[House Hearing, 114 Congress]
[From the U.S. Government Publishing Office]
OVERSIGHT OF THE FINANCIAL
INDUSTRY REGULATORY AUTHORITY
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON CAPITAL MARKETS AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED FOURTEENTH CONGRESS
FIRST SESSION
__________
MAY 1, 2015
__________
Printed for the use of the Committee on Financial Services
Serial No. 114-20
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
______
U.S. GOVERNMENT PUBLISHING OFFICE
95-064 PDF WASHINGTON : 2015
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HOUSE COMMITTEE ON FINANCIAL SERVICES
JEB HENSARLING, Texas, Chairman
PATRICK T. McHENRY, North Carolina, MAXINE WATERS, California, Ranking
Vice Chairman Member
PETER T. KING, New York CAROLYN B. MALONEY, New York
EDWARD R. ROYCE, California NYDIA M. VELAZQUEZ, New York
FRANK D. LUCAS, Oklahoma BRAD SHERMAN, California
SCOTT GARRETT, New Jersey GREGORY W. MEEKS, New York
RANDY NEUGEBAUER, Texas MICHAEL E. CAPUANO, Massachusetts
STEVAN PEARCE, New Mexico RUBEN HINOJOSA, Texas
BILL POSEY, Florida WM. LACY CLAY, Missouri
MICHAEL G. FITZPATRICK, STEPHEN F. LYNCH, Massachusetts
Pennsylvania DAVID SCOTT, Georgia
LYNN A. WESTMORELAND, Georgia AL GREEN, Texas
BLAINE LUETKEMEYER, Missouri EMANUEL CLEAVER, Missouri
BILL HUIZENGA, Michigan GWEN MOORE, Wisconsin
SEAN P. DUFFY, Wisconsin KEITH ELLISON, Minnesota
ROBERT HURT, Virginia ED PERLMUTTER, Colorado
STEVE STIVERS, Ohio JAMES A. HIMES, Connecticut
STEPHEN LEE FINCHER, Tennessee JOHN C. CARNEY, Jr., Delaware
MARLIN A. STUTZMAN, Indiana TERRI A. SEWELL, Alabama
MICK MULVANEY, South Carolina BILL FOSTER, Illinois
RANDY HULTGREN, Illinois DANIEL T. KILDEE, Michigan
DENNIS A. ROSS, Florida PATRICK MURPHY, Florida
ROBERT PITTENGER, North Carolina JOHN K. DELANEY, Maryland
ANN WAGNER, Missouri KYRSTEN SINEMA, Arizona
ANDY BARR, Kentucky JOYCE BEATTY, Ohio
KEITH J. ROTHFUS, Pennsylvania DENNY HECK, Washington
LUKE MESSER, Indiana JUAN VARGAS, California
DAVID SCHWEIKERT, Arizona
FRANK GUINTA, New Hampshire
SCOTT TIPTON, Colorado
ROGER WILLIAMS, Texas
BRUCE POLIQUIN, Maine
MIA LOVE, Utah
FRENCH HILL, Arkansas
Shannon McGahn, Staff Director
James H. Clinger, Chief Counsel
Subcommittee on Capital Markets and Government Sponsored Enterprises
SCOTT GARRETT, New Jersey, Chairman
ROBERT HURT, Virginia, Vice CAROLYN B. MALONEY, New York,
Chairman Ranking Member
PETER T. KING, New York BRAD SHERMAN, California
EDWARD R. ROYCE, California RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas STEPHEN F. LYNCH, Massachusetts
PATRICK T. McHENRY, North Carolina ED PERLMUTTER, Colorado
BILL HUIZENGA, Michigan DAVID SCOTT, Georgia
SEAN P. DUFFY, Wisconsin JAMES A. HIMES, Connecticut
STEVE STIVERS, Ohio KEITH ELLISON, Minnesota
STEPHEN LEE FINCHER, Tennessee BILL FOSTER, Illinois
RANDY HULTGREN, Illinois GREGORY W. MEEKS, New York
DENNIS A. ROSS, Florida JOHN C. CARNEY, Jr., Delaware
ANN WAGNER, Missouri TERRI A. SEWELL, Alabama
LUKE MESSER, Indiana PATRICK MURPHY, Florida
DAVID SCHWEIKERT, Arizona
BRUCE POLIQUIN, Maine
FRENCH HILL, Arkansas
C O N T E N T S
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Page
Hearing held on:
May 1, 2015.................................................. 1
Appendix:
May 1, 2015.................................................. 29
WITNESSES
Friday, May 1, 2015
Ketchum, Richard G., Chairman and Chief Executive Officer,
Financial Industry Regulatory Authority (FINRA)................ 5
APPENDIX
Prepared statements:
Ketchum, Richard G........................................... 30
OVERSIGHT OF THE FINANCIAL
INDUSTRY REGULATORY AUTHORITY
----------
Friday, May 1, 2015
U.S. House of Representatives,
Subcommittee on Capital Markets and
Government Sponsored Enterprises,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:48 a.m., in
room HVC-210, Capitol Visitor Center, Hon. Scott Garrett
[chairman of the subcommittee] presiding.
Members present: Representatives Garrett, Hurt, Royce,
Neugebauer, Huizenga, Hultgren, Poliquin, Hill; Maloney,
Sherman, Lynch, and Himes.
Chairman Garrett. Good morning. The Subcommittee on Capital
Markets and Government Sponsored Enterprises will come to
order. I appreciate everyone's indulgence for votes, for those
important pieces of legislation.
Today's hearing is entitled, ``Oversight of the Financial
Industry Regulatory Authority.'' I will begin with opening
statements and then turn to our panel.
I now yield myself 3 minutes.
Today we will hold, as I said, an important hearing, to
provide for much-needed oversight of the Financial Industry
Regulatory Authority (FINRA). But despite its status as a self-
regulatory organization (SRO), some would argue that it hardly
resembles what would many call an SRO, and is what now appears
to be more of a quasi-government regulator. Some even call it a
deputy SEC.
Indeed, its recent actions are closer to that of ever-
expanding Federal bureaucracies that we have become accustomed
to now in Washington, that seek to go further into people's
lives and businesses.
And so, despite FINRA's enforcement of rules for the
broker-dealer community that it regulates, it recently has come
out in favor of the SEC moving forward with a uniform fiduciary
standard, a sentiment shared by SEC Chair Mary Jo White.
I should point out that when Chair White was before the
full Financial Services Committee in March, she was unable to
provide this committee with any studies or any other data,
especially as it relates to the proposal's impact on low- and
middle-income investors, which convinced her of the need for
the new proposal in the first place.
So I hope that Mr. Ketchum can elaborate today on the
studies and any empirical data that he may have reviewed which
has persuaded him and FINRA that the SEC should move forward on
sweeping regulations and reconstruction of our security laws.
As I previously noted elsewhere, and in other
conversations, FINRA's comprehensive automated risk data
system, also called CARDS, is a solution in search of a
problem. Even after changes to the original proposal, I remain
far from convinced that this costly, intrusive, and burdensome
proposal is actually needed. The costs will far outweigh any
potential benefits, and will further squeeze out small broker-
dealers who are already facing increased regulatory compliance
costs.
Additionally, CARDS would establish a new government
database that would retain sensitive information about millions
of Americans that can be, as we have been told, re-engineered
to determine their personal identity. This, as some have said,
amounts to the CARDS proposal being ``a few cards short of a
full deck.''
As FINRA is attempting to stand up CARDS, it is also
bidding to become the operator of something called the
consolidated audit trail (CAT). In bidding for CAT, FINRA is in
a unique position to the other bidders on this proposal.
Why is that? Because it sits on the SRO committee that will
recommend a winner to the SEC. This would appear to be a
blatant conflict of interest.
But, notwithstanding that, I think having a single
financial regulator with the data held by CAT and CARDS, should
give every American some pause.
In all, FINRA continues to step far beyond, I believe, the
bounds of its originally intended jurisdiction and into
personal investing decision-making of everyday Americans. It is
this committee's duty to ensure that FINRA supplements, but
does not supplant, the SEC. So, with that said, I want to thank
the panel, which consists of one witness, Mr. Ketchum, for your
appearance today at the hearing.
The gentleman from Massachusetts is now recognized for 2
minutes.
Mr. Lynch. Thank you, Mr. Chairman. I appreciate your
indulgence.
I think there has been some recent activity that, indeed,
does call into question FINRA's conduct. While some may suggest
it is hyperactivity, I think that the events going back to the
May 6, 2010, ``flash crash'' when the Dow Jones Industrial
Average rapidly dropped about 600 points in 5 minutes before
quickly rebounding, that event has brought further evidence to
light.
Recently, on April 21, 2015, the CFTC and the Department of
Justice announced that the agencies were bringing civil and
criminal charges, respectively, against Navinder Singh Sarao, a
U.K. trader who had been manipulating the global financial
markets from his home for years, for allegedly helping to cause
the May 6, 2010, ``flash crash.''
