Self-Regulation Recommended for Investment Advisors

U.S. Treasury Secretary Henry Paulson just released a 212-page blueprint to overhaul the nation's financial regulatory system and Paulson recommends that investment advisers “be subject to a self-regulatory regime similar to that of broker-dealers.”

Paulson notes that the distinctions between stockbrokers and investment advisers have blurred as fee structures have changed. Brokers are now primarily governed by the self-regulatory FINRA, while investment advisers are overseen by the SEC and state regulators.

So, Paulson recommends self-regulation of investment advisers which would “enhance investor protection and be more cost-effective than direct SEC regulation.” The blueprint also calls for a Conduct of Business Regulatory Agency to set national standards for business conduct laws which would apply to all types of financial-services firms and “pre-empting state business conduct laws directly relating to the provision of financial services.” Also, states should either be given a role in such an agency's rule-making process or be put in charge of monitoring compliance and enforcement.

Such a model appears as though it would relegate state regulators to a secondary role in policing the markets and states aren’t happy about it. "States have been in the forefront of detecting the adverse impact of rogue investment schemes on the individual investor," said William Galvin, Massachusetts Secretary of the Commonwealth. Some are concerned that loss of regulatory competition would mean the Feds are less motivated to take action in cases they’re reluctant to regulate. Mary Schapiro, chief executive of the FINRA, also worry investors would be left confused and exposed.

Arbitration claims filed by investors with FINRA rose slightly in February compared to last year and it is expected to continue to rise in 2008. This rise is normal since down markets tend to bring increasing numbers of arbitration claims. It typically 6 to 18 months for arbitration claims to climb and this January marked six months from the onset of the subprime-mortgage market implosion.

Wall Street is barely emerging from the onslaught of arbitration claims that emerged after the technology-stock bust and the accompanying research-analyst scandal and now it looks like another wave is coming. In 2000, about 5,500 arbitration claims were filed at the National Association of Securities Dealers, a predecessor to FINRA; that number jumped to almost 7,000 in 2001, and peaked at close to 9,000 in 2003. Since then, the numbers have dropped significantly, reaching a low of just over 3,200 in 2007 but the year-to-date numbers through February show already show a 4% rise in claims, from 535 to 558 in the same period last year.