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Does Broker Watchdog Need a Shorter Leash?

The Supreme Court’s decision Tuesday to decline to hear a lawsuit brought against the brokerage industry’s regulator has many advocates worried the watchdog is growing too powerful.

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Created in 2007, the Financial Industry Regulatory Association (Finra) is a “self-regulatory organization,” that critics say is entrusted with many of the same powers and legal protections as a government agency – but without the same accountability.  The lawsuit, filed by brokerage firm Standard Investment Chartered, charged that small brokers had been given misleading information by the National Association of Securities Dealers (an earlier self-regulatory organization) about its merger with the regulatory arm of the New York Stock Exchange to create Finra. By declining to hear the case, the high court upheld the decision of the 2nd U.S. Circuit Court of Appeals, which said self-regulatory organizations are protected from such from lawsuits.

Industry experts say self-regulatory organizations are generally protected from lawsuits directly related to their enforcement and regulatory powers. But consumer advocates worry about granting this immunity to private groups, arguing that the protection has been extended too far, making self-regulatory organizations less accountable to the general public and harder to monitor. “Self-regulatory organizations like Finra have basically been granted a type of immunity that normally would only apply to government agencies,” says Michael Smallberg, an investigator for the Project on Government Oversight. But at the same time, he adds, Finra doesn’t “have to comply with federal transparency rules or conflict of interest rules.”

A spokesman for FINRA said, “The Supreme Court’s determination not to hear this case causes no harm to investors and confirms well-established case law regarding the legal status of SROs.” The Securities Industry and Financial Markets Association, a trade group representing brokers, declined to comment.

To be sure, it’s unlikely that individual investors would want or need the right to sue Finra, says Mercer Bullard, an investor-rights advocate and associate professor of law at the University of Mississippi. The lawsuit in question was brought by a brokerage firm, and most disputes with Finra are likely to come from brokers, who financially support Finra and are regulated by it, Bullard says. Finra, in turn, is policed by the Securities and Exchange Commission, the government body that oversees it. In fact, he says investors may actually be better off with a stronger Finra, if it means better oversight of its brokerage members.

Still, many advocates say the decision is a blow to investor rights. “Self-regulation is not really a workable concept in our view, because the regulator has too many interests in common with the folks it’s regulating,” says Linda Sherry, a spokeswoman for Consumer Action. “This is really a situation in which the fox is guarding the henhouse.” And while the SEC oversees Finra, the public doesn’t directly elect SEC commissioners, and “each of those degrees of removal from the politically accountable actor weakens the incentive to follow the law,” says Scott Michelman, a staff attorney for Public Citizen.

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