As reported in the New York Times, Mr. Sarao is accused of
entering and withdrawing thousands of orders, worth tens of
millions of dollars each, on hundreds of trading days, in an
attempt to push down the price of futures contracts tied to the
value of the Standard & Poor's 500, a practice known as
``spoofing.''
Once the price fell, Mr. Sarao would buy the contracts and
reap the profits. However, on the day of the ``flash crash'' on
May 6, 2010, prosecutors contend that Mr. Sarao placed large
orders repeatedly over several hours, leaving the market
vulnerable to big moves when another big trade came in from an
investor in the United States.
Reports indicate that the regulators completely missed Mr.
Sarao's activity, because they weren't looking at complete
data. As a result, it took regulators 5 years--5 years--to
track down the actual culprit of the ``flash crash.''
The equity markets have rapidly evolved. Now, there are
thousands of stocks and over 1,000 exchange traded funds (ETFs)
trading on 11 stock exchanges. There has been the introduction
of over 40 dark pools.
And I think what we would like to hear from the witness is
whether the fragmentation of liquidity has hurt your cross-
market surveillance methods, and do you think there are too
many venues in which to trade securities?
FINRA is responsible for regulation in the securities
industry, and can reach across securities markets centers to
look for manipulative behavior. And I am just wondering with
the evolution of the markets, does FINRA still have the ability
to do that, to reach across asset classes, like futures and
currencies.
Since many strategies today employed by proprietary traders
reach across various asset classes, do you think it would make
sense for the CFTC and the SEC to work more closely together
and share that information? Those are some of the questions
that I think the ``flash crash'' investigation has raised. It
will be interesting to hear the answers from our witness. And I
yield back the balance of my time.
Chairman Garrett. The gentleman's time has expired.
Mr. Hurt is recognized for 2 minutes.
Mr. Hurt. Thank you, Mr. Chairman. Mr. Chairman, I want to
thank you for holding today's hearing. I am pleased that the
subcommittee has taken the time to conduct oversight of the
Financial Industry Regulatory Authority and its activities.
Making sure that we have fair and effective regulation is vital
to maintaining efficient capital markets, especially for
smaller firms that are subject to FINRA's supervision.
While a larger firm may be able to absorb FINRA's
compliance costs, smaller broker-dealers are often hampered by
them. FINRA's proposed CARDS initiative is one example of an
idea that I believe is too costly and burdensome, particularly
for smaller firms.
Investors in both Virginia's Fifth District, my district,
and across the country rely on FINRA to regulate broker-dealers
in a responsible way. FINRA also has responsibility to operate
in a fair, consistent, and transparent manner, given the
authority that it exercises.
FINRA must be mindful of the potential economic impacts its
rules may have, particularly at a time when economic growth
remains vitally important.
I believe FINRA should focus on streamlining its
duplicative systems and improving its operations, so as to
better serve the broker-dealer community and their customers. I
hope that today's hearing gives us an opportunity to examine
the work that FINRA is doing and the ways in which we can
ensure that broker-dealers continue to efficiently regulate and
to remain vibrant for years to come.
I look forward to the testimony of Mr. Ketchum, and I thank
him for his appearance before the subcommittee today.
And, Mr. Chairman, I yield back the balance of my time.
Chairman Garrett. The gentleman yields back.
The gentlelady from New York is recognized for 3 minutes.
Mrs. Maloney. Thank you, Mr. Chairman, for holding this
important hearing.
We talk a lot about investor protection on this committee,
and FINRA plays a central role in protecting investors in our
securities markets. Investor protection takes many forms, but
in general we focus on two main areas: first, ensuring that
investors have enough information to make fully informed
investment decisions; and second, making sure that investors
are treated fairly by the securities professionals with whom
they deal. These categories do overlap.
Sometimes investors get their information about a security
from their broker. In that case, ensuring fair treatment means
making sure that the broker discloses all the pertinent
information to the investor and it is in this second category
of investor protection, ensuring fair treatment, that FINRA
plays an enormously important role.
Every broker and brokerage firm that sells securities to
the investing public must be licensed and registered with
FINRA. The regulation of broker conduct is extremely important
because of the inherent informational advantage that brokers
have over ordinary investors.
Brokers by their very nature have access to a great deal of
information that investors do not have. Most importantly, since
brokers take orders from both buyers and sellers all day, they
know which products are in demand.
As a result, it is important that appropriate standards are
in place to ensure that brokers don't use that informational
advantage to the detriment of investors. That is where FINRA
comes in. FINRA ensures that brokers don't mislead investors
and that they don't sell investors products that are
inappropriate for them or are deliberately designed to be too
complex for them to understand.
And while this is a critically important role, it is not
the only role that FINRA plays in our markets. It also plays a
key role in market surveillance by identifying red flags and
trading patterns that suggest possible insider trading or
fraud.
For instance, if there is an unusual amount of buying in a
particular stock right before a company announces it is being
acquired, it is FINRA that usually detects that activity and
refers it to the SEC's Enforcement Division.
In 2014 alone, FINRA referred over 700 matters to the SEC
for possible enforcement. So without these kinds of red flags
and referrals from FINRA, the SEC would be significantly less
effective.
Also, it is an independent relationship and one that we
should periodically examine to ensure that everything is
working properly. That is why we are here today to conduct this
necessary oversight of FINRA.
So I look forward from hearing from our witness, and I
yield back the balance of my time. Thank you for calling this
hearing.
Chairman Garrett. I thank the gentlelady.
Now, we turn to our witness, Mr. Richard G. Ketchum,
Chairman and CEO of FINRA. Thank you very much for your
indulgence and your patience, and you are now recognized for 5
minutes.
You have been here before, so you know that your complete
written testimony has already been submitted to the record. And
you are recognized for 5 minutes.
STATEMENT OF RICHARD G. KETCHUM, CHAIRMAN AND CHIEF EXECUTIVE
OFFICER, FINANCIAL INDUSTRY REGULATORY AUTHORITY (FINRA)
Mr. Ketchum. Chairman Garrett, Ranking Member Maloney, and
members of the subcommittee, I am Richard Ketchum, Chairman and
CEO of the Financial Industry Regulatory Authority, or FINRA.
On behalf of FINRA, I would like to thank you for the
opportunity to testify today.
FINRA oversees approximately 4,000 brokerage firms and over
600,000 registered brokers. FINRA's programs range from
registering individuals to examining securities firms, writing
rules, enforcing those rules and the securities laws, and
educating the investing public.
FINRA carries out this work under authority from Federal
law and oversight by the SEC. Our work is informed by a board
and advisory committee structure that incorporates both public
and industry representation.
In addition to regulating brokers and brokerage firms,
FINRA monitors approximately 99 percent of all trading in U.S.
listed equities markets, or nearly 6 billion shares traded each
day. In fact, FINRA's market surveillance systems process
approximately 30 billion market events each day to closely
monitor trading activity in equity options and fixed-income
markets in the United States.
And I would note to the question raised earlier in the
statements that FINRA has, for decades, looked at order
information of surveillances, and for a period of 5 years, has
had surveillances with respect to spoofing and layering that
has resulted in multiple disciplinary actions.
The programs we operate are continually evolving to improve
and reflect relevant changes in industry operations and
technology.
In my written statement, I describe our rulemaking process,
as well as the economic analysis we build in through our Office
of the Chief Economist, as well as our retrospective rule
review process, which has just resulted in the first set of
rule changes approved by our board in April.
Our examination program has shifted over the past few years
to a far more risk-based system, one that is built on gathering
information prior to examinations, evaluating the risk areas
posed by an individual firm, and focusing resources on the
areas where the most risk to investors lies.
Alongside these efforts, however, we have maintained our
commitment to regular on-site examinations, and we conduct
these exams on cycles that range from annually to every 4
years, depending on the firm.
We have also enhanced programs such as our Office of Fraud
Detection and Market Intelligence, and added new ones, such as
our high-risk broker program, in an effort to develop new ways
to quickly identify and address potentially harmful conduct.
When we find this conduct and bring disciplinary actions,
we focus not just on fines, but importantly, on restitution to
harmed investors. Last year, we ordered over $32 million in
restitution to customers. And cases brought by other
authorities based on referrals from FINRA resulted in even more
money returned to investors.
In the market regulation area, the primary challenge is to
ensure that regulation is effective in today's increasingly
fragmented marketplace. Through our work for exchange clients,
FINRA has been able to aggregate trading data across the
markets to conduct comprehensive cross-market surveillance.
This cross-market surveillance enables FINRA, in partnership
with exchanges and the SEC, to better protect investors and
promote market integrity.
FINRA also is working to design surveillance programs that
will span equities and options markets together to identify
potentially manipulative conduct across products.
And, of course, when the SEC's consolidated audit trail is
functional, that will be the most complete picture of market
activity and a vital tool for effective regulation.
Complementing these regulatory and examination programs are
efforts to enhance the information available to investors.
