What is FINRA and What Do They Do?
Contents
The Financial Industry Regulatory Authority (FINRA) is a U.S. self-regulatory organization that oversees brokerage firms and their employees to ensure that securities markets function fairly.
FINRA is a private corporation that acts a self-regulatory organization (SRO) for member brokerage firms and exchange markets. FINRA´s mission is to protect investors by ensuring that the security industry in the U.S. operates with fairness and honesty.
Established in 2007, FINRA operates under the supervision of the Securities and Exchange Commission (SEC). FINRA creates FINRA rules, ensures their compliance, and is involved in resolving disputes between brokers and investors. The organization also plays a key role in educating investors about their rights and risks in financial markets.
Note: The ultimate regulator of the U.S. securities industry is the U.S. Securities and Exchange Commission (SEC). FINRA is only a self-regulatory organization (SRO).
FINRA Regulated Brokers
Short Facts About FINRA
- FINRA is the largest independent regulator for securities firms doing business in the United States. Data from October 2023 show, that at that point, FINRA oversaw nearly 3,400 brokerage firms, almost 150,000 branch offices, and over 612,000 registrered securities representatives.
- FINRA have their main offices in Washington, D.C. and New York City. There are also 20 regional offices located in other parts of the U.S.
- FINRA offers regulatory oversight over all securities firms that do business with the public.
Understanding the Background
The Investment Bankers Conference, Inc. was founded in 1936. In 1939, it was registered as a national securities association with the SEC, under the name National Association of Securities Dealers, Inc. The association was registered in accordance with the auhtority granted by the 1938 Maloney Act amendments to the Securities Exchange Act of 1934, and was therefore permitted to supervise the conduct of its members subject to the oversight of the SEC.
In 1971, the National Association of Securities Dealers, Inc (NASD) launched a computerized stock trading system – the National Association of Securities Dealers Automated Quotations (NASDAQ).
In 2000, NASDAQ underwent recapitalization and became an independent entity from NASD.
In July 2007, the SEC approved the formation of a new self-regulatory organization (SRO) that would succeed the NASD. This new SRO – the Financial Industry Regularoty Authority (FINRA) – was formed by consolidating the NASD with the member regulation, enforcement and arbitration functions of the New York Stock Exchange (NYSE Regulation, Inc.).
FINRA is thus the successor of both the NASD and the NYSE Regulation, Inc.
How Does FINRA Protect Traders?
FINRA plays a vital role in ensuring the integrity of the U.S. securities markets. Through regulation, licensing, education, and dispute resolution, it provides comprehensive protection for traders and investors. FINRA’s enforcement of industry standards, transparency through tools like BrokerCheck, and investor education programs, ensure that traders are well-informed, better protected from misconduct, and able to resolve disputes more efficiently.
Examples of what FINRA is doing to protect traders
1. Regulation and Enforcement
FINRA ensures that brokerage firms and brokers registered with them adhere to securities laws and best practices. It sets industry standards and enforces regulations designed to maintain the fairness and integrity of the securities market. Registered firms and brokers who fail to comply with these rules face penalties, including fines, suspensions, or bans from the industry. FINRA conducts regular audits and on-site inspections to ensure firms are following the rules.
FINRA also regulates trading practices, ensuring that the securities markets operate in a way that promotes trust and fairness. This includes overseeing trading platforms, systems, and technology to prevent market manipulation or unfair trading practices.
2. Surveillance
FINRA actively works to prevent fraud, insider trading, and market manipulation in the securities industry. It uses advanced surveillance systems to detect suspicious trading activity and has the authority to investigate and prosecute wrongdoers. Traders can feel more confident knowing that FINRA monitors the markets to ensure fairness and protect against exploitation.
3. Managing the Licensing and Qualification of Brokers
FINRA manages the licensing of brokers and financial advisors in the U.S. To work as a broker, individuals must pass exams such as the Series 7 and Series 63 to ensure they possess the required knowledge and ethical standards. FINRA enforces continuing education requirements, ensuring that brokers maintain their competency and knowledge of changing market regulations. This licensing system helps protect traders by ensuring that their brokers are qualified and trained to handle investments responsibly. A broker found violating FINRA’s ethical standards may face suspension or revocation of their license.
4. BrokerCheck
FINRA promotes transparency in the securities industry through services like BrokerCheck, a tool that allows investors to verify the backgrounds of brokers and firms. By accessing BrokerCheck, traders can view disciplinary records, work history, and qualifications of their broker before making any financial decisions. This helps traders avoid dealing with brokers who have histories of misconduct or regulatory violations. Through BrokerCheck, traders can also verify whether a brokerage firm is in good standing or has any pending legal actions, thus providing them with a safer trading experience.
