If brokers move their business to fintech firms, FINRA may not have oversight. Is this a good thing?

FINRA is considering a rule that would reduce the supervisory burden of US brokerage members’ outside activities. The rationale is that if a broker isn’t engaged in brokerage business then they should not be supervised as they are today. That makes sense, except for the fact that much of the brokerage business is now driven by technology. Where does that leave investor protection?
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In FINRA’s Regulatory Notice 18-08, the proposed rule would require registered persons to provide their members with prior written notice of a broad range of outside activities, while imposing on members a responsibility to perform a reasonable risk assessment of a narrower set of activities that are investment related that today. This would allow members to focus on outside activities that are most likely to raise investor protection concerns. “The proposed rule would not impose supervisory and recordkeeping obligations for most other outside activities, including IA activities at an unaffiliated third-party IA. At the same time, the proposal would hold a member responsible for approved activities that could not take place but for the registered person’s association with a member.”

FINRA shows five areas that would no longer be heavily supervised by broker members:

  1. Selling Private Placements Away from Member
  2. Activities at Third-Party IA
  3. Non-Investment- Related Work (e.g., car service, seasonal retail)
  4. Activities at Affiliates (e.g., IA, Insurance and Banking Affiliates)
  5. Personal Investments (e.g., Buying Away)

Like any big change to regulation, this one has its critics too. A press release from the Public Investors Arbitration Bar Association included this choice quote: “These changes will create a regulatory black hole that will insulate brokerage firms now serving as the first line of defense against outside investment schemes at the direct expense of protecting investors. Rather than fixing the rogue broker problem, FINRA has chosen to focus on how to let its member brokerage firms wash their hands of any responsibility for these unscrupulous actors.”

Our attention is on the fact that many US brokers have invested heavily in technology to the point that their technology divisions are proper independent fintech businesses, selling services to their parent company, to clients and to other brokers. These divisions can reasonably make the argument that the way they earn their living is not dependent on their employees’ brokerage registrations. As such, with a notice to the parent firm, the tech group’s registered employees can engage in any activity that is no longer actively supervised in FINRA’s list of five activities. Bad apples can grow anywhere including at fintech firms. If FINRA is no longer supervising finch’s affiliated with brokers, then someone with access to brokerage data but not in the brokerage business could engage in buying away, trading based on investment data, or other activity that would not be permitted under FINRA’s current rules or in the future if the employee were a registered person working at a brokerage.

This is a legitimately challenging time for US brokers, and a relief from regulation would serve them well. This gives FINRA’s proposal a reasonable logic: if an activity doesn’t require a broker-dealer registration to conduct then it should not necessarily be regulated. On the other hand, carving out exemptions for regulation that could wind up representing the bulk of the US brokerage work force, with the exception of registered representatives, and could open the door to trouble down the line. The problem of finding a middle ground sounds similar to the Office of the Comptroller of the Currency’s efforts to allow fintechs to register as banking entities. This may yet take some work on FINRA’s part to find the right balance of investor protection and minimizing the regulatory burden on brokers.

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