FINRA created important transparency for the corporate bond
market with the launch of our trade system over a decade ago,
significantly reducing spreads in that market. We have now
expanded trades to include agency debentures and many asset-
backed securities, with more to come over the next 12 to 18
months.
We also recently began collecting and making public
reported volume and trade count information for all dark pools.
Market participants, investors, regulators and academics are
now able to see with unprecedented granularity volume
information and trends regarding dark pool trading on a
security by security basis.
Finally, I would note that 10 years ago FINRA established
the FINRA Investor Education Foundation to provide investors
with useful information and tools. Since its inception, the
FINRA Foundation has approved nearly $100 million in grants in
targeted projects. And these efforts have led to tangible
benefits for investors in all parts of the country.
In all of these areas and others, FINRA remains committed
to working closely with investor and industry representatives,
fellow regulators, and our oversight committees, as we continue
to carry out our mission of protecting investors and
safeguarding market integrity.
I appreciate the opportunity to testify today, and I would
be happy to answer any questions you may have.
[The prepared statement of Chairman Ketchum can be found on
page 30 of the appendix.]
Chairman Garrett. Great, thanks. I appreciate your
testimony.
I will now recognize myself for 5 minutes for some
questions.
So the predecessor of FINRA was the NASD. I would argue,
and many would argue, that the NASD was a true self-regulatory
agency. And I would argue that FINRA today is neither a true
self-regulator, nor is it a government regulator. It acts more
like a deputy of the SEC, than it does as a self-regulator.
In the beginning of this year, a witness from the Mercatus
Center, Hester Peirce, suggested several ways to look at this
issue that I just laid out, and suggested several ways to
improve--maybe to restore FINRA's structure, if you will, and
to improve its accountability, and, as she put it, ``to reshape
FINRA into a true self-regulatory organization.'' The
regulators actually run by the industry it regulates and
allowing the emergence of competing self-regulatory
organizations.
So I will give you a minute here to respond.
Should the membership, if you will, of FINRA have a greater
say in its operations, a greater say in its organization, a
greater say in the policies that it proposes? A greater say in
the rule proposals? A greater say in its agenda, than it does
now? And I understand--and you laid out in your written
testimony--the advisory committees and that sort of thing, that
exist today. So I am asking, should there be greater say than
what already exists as in the current structure?
Mr. Ketchum. The short answer would be that I think the
balance is correct today. I was honored to work and serve at
the NASD throughout the 1990s.
Chairman Garrett. Right.
Mr. Ketchum. And I saw the evolution of the NASD into a
balance that I think is very similar to FINRA in those 1990s.
I think what is left is a board that has a majority of
public members, but has industry members that reflect each of
the segments of the industry to ensure that there is input with
regard to any rules or questions with respect to our program.
Chairman Garrett. So this--
Mr. Ketchum. That is built across committees, both of small
member firms, and I recognize the points made earlier that
absolutely require our attention, as well as committees on a
subject matter basis. So I believe what--
Chairman Garrett. But those committees--and there are a
whole slew of them. I understand that.
Mr. Ketchum. Yes.
Chairman Garrett. Would you honestly say that those
committees are the ones that actually shape the policy and the
rules that come out--that get proposed?
Mr. Ketchum. Yes, I would say they have a great deal of
input. The decisions are fundamentally decisions that have to
be made by the staff and the board, which is absolutely the way
it was at the NASD.
Chairman Garrett. So where--
Mr. Ketchum. But the input of those committees get directly
communicated to the board.
Chairman Garrett. Right, so where--
Mr. Ketchum. Not something we do, but directly communicated
to the board.
Chairman Garrett. So since you were around both times, now
and then, where today do the actual ideas or the proposals--
where do the actual proposals come from? Do the actual
proposals come from the committees? Or, as you just said, the
staff and the board? Does the staff say, ``Here is the idea.
Here is the proposal,'' and then go to the committee and say,
``Hey, give us your two cents on this?'' Or it is the other way
around? Is it from the bottom up? Yes?
Mr. Ketchum. Chairman Garrett, I think the answer is both.
We get ideas from committees that lead to rulemaking. We get
reaction to suggested proposed rules from committees that
profoundly change and adjust what the rulemaking is because of
the valuable input they provide--
Chairman Garrett. And what--
Mr. Ketchum. --as well as input from the standpoint of
investors.
Chairman Garrett. And so, to take a particular example,
such as the CARDS idea, where did that come from? Did that come
from the bottom up, from the small broker-dealer suggesting
that? Or did that come from staff and the board?
Mr. Ketchum. No, the CARDS proposal came from staff and its
experience in using data analytics with respect to the exam
program.
Chairman Garrett. I'm sorry?
Mr. Ketchum. It--
Chairman Garrett. Wait, I just--
Mr. Ketchum. --the CARDS proposal came from the staff as a
result of our experience in using our data to analyze and try
to target our exams, and looking to ways to do that more
effectively from the standpoint of an early warning system.
The proposal has consistently evolved as a result of
comments made by folks in the industry.
Chairman Garrett. And do the committees at the end of the
day have a--I don't want to use the term ``veto,'' which is too
strong of a term, but something akin to that when these things
come down?
Mr. Ketchum. No, and they should not. Fundamentally, FINRA
should--and what FINRA provides should be an independent
organization that is informed by the industry, that provides a
level of formal and informal input that is dramatically
different than government, but its decision should be
independent.
Chairman Garrett. So why do you think it is when I meet
with a lot of the smaller guys, that they say that they feel
that FINRA is something with which they have no communication,
no contact, no influence? That it is just--my word, not
theirs--``aloof, separate from them?'' Why do you think I get--
why do I hear that from the folks?
Mr. Ketchum. I feel badly that you do get it from the
folks. Small business--small broker-dealers have a challenging
environment. We try to interact with them regularly. Both I and
my staff meet with small firms around the country. And we have
a small firm advisory board that regularly changes. It includes
both members who are elected by small firms, as well as
additional members who provide great value. So we try to get as
much--and we have three representatives of small firms on our
board as a matter of requirement at all times.
So, I do believe small firms provide a lot of input into
FINRA.
Chairman Garrett. All right. My time has expired. And I
also want to recognize Mr. Hill for his expertise and
experience on these matters, and his advice to me on these
issues going forward.
Thank you, Mr. Hill.
With that, I now recognize the gentlelady from New York,
Mrs. Maloney.
Mrs. Maloney. Thank you. And thank you, Mr. Ketchum, for
your testimony. I would like you to comment on this article
that was in The Financial Times earlier today. It said that
U.S. banks push for a delay in reporting corporate bond trades.
And, apparently, they are saying that there is a lack of
liquidity in the bond market. And that if you delayed your 15-
minute requirement of reporting trades to the TRACE system, it
would help the liquidity problem.
So I would like you to comment on this proposal, and on
whether or not you believe there is a lack of liquidity in the
corporate bond market or municipal bond market. And do you
think that a delay in the reporting time for large corporate
bond trades would improve liquidity?
Mr. Ketchum. We are reaching out to the industry. So it is
an excellent question, Ranking Member Maloney. And we regularly
have conversations over the impact of TRACE reporting.
As you know, there have been dramatic changes with respect
to the fixed-income market in recent years. Many of them come
in the reaction of the failures and market impact coming out of
the credit crisis.
That has led to much higher capital requirements, the
Volcker Rule that limits the ability for proprietary trading
with respect to bank holding companies, a range of other issues
that have all had significant impact from the standpoint of the
liquidity of the fixed-income market.
So we will--most of the comments we have heard focus on the
least actively traded issues. We are going to do--I think they
should be analyzed from a matter of data, and we are going to
do additional analytical work to look at whether there has been
a measurable change in liquidity with respect to those types of
issues. And consider very closely several of the suggestions,
most of which focus on the timing with regard to the reporting
of larger trades.
I will note the other side, though, and I know you are very
familiar with this, which is TRACE has resulted in the dramatic
reduction of spreads that, from the standpoint of the
fundamental retail investor or those of us who invest
indirectly through mutual funds, has dramatically reduced the
cost of trading in the fixed-income market.
That is not something we should want to lose anymore than
the transparency TRACE provides to allow you to evaluate the
quality of the execution you receive.
But we take liquidity concerns seriously, and we will do
both statistical analyses and reach out more to the industry.
Mrs. Maloney. Thank you.
I would also like to ask about the report that FINRA and
the SEC recently published on the treatment of investors who
are senior citizens. In that report, you found that some
brokers are still making investment recommendations that are
totally inappropriate for seniors. And as you know, we have had
such a low interest rate return since 2008. And while I believe
that this monetary stimulus has been necessary to lift the
economy out of our deep recession, low interest rates mean low
yields, and that has hurt the savings accounts and conservative
investments of our seniors. And they usually rely on it.
So my question is, do you think that this extended low-
interest rate environment is the main reason why broker-dealers
have been recommending riskier and possibly unsuitable
securities to our senior centers--in our senior centers and our
senior citizens?