5. Dispute Resolution Services
FINRA offers a dispute resolution process for investors and brokers, providing both arbitration and mediation services. When disputes arise over brokerage services, investments, or other related issues, FINRA’s arbitration and mediation process can help resolve conflicts more quickly and cost-effectively than taking cases to court. This ensures that traders have an efficient, fair, and impartial way to recover damages in cases where they have been wronged. Thousands of cases are handled annually, ranging from disputes about investment performance to unethical behavior by brokers. The service can be especially important for small-scale hobby traders who may not feel they have the time and resources required to take on a large trading firm in a strandard court case.
5. Education for Traders and Investors
FINRA plays a significant role in educating traders and investors. Its Investor Education Foundation provides free resources, articles, and tools to help traders and investors understand financial markets, their rights, and how to make informed decisions. This includes information on the risks of different investment products and how to detect and avoid fraud. Investor and trader education is vital, especially for new traders who may not fully understand complex financial products like options, futures, or derivatives. By equipping traders and investors with knowledge, FINRA helps them avoid scams, understand potential risks, and make better-informed financial decisions.
FINRA in Action – Examples of FINRA Cases
February 2024: FINRA fines Morgan Stanley $1.6 million
In February 2024, FINRA announced the decision to fine Morgan Stanley Smith Barney LLC $1.6 million for municipal securities violations and related failures.
The firm had repeatedly violated the close-out requirements stipulated by the MSRB Rule G-12(h), by not closing out failed inter-dealer municipal securities transactions in a timely manner. The firm had also failed to take promt steps to obtain physical possession or control of municipal security positions that were short for more than 30 calendar days. In addition to this, related supervisory failures added to the fine.
Morgan Stanley Smith Barney reached a settlement with FINRA, in which the consented to the entry of FINRA´s findings without admitting or denying the charges.
This case was the first ever FINRA disciplinary action based on the close-out requirements of the Municipal Securities Rulemaking Board (MSRB) Rule G-12(h). Firms that are FINRA members must adhere to the close-out requirements under MSRB Rule G-12(h). This case also involved Rule 15c3-3 of the Securities Exchange Act of 1934, which requires a broker-dealer to take prompt steps to obtain physical possession or control of securities it failed to receive for more than 30 calendar days.
During their investigation, FINRA unveiled that, from December 2016 through August 2021, Morgan Stanley Smith Barney LLC had failed to timely cancel or close out 239 inter-dealer municipal transactions aged over 20 calender days after settlement date. The total value of these transactions were approximately $9 million.
Further, the investigation showed that from January 2016 through August 2021, the firm had failed to take promt steps to obtain possession or control of 247 municipal securities that fell under the 15c3-3 rule of the 1934 Securities Exchange Act. The firm had failed to receive these securities for an average of circa 177 days. The combined value of these securities was approximately $9.4 million.
The firm´s failure to establish and maintain routines and procedures to achieve compliance with the MSRB close out requirements and the Exchange Act Rule 15c3-3 added to the fine. Morgan Stanley Smith Barney waited until June 2021 to change its processes for municipal fails-to-receive, and to September 2021 before updating its supervisory procedures.
Of the $1.6 million fine, FINRA allocated $1.2 million to the Municipal Securities Rulemaking Board (MSRB).
November 2023: FINRA fines BofA Securities $24 million
In November 2023, FINRA announced their decision to fine BofA Securities, Inc. $24 million for U.S. Treausury securities spoofing and related supervisory failures.
An investigation by FINRA had unveiled 717 instances of spoofing activity carried out from October 2014 through February 2021 by two traders in the United States; one supervisor and one junior trader. The investigation also showed other failures, including supervisory failures, for a period exceeding six years at BofA Securities.
In settling the case, BofA Securities consented to the entry of FINRA’s findings, without admitting or denying the charges.
From at least October 2014 through September 2022, BofA Securities did not have an adequate system in place to detect spoofing in U.S. Treasury markets. A supervisory system was not put in place until November 2015, and the system remained deficient until mid-2019 since it was only looking for spoofing in algorithmic trading – not spoofing carried out by human traders. Until at least December 2020, BofA Securities´s surveillance routines failed to capture orders entered by its traders into certain systems provided by external venues. The FINRA investigation also showed that BofA Securities did not supervise for cross-product spoofing in Treasuries through September 2022.
Treasuries spoofing is a fraudulent trading activity where a trader places orders, that they do not intend to have executed, to create the appearance of market activity on one side of the market. The idea is to induce other market participants to act based on what they think are real (bona fide) orders that will be executed. Spoofing is carried out to trick other market participants to trade at a time, price, or quantity that they would otherwise not have selected.
Spoofing undermindes the transparency and integrity of markets, by creating a false image of supply and demand. It can be especially harmful when it targets the U.S. Treasury securities market, since prices on this market are utilized as benchmarks for numerous other financial instruments and transactions.