively. A fiduciary standard would establish a benchmark for the regulator and the regulated, to help ensure that brokers and investment advisers have consistent obligations through each step of their financial advice. The first question they must ask when considering a new product for a customer is not whether a product is acceptable but whether it is in the best interests of the customer.

And we believe that extending a fiduciary duty to all professionals providing individualized advice to retail customers can be done in a way that recognizes the variety of broker-dealer business models that currently exist.


Even before the SEC takes final action, there are a few areas where we can begin implementing changes to move the standard forward. One of those areas is disclosure. While improving disclosure alone is not a substitute for a harmonized standard, it is a crucial cornerstone to make any standard work.

Today, disclosure is often legalistic and dense, creating a challenge for investors to absorb facts that are critical to their investment decisions.  As a result, many investors simply ignore the paper-based disclosures provided to them.  

We believe we can fix this by reflecting on how financial services professionals interact with investors, educating investors so they make informed decisions, and determining how best to use existing technology and tools to help financial services professionals get the message across. Among other things, we need to capture investors' attention during the initial stages of a relationship or transaction; provide detail from a more web-based standpoint; and use a minimalist but effective point of sale disclosure to remind customers of the questions they need to ask to reach an informed decision. 

To that end, FINRA published a concept proposal late last year seeking comment on whether firms, at or prior to commencing a business relationship with a retail customer, should be required to provide a written statement that describes the types of accounts and services they provide. Firms would also be required to disclose the conflicts associated with such services.

The document we propose is similar in purpose to Form ADV, which investment advisers currently provide to advisory customers. Through the comment process, we have gathered input from a variety of stakeholders about what may be the right combination of information to provide investors up front and how best to provide detail from a web-based standpoint. We see disclosure as a stepping stone toward a fiduciary standard. It supports the three principles FINRA believes are fundamental to a fiduciary relationship: avoiding conflicts where possible; fully disclosing conflicts that do exist; and taking actions that are in the best interests of customers.

Exam Program Updates

I want to close with an update on our exam program and our long-term transition to a more risk-based approach. The goal, as always, is to focus our efforts where we believe risk, especially risk to customers, is greatest, while making sure that every firm is examined at least every 3 to 4 years, regardless of risk.

As a starting point, let's talk about what we mean by risk. It means more than just regulatory compliance risk. As we've learned over the last few years, a firm can be compliant but still present tremendous risks to investors, the financial markets and other firms. Comparatively, compliance is more of a black and white issue—there is a rule you can point to and often times an objective measure of compliance to that rule. Risk is a more subjective science. It is colored by the business model a firm employs, products and services it offers, the clients it sells to and the manner in which the firm funds itself. And those risks change dramatically as micro- and macro-economic factors change. As FINRA moves toward a more risk-based approach, we will necessarily be driven to better understand the differences in business models, the various products and services firms are engaged in, and the clients and counterparties they deal with; hardly a black or white—or a one-size-fits-all—approach for that matter. 

Moving toward more risk-based programs means that we have to make intelligent, informed decisions about risk and where it is—and focus our efforts accordingly. Risk should inform the way we deploy our resources and how intensely we apply those resources based on the materiality of the risk, the alignment to our risk appetite, and how that risk lines up with our other priorities. We can prioritize where the threat of harm is greatest based on the potential for investor harm, market disruption or loss, among other things.

What we are doing is trying to better grasp the various businesses and activities in which a firm and its personnel are engaged so that we see more clearly the risks that the firm is exposed to or facing. Armed with that information, we can decide where to apply our examination resources and with what level of intensity.

All of this means we need to develop an appropriate way to identify and size up risk for each firm. This will not happen overnight. Instead, we'll need to leverage data—independent, granular data from both vendors and firms—in order to see what brokers are doing, how they are interacting with their customers, and identify potential outliers on which to focus. Given the number of brokers and accounts, we need to use this data to be more efficient and effective in pinpointing the places to focus. Firms with independent distributor business models or those with far-flung branch office networks understand the unique challenges presented here.

But in the end, the goal is to establish a more targeted regulatory program that will help FINRA react faster when risks materialize.


Let me close with one last thought. One of the keys to enacting lasting reforms will be regular communication and dialogue among regulators and the industry. Your ongoing efforts to make sure the independent broker-dealer perspective is heard are valuable, in that they can help us understand the regulatory and compliance challenges your firms are facing. So let's keep talking.

Thanks for listening. I'd be happy to take your questions.