Mr. Ketchum. It is an excellent question, and yes--
Mrs. Maloney. And senior investors?
Mr. Ketchum. I think it has been a contributing factor for
exactly the reasons you so eloquently mentioned.
Senior investors, who are often dependent on a fixed-income
and very dependent on their investments, have been dramatically
impacted with regard to low yields. The temptation to reach for
higher yields with respect to a range of complex or less liquid
investments is very real. And the temptation of the industry to
sell them, even when they are not suitable, is something that
we have a great concern of, and we have certainly seen in some
instances.
I would emphasize that generally speaking, the industry is
very careful from that standpoint and has worked, I think,
considerably harder from the standpoint of the quality of
controls and disclosures they use.
But the concerns are real, the abuses have happened, and
our focus is very much on senior investors. And indeed, we
just, with Susan Axelrod, who is sitting right behind me, her
leadership opened up a senior help line to try to give seniors
the opportunity to have a place to go to ask questions, whether
about their accounts or otherwise.
So, the concerns you raise are very real.
Mrs. Maloney. Thank you.
Chairman Garrett. Thank you.
The vice chairman of the subcommittee, Mr. Hurt, is now
recognized for 5 minutes.
Mr. Hurt. Thank you, Mr. Chairman.
Thank you, Mr. Ketchum, again, for appearing before our
committee and for the contact that you have been in with us as
we try to work through some of these issues.
Obviously, from the big picture, when we look at proposals
such as the CARDS proposal, the uniform fiduciary standard
proposal, what we are trying to balance--and I know you are
sensitive to this, but what you are trying to balance, it seems
to me, is a regulatory scheme that is efficient and is
necessary, on the one hand, and that, on the other hand, does
not limit consumer choice and jack up consumer cost, because
that is ultimately what happens, it seems to me, when you have
over-regulation.
Following up on Mrs. Maloney's questions, one thing I would
point about the uniform fiduciary standard--and I ask you to
comment on this--is that if there are abuses already under the
suitable standard, it seems to me that you all already have the
power to be able to go after folks who violate those standards.
And if that is the case, then why would--and we all know
broker-dealers have all kinds of requirements they have to live
up to--we risk the possibility of higher costs and fewer
choices by imposing a higher standard that is not necessary?
Mr. Ketchum. Congressman, first, I want to say I think you
set out the balance absolutely correctly, and I completely
agree with the way you phrased it. I think that has to always
be the way we look at each initiative, certainly from a
rulemaking standpoint.
On the fiduciary standard, I think some of the references
here refer to my statements in a variety of conferences saying
that I believe that the right way to move forward is with Chair
White's leadership, for the Commission to look at the
possibility of a balanced fiduciary standard across all
products and that I regret the possibility of having different
standards with regard to the Labor Department proposal and what
exists in the securities market.
I absolutely agree with you that the present regulatory
structure is strong. We bring, as was noted, over 1,000
enforcement cases each year. The rules, with respect to
suitability and supervision that exist in the securities
markets for broker-dealers, combined with regular examinations
and oversight with regard to FINRA and the SEC are things that
investors should feel very good about and result in strong
protection.
Mr. Hurt. Let me quickly ask you a couple of questions
about the CARDS proposal, relating to a study that was
mentioned in a Wall Street Journal piece this morning,
something that has been referred to in the past, relating to
the MIT study, that you can take--you don't need personally
identifiable information if you have date, location, and four
transactions.
What is your opinion of that study, and how does that
affect FINRA's thinking on the proposal?
Mr. Ketchum. As we have said in the written statement, we
absolutely are committed to take no steps with respect to
creating a new centralized database where there is significant
risk with respect to reengineering. One of the values of the
comment process was it brought things to our attention and
raised issues. We have stepped back very much to evaluate those
things.
And as I indicated in the statement, we don't plan to move
forward with CARDS--
Mr. Hurt. Until those concerns are addressed. But what does
that mean? Can you--what can you share with us in terms of what
that means when you say, ``our concerns are addressed?''
Because I think that we would like to know, to have some idea
of what the timeline is and how you get to that place.
What are the things that you are looking for in terms of
addressing those concerns, specifically?
Mr. Ketchum. Let me be, first, absolutely clear. I think
the first step in the goal around CARDS, how it is delivered,
is to create a more effective early-warning system so that we
can identify serious frauds, serious sales-practice matters
that we can step in and react more quickly to--
Mr. Hurt. Got it.
Mr. Ketchum. --before investors are hurt. We don't believe
that account-level information is necessary for that, as we
have reflected on it.
So we are stepping back, having a number of conversations--
Mr. Hurt. What are the security, because two issues are--it
seems to me there are costs and the need for it, the cost-
benefit issue.
But also, the security issue is significant. And how
important is that?
Mr. Ketchum. The security issue is absolutely critical.
That is why I say anything we look towards doing from this
standpoint will be done without account information. And we are
looking at the alternative information that we already have in
place, what information may come someday with respect to the
consolidated audit trail and evaluating those as alternatives
as well.
Mr. Hurt. Thank you, Mr. Ketchum.
I yield back my time.
Chairman Garrett. The gentleman yields back.
The gentleman from California is recognized.
Mr. Sherman. I first want to pick up on the comments of the
gentleman from Virginia and these Department of Labor
standards.
We have kind of a choice. We can provide the maximum
protection to investors and, in that way, eliminate investment
choices. You can only invest in plain vanilla.
Or we can say, ``You get a little protection, and you get a
little more freedom, and you can invest.''
We now have a system in which we provide--some would say
more protection, some would say less options to my IRA than to
my widowed mother's life savings.
Is there any reason why middle-class people controlling
their brokerage accounts should have different protection
standards, depending upon whether those accounts are IRAs? And
if so, why would you provide--why are we developing a system to
provide more of a straitjacket for me and less protection for
my mother?
Mr. Ketchum. First, I think it is a very fair question. I
want to underline at the beginning, I am passionate from the
standpoint of protecting investors, and I also agree with you
that our system works because investors have a range of choice
with respect to products built around a lot of requirements to
ensure that what is provided to them is suitable.
I do agree with, I think, your central premise. I think any
of us, when we go about investing, don't think about investing
with respect to tax-advantaged accounts differently than we
think with respect to our other investments.
And I think that a proper environment that properly
protects investors builds the right level of disclosure
requirements, the right focus with respect to the industry in
managing their conflicts and ensuring those conflicts don't
result in recommendations that harm investors, should look
across products.
And that is why I have tried to say that I believe the
right direction forward here, with great confidence in Chair
White, is for the SEC to look and reach its determinations as
the Dodd-Frank Act provided the capability across all products.
Mr. Sherman. I would hope that the agency that could
provide the same level of logical protection and or options to
both the IRA account and the widow's savings, would step
forward.
We have had some frauds. Often, these frauds are
perpetrated by well-mannered, well-dressed gentlemen. And then
we have rules that seem to work only if someone behaves as a
``gentlemen'' in the standards of England a couple hundred
years ago. For example, it is important that your--the broker-
dealers be audited.
Do you make sure, when you get the audit report, that it
was actually signed by the auditor by contacting the auditor?
Or do you just need a good inkjet printer to forge the
stationery?
And second, do you make sure that the auditor is large
enough to handle that size client? If that had been done, of
course, Bernie Madoff never would have gotten away with it. Do
you take those two very elementary steps, which would be
unnecessary if everybody behaved like a gentleman or a lady?
Mr. Ketchum. Audits are important. I think the exams we
produced--
Mr. Sherman. Do you do those two steps, those two simple
steps?
Mr. Ketchum. We do check with respect to the auditor. The
PCAOB does have requirements as to what required levels of
audits are and--register audits--auditors at this point.
We don't have any rules that restrict size of auditors with
respect to--
Mr. Sherman. The accounting profession has a rule. It says
you have to be independent, you have to be big enough to do the
job, you have to be big enough to do the job without that job
constituting 50 or 80 or 100 percent of your fees that you can
generate in a year. So one person, a CPA firm, can't do it.
So you make sure that the auditors sign the report? You
don't just take a look at the piece of paper and think that is
good enough?
Mr. Ketchum. No, we don't go back to each auditor.
Mr. Sherman. You don't bother. You trust everybody.
Mr. Ketchum. If I can clarify, the PCAOB has a regular
oversight coming out of Dodd-Frank with respect to all
auditors.
Mr. Sherman. Yes, but they don't make sure that the report
was actually signed by the auditor. Just all you need to do is
steal a piece of stationery. It shouldn't be that tough if your
name is Madoff.
But let me also ask you, you have this broker check system.
Mr. Ketchum. Yes.
Mr. Sherman. You have a lot of people you are asking about
possible bankruptcies, criminal convictions, et cetera. When I
have a tenant, I can spend $50 and use a commercial service to
make sure that the person reporting to me is telling me about
bankruptcies, unlawful detainers, criminal--do you use that or
is it just--or do you just count on the broker to tell you
about these matters?
