The Demise Of FINRA’s District Committees…And Self Regulation, Too?

From Ulmer’s Broker-Dealer Law Corner Blog
By Alan M. Wolper

Many people, myself included, are of the view that FINRA today remains a self-regulatory organization in name only. For years now, FINRA has taken a series of actions decried by its member firms – new rules, new interpretations of old rules, zealous enforcement of rules, the imposition of punitive sanctions – who correctly complain that FINRA has lost sight of the fact that it is, at its roots, a membership organization run by and for its constituents, i.e., broker-dealers.  Instead, FINRA principally acts as an enforcer, aggressively pursuing even the most modest of rule violations (despite what its senior management has said to the contrary in recent public pronouncements).

Even with that said, there has remained one last bastion of self-regulation: the District Committees. FINRA is comprised of 12 Districts, and each District has its own District Committee, elected by the membership.  Unlike the NAC, i.e., the National Adjudicatory Council, and the Board of Governors – the two levels of governance directly above the District Committees – all members of the District Committees are people currently registered with broker-dealers.  The NAC and the Board, by comparison, are comprised of a majority of non-industry members.  This was done at the SEC’s specific direction, to dilute the ability of the member firms to dictate FINRA’s ideological direction, I suppose to try to ensure that the inmates don’t somehow take over the asylum.  I mean, how can actual members of the securities industry possibly know what’s best for the industry, right?  Better bring in some CEOs and college professors.

But not at the District Committee level. There, all you see are branch office managers, chief compliance officers, firm presidents, and the like.  Everyone is registered, and everyone has skin in the game.  These are people who, almost universally, know what’s going on, how difficult it can be to run a clean shop, and how hard, at times, it can be to deal with FINRA.

The District Committee used to be a pretty powerful group of people. As I presume all readers of this blog understand, the role of District Committees changed in the late 1990s, as part of the SEC’s 21(a) Report on NASD, and not necessarily for the better.  As a result of the concerns that the SEC noted in that Report, the power of District Committees to authorize the issuance of Enforcement complaints and to review and approve settlement offers was removed and given, instead, to Enforcement itself  (subject to oversight by the Office of Disciplinary Affairs).  The only roles left to members of the District Committees following that power shift were to (1) sit on the occasional Enforcement hearing panel, and (2) attend quarterly meetings, where members of FINRA’s senior management flew in to describe all the new, cool initiatives that they’d conjured up in Rockville, DC and New York.

While those meetings were designed to be a give-and-take between the membership and management, it was clear from the outset that the collective voice of the District Committee members was faint, at best. Indeed, their job was never to approve of new proposed initiatives, since, in fact, senior management didn’t need their imprimatur to pass new rules, so their views on the subject were, ultimately, meaningless.  Simply put, the District Committee members were there to provide a degree of window dressing, to make it appear that FINRA management actually cared what the members thought.

This charade has, sadly, become obvious. What was once considered to be a position of note, a feather in the cap of anyone fortunate enough to be selected to sit on a District Committee, in short, an honor, has become something decidedly less worthy of celebration.  It has gotten to the point where instead of contested elections between multiple qualified candidates vying to win a seat on a District Committee, now, there aren’t enough people with sufficient interest in the job to bother with the process.  How do I know this?  FINRA itself told me.

Just a couple of days ago, FINRA filed a rule proposal with the SEC designed essentially to do away with the District Committees and replace them with Regional Committees.  Included in that proposal is this telling sentence: “FINRA has noted the membership’s general lack of interest in District Committee service.”  On what does it base that observation?  According to FINRA,

[t]he number of District Committee seat vacancies is the primary indicator of the membership’s declining interest in District Committee service. For the past six years, there has been an average of 29 vacant District Committee seats per year.  Of this 29-seat average, 13 (approximately 45%) have been contested seats (two or more candidates), eight (approximately 28%) have been seats with only one candidate, and eight (approximately 28%) have been seats without any candidates, thus requiring FINRA to find an eligible person to appoint to the seat.

The idea that over half the open District Committee seats attract either only one candidate or, worse, no candidates at all, speaks volumes about the superficial role that the District Committee plays in today’s FINRA, not to mention the fact that the membership correctly understands this sad truth.

To address this, FINRA has proposed several changes. First, it will eliminate the District Committees and replace them with Regional Committees.  Perhaps that’s not a big deal, inasmuch as the District Committees have already been meeting on a regional basis for years and years.  Second, it will alter the current composition of the District Committees, which is derived by a specific formula.  Now, each District Committee reflects “a configuration of three small, one mid-size and three large firm representatives.”  According to FINRA, this “three-one-three composition is intended to align District Committee representation more closely with the industry representation on the FINRA Board.”  But, FINRA maintains that this “configuration does not necessarily reflect the industry composition within the regions as each region differs regarding firm number, size and business lines.”  As a result, it wants to throw away the formula, which would make all seats on the District Committee at-large seats.  In addition, the requirement that only small firms could vote for the small firm seat, only mid-size firms could vote for the mid-size seat, etc., would be eliminated, and any member firm could vote for any vacant seat.  There are some other small tweaks, but these are the big changes.[1]

I have no idea if these changes will actually work to increase interest in District Committee membership. I hope that they do, because it is sad and disturbing that FINRA has watered down the role of the District Committees to the point that firms apparently no longer care about getting their best and brightest people to sit on them, as firms once did.  But I understand why they don’t.  I understand why people don’t want to waste their time simply being props in FINRA’s stage-managed productions where senior management pretends to be interested in what the District Committees have to say and then does what it wants anyway.

If the securities industry is ever going to get serious about fixing things, about taking back control of how FINRA acts towards its members, it must embrace that fact that changes need to start locally – at the District Committee level (or Regional Committee level, if this rule proposal is passed). Qualified individuals who feel strongly about what’s wrong with FINRA should actively participate in the FINRA committee system and make sure that their voices are heard.  If not, if the industry continues to abdicate its responsibility to ensure that self regulation survives, then it loses its right to complain about things, and, ultimately, member firms will get what they deserve.

[1] There is a very interesting throw-away line in the rule proposal regarding the role of District Committee members to comprise Enforcement hearing panels.  It states that “FINRA also is exploring options to enlarge the pool of panelists.”  I wonder what that could possibly mean?  It is incredible to consider that FINRA can’t attract enough people interested enough in the Enforcement process to volunteer to sit on hearing panels.