Mr. Ketchum. No, we do both. We--the Commission has now
approved a rule that requires additional broker checks before--
by the broker at the time the employee comes in, and we do
exactly those reviews and have just completed reviews of that
across the entire broker check database.
Mr. Sherman. And do you have an integrated system, since
many of the people who are with broker-dealers are also
involved in other investments like real estate, insurance, et
cetera, do you have a centralized system of all those who have
been disciplined by the various State regulatory bodies that
deal with real estate agents, insurance agents, et cetera?
Mr. Ketchum. Those disciplinary reports are required to be
reported as part of the U4. We would love to have a unified
system but we don't have the jurisdiction to do that.
Mr. Sherman. Do you contact each State and get the data?
Mr. Ketchum. We--the firms are required and the brokers are
required to put it in. We would love to have it, and we have
proposed it, but the States have been unwilling to have a
uniform system.
Chairman Garrett. The gentleman's time has greatly expired.
The other gentleman from California?
Mr. Royce. Thank you, Mr. Chairman.
I would just like to follow up on Mr. Hurt's comments and
some of your thoughts, again, on this risk-based surveillance
and how your early warning system would work. And I take it
from your comments--and by the way, I share his concern about
the way the CARD program was going. From your comments it seems
there is a--do you still feel there is a way to collect data in
the aggregate that is going to allow you to go forward without
putting individual account level data at risk?
Could you explain a little bit more about the timing, how
long this is going to take, and what you have in mind there?
Mr. Ketchum. First and foremost, it will take whatever time
it requires, and part of that whole decision is to whether we
build a new system or not. One of the things we are doing,
Congressman, is looking closely at the other information we
have, the information we pulled down before exams and the
information that is available from firms' financial reports to
reach a decision.
But if we do move forward with any proposal, it will go
back to our board. It will be put out as a new notice to the
industry and to other segments, investors and the like, and all
of that will be done with a public comment period before we
make a decision, before the board makes a decision as to
whether to file the rule with the SEC.
Mr. Royce. Thank you.
Mr. Ketchum. I would say it would take a considerable
amount of time.
Mr. Royce. And then the short question, I was going to ask
you here about this United Kingdom rule that was implemented
there last year to ban commission payments from mutual funds to
brokers, and some of the statistics on that, about 310,000
clients stopped being served by their brokers because their
wealth was too small for the broker to advise profitably. And
then you had another 60,000 investors who were not accepted as
new clients since then for that same reason.
And I was going to ask you, are these statistics
concerning? And do you believe that the Labor Department's
fiduciary duty proposed rule could lead to similar impacts
here?
Mr. Ketchum. I think the statistics are certainly
concerning and should be part of the review of the Labor
Department's rule. We are still in the process of reviewing the
rule. I think the Labor Department made significant strides in
creating a more balanced rule, but there are parts of the
release and the description of broker-dealer business that we
don't think is accurate.
So I completely agree with your premise that moving to an
environment where fee-only advisory accounts are the only
effective way to operate in the United States is a very bad
step and that with respect to middle-class investors the
availability of both--the choice between fee-only and
commissions is important.
And any steps taken should look carefully at ensuring that
type of environment remains in the United States.
Mr. Royce. And I would also ask you how you respond to
criticism that SROs are becoming a fifth branch of government,
and FINRA is starting to look a lot like a deputy SEC, as
somebody said?
Mr. Ketchum. I don't think we are anything like a deputy
SEC. I do accept that FINRA has a unique position that is
different than other self-regulatory organizations, and that--
and with the merger with New York Stock Exchange regulation and
our responsibilities, that does deserve very careful oversight.
FINRA is way different than a government agency. It has
industry members on the board, it has the ability for informal
access through committees and otherwise with regard to industry
members. Those persons get the opportunity to look on an
informal basis at any rule that we propose or are considering
proposing. We respond to those comments and we also pass those
comments onto our board.
So I think FINRA is an independent organization that is
informed in a very effective way from the standpoint of
industry concerns.
Mr. Royce. Let me ask you one last question. It appears
that we are moving towards expansive quasi- or direct
government regulation in retail securities markets. And I was
going to ask if you think similar regulation is needed for
private trading platforms known as dark pools or is there a
difference, in your view, between regulation of retail markets
and areas where sophisticated institutional investors are the
market participants?
Mr. Ketchum. That is an excellent question. I do believe
there is need for greater transparency with respect to dark
pools that are an integral part of the U.S. equity markets. And
we, in fact, have had that occur from the standpoint of
reporting requirements we have built in.
I believe there is a necessity for effective and aggressive
oversight. And we try to provide that. I do think dark pools
have a role in the complicated and sophisticated marketplace
that we have, and we should ensure that role continues to occur
and provides competitive balance and choice that is valuable.
But to your point, I think it is a good time and I am glad
that the SEC has indicated their intention to step back overall
and look at the equity market structure.
Mr. Royce. Thank you, Mr. Ketchum.
Thank you, Mr. Chairman.
Chairman Garrett. The gentleman yields back.
The gentleman from Massachusetts is recognized.
Mr. Lynch. Thank you, Mr. Chairman.
And thank you, Mr. Ketchum, for your willingness to testify
and help the committee with its work.
I realized--there is some friction here that is underlying
some of the questions here and that is I think because some
people see you as an SRO and as an organization that is meant
to serve your broker members, your members, and then some of us
think that your overriding mission is really to protect the
investor.
So let me posit something. Suppose you have brokers out
there that are doing high-frequency trading. And they are
chasing rebates and fees instead of pursuing best execution on
behalf of the investors. Okay, so your members are chasing fees
and rebates and the investor is being disserved by that
practice.
Where is FINRA's loyalty? Are you protecting your members
or are you protecting the investing public? That is the
question.
Mr. Ketchum. Our statutory responsibilities and our passion
is investor protection and market integrity. That always comes
first. High-frequency trading is not one thing. Much of it is
proprietary and doesn't involve customer accounts, but you are
right, some of them do.
Many are sophisticated, but the concerns around high-
frequency trading is a huge focus of our surveillance program.
And while much high-frequency trading is effectively market
making in the--
Mr. Lynch. Let me--I don't have a lot of time--
Let me just ask you that, though. You have raised a good
point. In your current toolbox, are you able to properly
surveil the conduct of high-frequency traders to make sure that
in the course of executing those trades, the investor is
getting the best execution?
Mr. Ketchum. Where that manipulative activity would be
occurring in either the equity market, fixed-income market, or
options market, yes we do. And we have had for years
surveillances particularly looking at things like spoofing,
layering, marking the close, and wash sales and brought
numerous cases.
You raised in your opening statement, Congressman, a valid
concern with respect to the fact that we do not have a common
jurisdictional program and a common program with regard to
interest rate swaps and with regard to futures.
I would note for one thing it would be great if futures
activity was included in the SEC's proposed consolidated audit
trail.
Mr. Lynch. Yes, let me just jump in here. This is--the SEC
has stated that FINRA is unable to monitor the off-exchange
market activity of non-member firms and detect potentially
manipulative or other illegal behavior as efficiently or
effectively as it can FINRA members. Do you agree with that?
Mr. Ketchum. Yes. That relates to a recent SEC--
Mr. Lynch. Are you operating with a full set of data?
Mr. Ketchum. We would--where the consolidated audit trail
goes, which includes customer information--
Mr. Lynch. That is not up yet, though, right?
Mr. Ketchum. No. The steps that the SEC is proposing--
Mr. Lynch. I don't want to burn all my time here. I am just
trying to get a sense of where you are at and where you might
need help.
Mr. Ketchum. Yes. The SEC has a proposed rule that
addresses that and we support it.
Mr. Lynch. Okay. And what is the timing on the consolidated
audit trail? We have been doing this for several years and we
are still some distance away, I imagine.
Mr. Ketchum. I am on the other side of an information
barrier. The exchanges and FINRA have filed a plan. The next
step is for the SEC to publish it and that has not yet
occurred.
Mr. Lynch. Okay. In your recent brokerage inspections,
FINRA found that some firms do not have active best execution
committees. So I don't know if the firms themselves are
actually paying as much attention as they should. Is there a
way--now, you say we have some tools, although we are not
acting--we are not operating with full or complete data. Is
there a way currently where we can find out whether brokers are
chasing the rebate and fees? Or--and that should show in a
pattern or whether the preponderance of the brokers are
actually providing best execution?
Mr. Ketchum. One of the things we particularly look at is
whether brokers can justify where they place most of their
customer orders. As you know, they tend to route them often to
a predominant market site and that is absolutely a concern of
ours. Most firms do, but where firms don't, we look at the--at
either changing behavior or enforcement actions.
Mr. Lynch. Okay. Thank you. My time has expired. I yield
back.
Thank you, Mr. Chairman.
Chairman Garrett. Thank you.
Mr. Hultgren is recognized for 5 minutes.
Mr. Hultgren. Thank you, Mr. Chairman. And thank you,
Chairman Ketchum for being here today, as well. I would like to
focus my comments and questions on the SEC and the Department
of Labor, its effort to expand the definition of fiduciary
which further extends Federal regulatory control into
Americans' financial planning decisions. This move could
restrict the number of investment products financial advisers
could offer to their Main Street customers, making it harder
for average Americans to invest. I have heard loud and clear
from my constituents about the negative consequences of a
fiduciary standard, including the tens of thousands of small
investors throughout the district I represent, the 14th
Congressional District of Illinois.
They tell me that this change would not represent true
consumer protection but would, instead, make it harder for
Americans to plan for their future, put money away for their
children's education and invest. While customers need enough
information and options from their financial adviser to decide
what products they need, I believe there is a danger that a
fiduciary rule would strip their ability to get advice and
help.
This is why I co-sponsored the Retail Protection Investor
Act, which delays the proposed rule until the Securities and
Exchange Commission issues its own fiduciary rule and also
requires the SEC to study alternatives to a uniform fiduciary
standard and the impact of such a standard on everyday
investors.
Fiduciary proponents argue that a higher standard is needed
because the current broker-dealer supervision regime is
insufficient. Mr. Ketchum, my questions are really to that.
Given that FINRA plays a significant role in broker-dealer
supervision, can you describe the current regulatory and
compliance regime with which FINRA-registered broker-dealers
must comply?
Mr. Ketchum. Yes, Congressman. We have a rigorous
examination program in which all members, depending on their
size and complexity, are examined between once every year or 4
years. We regularly are oversighting from a surveillance
standpoint to identify instances that suggest that there is a
problem with respect to how they are operating.
We bring over a thousand enforcement cases a year. As was
noted earlier, we provide referrals to the SEC with respect to
regulatory concerns that are outside of our jurisdiction and we
bar over 400 persons each year who are operating
inappropriately from the standpoint of their position as
registered persons.
We also have rules focusing on suitability and on
supervision and on written supervisory procedures that provide
a very strong environment for investor protection. I can't say
that it couldn't be better, but I agree with you that the care
has to be taken exactly as you describe, to--and it certainly
would be preferable with my standpoint for the SEC to be the
expert agency moving these type of issues forward.
Mr. Hultgren. Let me dig a little deeper. What steps must
broker-dealers take to ensure that their customers are not
confused about broker-dealer services? Are broker-dealers
required to disclose to the customers material information
about potential conflicts of interest? Must they also refrain
from engaging in certain transactions if potential conflicts
are acute?
Mr. Ketchum. Yes. The broker-dealers have an obligation to
know their customers, evaluate their recommendations, ensure
they are suitable and there are numerous obligations from the
standpoint of disclosure, with respect to third-party payments
or other issues from the standpoint that--where a conflict may
exist, absolutely.
Mr. Hultgren. Thank you. Even if investors are confused
about the differences between broker-dealers and investment
advisers, is the only solution to impose a fiduciary standard
of care on broker-dealers? Would additional disclosure to
investors better protect them? Are there other ways to improve
disclosure without creating information overload or imposing
unnecessary regulatory burdens?
Mr. Ketchum. Yes. I think there are a number of ways. And I
think it is a challenge for all of us from a regulatory
standpoint to look for ways to increase the understandability
of disclosure. And I think those are important points.
I would note that a large part of the best interest
standard should fundamentally be ensuring that firms manage
their conflicts and provide proper disclosure. It should always
have the balance that you describe from ensuring that it also
doesn't impose unnecessary cost.
Mr. Hultgren. Yes. Fiduciary advocates have argued that
FINRA has a conflict of interest in their supervision of
broker-dealers, which makes your supervision lenient. Can you
respond to that?
Mr. Ketchum. Yes. And it is just absolutely not true. We
are funded--one of the upsides of FINRA is that we are not
funded by taxpayer dollars. We are funded by user fees with
respect to the industry. But industry members that do business
with customers are required to be a member of a securities
association. While they have the ability to start a new one,
today there is only one, and that is FINRA.
Mr. Hultgren. My time is almost up. I do appreciate your
time here and bringing some clarity for me and for others
hopefully here as well. As I do talk to advisers and broker-
dealers that I know in Illinois, they certainly don't feel
underregulated. Sometimes, they complain maybe that it is too
much. But I think it is important, again, for that confidence
to be there. So my time has expired. But thank you very much
for being here and thank you for your help on these questions.
I yield back.
Chairman Garrett. The gentleman yields back.
Going down to the very first row, Mr. Poliquin is
recognized for 5 minutes.
Mr. Poliquin. Thank you, Mr. Chairman.
Mr. Ketchum, thank you very much. I appreciate your
willingness to be here today. Thank you.
There are many of us on this committee, sir, and throughout
Congress who are getting concerned about the expansion of
regulators throughout our Federal Government. There are all
kinds of examples of this, Mr. Ketchum, that are beyond the
lines within which you operate.
For example: the Internal Revenue Service intimidating
taxpayers, law-abiding citizens because they share different
political views; and the EPA is repeatedly overreaching, making
it more difficult for some of our companies, our manufacturing
businesses, to grow and hire more people.
We had a fellow from the FDIC who was a regulator before
our Committee about a month ago. And it was disclosed that the
examiners at the FDIC are putting pressure on community banks
to stop lending money to lawful businesses they deem
undesirable, like firearms dealers or folks who sell tobacco.
And now we have the FSOC group that seems to want to put
more and more taxpayers at risk in the event that a significant
financial institution goes under. So it is a real concern of
mine. And I come from the general industry that you are
involved in now, sir.
Would you agree with me that when you increase regulations
like this, you drive up fees, you drive up complexity, and
those folks who are trying to save for their retirement and
invest for their kids' college savings, that this could be an
impediment to the choices they have with respect to the
investment vehicles they want to have and the rates of return
that they need to save for their kids' education and also plan
for their retirement? Can we agree on that, sir?
Mr. Ketchum. I can certainly agree on the goal. I can't
speak to a--on a variety of other regulatory agencies, but I
can tell you that is very much the goal from FINRA's
standpoint. We don't want to take any regulatory action where
the burden exceeds the cost. And that seems to be a serious
concern.
Mr. Poliquin. Good. And I also have a concern, Mr. Ketchum,
that it looks like now the Department of Labor and the SEC are
sort of competing over who in the heck is going to regulate the
investment management community and the mutual fund industry.
Why in the world would the Department of Labor want to get
involved in that space where they have no experience regulating
the investment business?
And to that end, if I may, now we have this discussion
about imposing fiduciary standards on brokers. The same
fiduciary standards that maybe a pension fund manager who is
running $50 billion. We had a fellow here from Rockland, Maine,
just over the border--I represent Western, Central, down east.
Mr. Ketchum. Rockland, Maine, is beautiful.
Mr. Poliquin. Thank you, sir. I appreciate it. If you
haven't been there recently, you ought to go back. And I
appreciate that very much. But this gentleman came in. He is a
broker in a small shop and he has about 200 customers. And his
customers, they maybe move some snow in the wintertime. They do
a little lobstering and they do a little bit of logging. And
they are saving the best they can for their retirement.
And this fellow is very concerned because if these
regulations get too burdensome on him, he is going to stop
meeting with this couple that he is helping plan for their
retirement. And all of a sudden, that advice leaves this
couple, and his clients may become more subject to scams that
could hurt their nest egg going down the road and put this
couple more at risk to become more dependent on the government.
So don't you agree that it probably makes sense to have the
folks at your organization who have the experience of
regulating brokers--and I think you regulate 640,000 brokers
across this country--don't you have the tools to continue to do
this? Why do we need to have other folks like the DOL involved
in doing something like this?
Mr. Ketchum. Congressman, as I have indicated, I believe
that this would be better if the SEC led and FINRA worked with
them, to have a review across all products. And I think your
concerns are very real and appropriate to be focused on. Of
course, it is also important to look to where we can improve
disclosures--
Mr. Poliquin. Sure.
Mr. Ketchum. --and where we can improve handling of
conflicts. But I agree that there has to be a careful focus.
And I believe the SEC is the right agency.
Mr. Poliquin. Mr. Ketchum, will you commit today to me and
to this committee that you will speak up loud and clear when it
comes to other folks who want to go beyond their lines, such
that the right people are making sure they regulate the right
participants in this industry?
Mr. Ketchum. I believe there should be a best interest
standard, and I do believe the SEC should lead it. And
everything I have said today, I have said earlier, and will
continue to say.
Mr. Poliquin. And do you believe that the 640,000 brokers
that you folks regulate are fairly regulated?
Mr. Ketchum. Yes, sir, I do.
Mr. Poliquin. Okay. You don't think they need any
additional fiduciary standards imposed upon them. Is that
correct, sir?
Mr. Ketchum. There are always opportunities to improve the
regulatory structure--
Mr. Poliquin. Have you looked at the proposed regulations?
Have you looked at the proposed rules coming out of the DOL, do
you agree with them?
Mr. Ketchum. We are still reviewing them.
Mr. Poliquin. And when will you make that decision?
Mr. Ketchum. We certainly are considering the possibility
of providing a comment letter to the Labor Department.
Mr. Poliquin. Okay. And I am also assuming that every time
you consider a new rule imposed on any market participants that
are trying to help our families save for their retirement, that
you look at what the cost will be in imposing that new rule? Is
that correct?
Mr. Ketchum. Yes, sir, as well as the alternatives that may
be less costly.
Mr. Poliquin. Great. Thank you very much for being here. I
appreciate it.
I yield back my time.
Chairman Garrett. Thank you for your questioning and your
advertisement for Maine.
[laughter]
Mr. Hill is now recognized for 5 minutes.
Mr. Hill. Thank you, Mr. Chairman. And, Mr. Ketchum, it is
nice to see you before the committee. I have certainly enjoyed
my over 2 decades of friendship with you.
I want to associate myself with Mr. Poliquin's line of
questioning. I thought it was excellent. Do you think that DOL
has stepped outside their box? Their ball has landed outside
the fairway in terms of the scope of what they are trying to
do? In other words, they have the right to oversee a group
retirement plan. No one argues with that, and they can set
those standards. But what about the relationship between an
individual investor in deciding to roll it into an IRA or what
the composition of it is, and whether it is a fiduciary
standard or not?
Mr. Ketchum. My understanding is, they do have the
jurisdictional ability to take that step. As I indicated
earlier, I believe that while the investor protection issues
around the decision to roll into an IRA are meaningful things
that we have addressed, as you know, with respect to investor
alerts and with respect to our exam and enforcement program,
they are part of a wide range of issues for investors. And I
think that there would be great value in looking at these
issues from the standpoint of the SEC as the expert agency.
Mr. Hill. Would you commit to write a letter to the
committee that outlines all the existing rules and regulations
that govern investor protection in the retirement arena now
that brokers and financial advisers are already living by that
protect investors? Because I think it is extensive. I think
your work there has been exceptional.
You were--FINRA was the first organization to lead a senior
sweep effort of the financial industry. That was over a decade
ago. And you have been focused on educating brokers and broker-
dealers and managers on this issue for years. And I think it
has demonstrated the results.
I think the committee needs to know that this is already
being done, and that the DOL's effort is a redundant
unnecessary exercise.
Mr. Ketchum. Congressman, first, thanks for those words.
And yes, we can certainly provide a description of all of our
programs. I would be glad to.
Mr. Hill. Thank you.
I want to talk a little bit also about how small firms--of
which you have many among your 4,000--have absorbed the Y2K
hysteria process from FINRA. TRACE reporting, OATS and RTRS
reporting. Mutual fund pre-sale planning, VA pre-sale planning,
written whole documentation, which is the latest of the
continuing hits from FINRA.
How do you balance--despite your Small Firm's Advisory
Committee, how do you balance this issue that we are losing
small firms like we are losing small banks? I think 3 percent
or 4 percent of the firms exit membership every year. How
sensitive is the agency to that? And how sensitive is the SEC
to that?
Mr. Ketchum. While I can't speak for the SEC, it is
certainly a focus from the standpoint of FINRA. We care very
much about the burden of our rules. In fact, one of the areas
where we are taking initiatives now is the retrospective rule
review. We have just done it and taken an initial proposal with
respect to a variety of amendments to our advertising rules in
response to that.
I think that we always have to keep analyzing the rules
that are already in the books and determine whether they are
imposing burdens across-the-board, particularly the small firms
that could be less. We are going to do that with respect to our
membership and change of business rules that you are very
familiar with, I know, from your days in the industry--again,
looking for ways to maintain the investor protection
capability--benefits that come from those rules to reduce
burdens.
Mr. Hill. I was pleased to hear you talk about the
difference between the agency business and the fiduciary
business. And one of my concerns across the regulatory system
has been that we ignore the customer here. Washington
consistently ignores the customer.
For 70 years, we have had a disclosure-based, caveat
emptor, suitability, management-focused securities regulatory
system, where the individual investors do have to take some
responsibility for their own investments, wealthy or not
wealthy. And some people want an agency-broker relationship,
not a fee fiduciary relationship. They don't want it. They
don't demand it. And yet, I feel like we are compelling and
pushing the industry as if that is going to be a savior for
something that I am not even sure what we are being saved from.
Would you elaborate just for a minute on this issue between
agency business and fee or fiduciary-oriented business?
Mr. Ketchum. Certainly, there are a variety of
characterizations of fiduciary--
Mr. Hill. We want both, don't we, for our customers across
the country--
Mr. Ketchum. I think it is--
Mr. Hill. --whether they are rich or poor or middle income?
Mr. Ketchum. I certainly think it is important for
customers to have choices. And I think it is important that no
steps are taken that reduce the ability for customers to
choose--particularly who are relatively inactive--to have
access to commission-based accounts. I do believe there are
ways to improve the disclosure and management of conflicts
today. But yes, it is very important to make sure that is
balanced in a way that continues to allow customers to have
choices.
Mr. Hill. I really think that it looks convenient to have a
fee-based product for people, and that somehow commissions have
this bad reputation. And yet, in many cases, I think if you
were to analyze your account, the people on commission pay far
less in managing their money on an annual basis potentially
than someone who is on a--particularly, a small account--say
under a half a million dollars would pay if they were in a fee
account.
Mr. Ketchum. I think that is a very real concern. And I
think that for many customers, commission-based is--given the
fact that they are maybe making a couple of transactions or
investing in one mutual fund in a particular year--commission-
based is absolutely critical to--
Mr. Hill. One final quick question. ETFs--when I was in the
business, there were only maybe 100 funds and $100 billion. Now
there are 1,600 funds and $1.6 trillion or so in exchange
traded funds. Do you think it would be useful to have greater
research--more access to research on exchange traded funds for
retail investors?
Mr. Ketchum. I know there is legislation that is put up
there, and that has been a point made by a number of industry
representatives. I do believe properly designed, an environment
that encourages more research, addresses some of the Section 5
offering issues with regard to ETFs, where that is not--the
research is not designed to push the ETF, but to provide
sector-based information that allows investors to make better
and more knowledgeable choices. That is certainly an area we
would be very glad to talk with your office about and look for
solutions.
Mr. Hill. Thank you, sir.
I yield back.
Chairman Garrett. The gentleman yields back.
Mr. Messer, you are now recognized for 5 minutes.
Mr. Messer. Thank you, Mr. Chairman. And thank you,
Chairman Ketchum. I appreciate your testimony. I appreciate
your stamina, as well.
I wanted to take a moment or two and talk a little bit
about the importance of arbitration and ask for your comments.
As you know, arbitration of broker-dealer disputes has long
been used as an alternative to the courts, because it is a
prompt and inexpensive means of resolving often complicated
issues.
Broker-dealers advocate strongly for FINRA to continue its
role as the primary forum for the resolution of consumer
disputes in arbitration.
Some have claimed, as I know you are well-aware, that
mandatory securities arbitration is unfair, and prevents retail
investors from exercising their rights to a jury trial to
resolve disputes. But the broker-dealers that I hear from back
in Indiana believe that FINRA's direct market knowledge and
your real world experience make you the best suited to continue
the role as the primary forum for the resolution of consumer
disputes in arbitration.
If the SEC--this is the question I want to get to--
exercises its authority in Section 921(a) of Dodd-Frank, and
either restricts or eliminates arbitration agreements, do
investors win? Or do lawyers win?
Mr. Ketchum. Congressman, I am very proud of our
arbitration and dispute resolution system. I think it has
sought to continue to improve, to continue to provide the right
balance with respect to public arbitrators. And I think that
any system that did not ensure that investors had access to
that arbitration system would be a very bad impact on
particularly middle-class investors.
Mr. Messer. Yes. Do you have any reason to believe that
securities arbitration contributed to the financial crisis?
Mr. Ketchum. No, I don't believe securities arbitration
contributed to the financial crisis at all. No system is
perfect from the standpoint of its performance. But I think
securities arbitration is in many, many ways very different
from the rules around it from consumer arbitration otherwise.
And I think it provides an independent, balanced, and fair
resolution of concerns in a quicker and lower-cost environment
for investors.
Mr. Messer. Yes. And could you comment on any specific
improvements that you tried to make at FINRA to deal with the
consumer experience in arbitrations?
Mr. Ketchum. I would be glad to. We have taken steps to
improve the--and to address concerns with respect to the motion
to dismiss in the discovery process. We have provided the
capability for either side to demand an all-public panel that
does not include anybody with respect to industry background.
We have also changed the definition of public arbitrator to
ensure the absolute independence of those persons.
I believe that the steps taken and the input from both the
industry and plaintiffs' lawyers have been enormously valuable.
And the steps taken have been true positive steps for
investors.
Mr. Messer. I appreciate that. In my final minute or 2
here, some earlier testimony talked about the Equity Market
Structure Advisory Committee. SEC Chair Mary Jo White has
talked about trying to make that comprehensive and data-driven.
I believe that you are a member--will be a participating member
of that Structure Advisory Committee. Is that correct?
Mr. Ketchum. That is correct.
Mr. Messer. Starting on May 13th. And I think you already
testified that you are looking forward to that, and believe it
should be a holistic review of market structure.
Mr. Ketchum. I am very much looking forward to it. And I
think the regulatory steps the SEC has taken over the last 15
years on the whole have provided real benefit for investors.
But the markets have evolved in ways that raise real concerns.
I was on an earlier advisory committee of the SEC and the
CFTC when we made a number of suggestions to review, including
on things like maker taker fees, often referred to as rebates.
And I think this is a great time to step back and look at those
issues, as well as look at the impact of SEC rules in the new
market environment.
So, yes, I am very much looking forward--
Mr. Messer. And in the limited time I have, I just--in that
spirit of some of the suggestions you made there, would ask you
about regulation NMS, which of course, many believe may be an
underlying factor behind increased market fragmentation, the
proliferation of ending trading venues, fee models, complex
order types, and advanced trading strategies, including high-
frequency trading.
Could you comment at all as to your belief in the impact of
regulation NMS?
Mr. Ketchum. Regulation NMS had many positive impacts from
ensuring best execution and encouraging competition. But it
certainly has resulted in more fragmented markets and it
doesn't distinguish between marketplaces that are very, very
small and other markets. So I think this is a good time to step
back and look at Reg NMS. And I congratulate Chair White in
including that as a key early focus of the committee.
Mr. Messer. Thank you.
I yield back.
Chairman Garrett. The gentleman yields back.
It looks like all the Members have asked questions. We
obviously had a smaller number of Members here, I think due to
the votes.
So, without objection, I would ask if a couple of other
Members have any additional questions? No? No? No? I do. Just a
couple.
And it sorts of throws off of Mr. Lynch's reference to the
approach to SROs in general. I will put words in his mouth, and
he was saying something to the effect of how some people want
SROs to be regulated or be controlled by the industry, and
other people want it to be more of not SROs at all, just a
regulator doing things. And I think the answer is obviously
somewhere in the middle.
So, two things. One, back at the end of last year, around
October, the New York Exchange took back some of their
authority--not their authority--took back some of the
responsibilities that had been with FINRA since 2010, I guess
it was, right?
And they are now setting up their own--what? Surveillance
system, I guess you would call it. So they are going to be
doing it all in-house, if that is the right--
Mr. Ketchum. No, they are not going to be doing it all.
They haven't begun anything. They took back on a going-forward
basis looking at their floor-related New York Stock Exchange-
only rules. We continue to do the cross-market surveillance for
the New York Stock Exchange and all the markets. It allows us
to look across markets to address and identify manipulative
activity.
Chairman Garrett. So exactly what are they taking back?
Mr. Ketchum. They are taking back rules with respect to how
orders are handled in the small amount of trading that occurs
on the floor, and some of the New York-only rules that relate
to how firms handle orders away from the floor.
Chairman Garrett. So that is what they are doing now? So
they are not--
Mr. Ketchum. They are not doing anything now. We continue
to do all of it now. They are in the process of building the
surveillance capability to do that with respect to their own
rules. Cross-market rules we will retain, and we are very
grateful to New York that they have allowed us to do that.
Chairman Garrett. Okay. And so they have no--because I am
just going by press reports. The press reports seem to be more
that they were going forward with more of a full surveillance
system that they would be setting up eventually.
Mr. Ketchum. The press reports overstated it. They will
have a surveillance system for their own rules. It is not
likely that will occur until the end of this year.
Chairman Garrett. Okay. Ms. Peirce from the Mercatus
Center, who was referenced earlier, discussed proposals to make
SROs more shaped by, reflective of the industry, if you will--
my words, not theirs. And she has had a number of proposals in
that respect. And I didn't go through all of her proposals.
Are you familiar with that at all?
Mr. Ketchum. I read Ms. Peirce's study some time ago, so I
am not sure I am positive with respect to each one of them.
Chairman Garrett. Okay. I am not going to go there at all.
But part of it is the broad 30,000-foot level to allow
for--and this sort of follows off my NYSE statement--additional
third-party entities to be able to compete, if you will, with
FINRA to allow for, if we go down the road to additional
standards as far as the industry is concerned, independent
entities to be able to perform the examinations, as opposed to
FINRA.
These are not new ideas. Can you just respond to those
ideas?
Mr. Ketchum. From the standpoint of market surveillance,
obviously much of the responsibility--
Chairman Garrett. Oh, not on the surveillance--
Mr. Ketchum. Oh, but on examinations--
Chairman Garrett. Examinations--right.
Mr. Ketchum. --I think one person with respect to the lack
of resources, the SEC and investor adviser side, Commissioner
Gallagher has made I think very thoughtful suggestions about
the part, and Chair White has indicated her interest and
support about the possibility of third-party exams for
investment advisers to deal with the fact that the SEC doesn't
have the resources.
The statute itself allows any group of firms to set up a
separate National Securities Association if they wish to have
an alternative to FINRA.
Chairman Garrett. Okay, so that would be for investment
advisers. That is what they are talking about. Is that a--
Mr. Ketchum. At least the proposals I know about are for
investor advisers.
Chairman Garrett. Right. Is that a possibility if they can
flesh that out? Is that a possibility, then, to expand that
over to broker-dealers as well, so you have a competing
network, but both are regulated as well in the broker-dealer
realm?
Mr. Ketchum. I would view a possibility of for-profit,
third-party examiners that are paid by the firm to do the exam,
as a least-good solution.
Chairman Garrett. That is the same situation you would have
if Chair White goes ahead with--
Mr. Ketchum. If there aren't enough resources, which
certainly exists with respect to investment advisers, it is
certainly better than nothing. I think having firms who are
paid directly by the entity to do exams is--speaking of
conflict of interest--a larger conflict that I wouldn't choose.
I think it is much better for firms if they are not happy with
FINRA to create their own national securities association,
which they have the right under the statute to do.
Chairman Garrett. With that, I will yield to Mr. Hill.
Mr. Hill. New Members of Congress get so little time to ask
questions. I can't resist.
Chairman Garrett. I yield the gentleman 30 minutes.
[laughter]
Mr. Hill. Plus, it is Friday. The staff has nowhere to go.
Mr. Ketchum. We could do lunch if you want. I mean--
Mr. Hill. Just to follow up on Mr. Messer's point about
arbitration, in your aging of arbitration cases from start to
finish, have you seen the length of time to come to a
conclusion and issue a decision lengthen out? Could you supply
me sort of--I use the word ``aging'' analysis in a business
sense, because I have heard from constituents about one year
and then 2 years, and we don't have a decision. And the concept
of speedy trial, even for an adviser that has a serious matter,
is of concern to me.
Could you respond to that and provide some data on that?
Mr. Ketchum. We would be glad to provide data. I think
there was a challenge a few years after the credit crisis, I
believe because of the good things about up-markets are there
are less arbitrations. I don't think we have an aging problem
now, but I can't speak confidently on that. We would be glad to
provide you information.
Mr. Hill. And then just one other thing on my favorite
subject, CARDS, and you know my personal views on the CARDS
proposal in detail. I won't burden the world with them here.
But could you--it is my premise that FINRA can achieve the
CARDS level intel with your existing authorities and your
existing powers.
And so, through sweeps and through access of clearing firm
data, you can certainly satisfy your curiosity about looking
for patterns and potential fraudulent activity with that data
stream you have now.
Isn't that accurate? At a big picture level, maybe not at
the exact design level? And I am asking you as the CEO, not the
IT director. So, even if your enforcement or IT people say it
can be done--people told me that in my company all the time,
but as chief executive officer, I didn't go along with them.
So I am curious, can't you achieve your public policy
objective in a different way, if you didn't have CARDS?
Mr. Ketchum. We could certainly achieve a lot. We can
achieve a lot by using the data we have and the data that may
become available over time more effectively, you are absolutely
right there.
I would love to have more capability for an early warning
capability to jump in on serious frauds and sales factor
pieces. But, as I said in my written testimony, we are going to
step back and look at all of that, because they are fair
questions, and we should complete that analysis before making
any decision.
Mr. Hill. Thank you, sir.
And thank you, Mr. Chairman.
Chairman Garrett. Sure, thanks. So, that concludes today's
hearing.
The Chair notes that some Members may have additional
questions for this witness, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to this witness and to place his responses in the record. Also,
without objection, Members will have 5 legislative days to
submit extraneous materials to the Chair for inclusion in the
record.
Mr. Ketchum. Thank you, Mr. Chairman.
Chairman Garrett. Thank you very much.
With that, the panel is excused, and Mr. Ketchum, thank
you. And this hearing is adjourned.
[Whereupon, at 12:10 p.m., the hearing was adjourned.]
A P P E N D I X
May 1, 2015
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