Finra is overreaching, some say

By Sara Hansard June 2, 2008, 6:01 AM EST Post a Comment

Executives of the financial services industry are asking how much power the Financial Industry Regulatory Authority Inc. should have after it proposed rules that would require broker-dealer principals to supervise insurance and investment advisory services more closely.

Under existing regulations, broker-dealer supervisors don't have to oversee non-brokerage activities.

The proposal, however, has opened the regulator to charges that it is overreaching.

"The first draft [of the regulation] needs some work," said Glenn Wilson, commissioner of the Minnesota Department of Commerce.

Insurance regulators "want to make sure that what's insurance is regulated by insurance regulators and what's securities is regulated by securities regulators," said Susan Voss, commissioner of the Iowa Insurance Division and a member of the life insurance committee of the National Association of Insurance Commissioners in Kansas City, Mo.

The rule change is unnecessary because insurance commissioners "require all kinds of suitability and disclosure and licensing" for insurance products, said Mr. Wilson, who is also on the NAIC life insurance committee. Moreover, insurance regulators have been working with securities regulators to create matching regulatory systems.

Finra is attempting "to make new rules and impose new rules," said a chief regulatory officer with a broker-dealer firm who declined to speak for attribution. "For [Finra] to say they want to know about my fixed-insurance business is overreaching."

The proposal, if enacted, would allow Finra would intrude more into the way broker-dealers conduct their non-securities businesses, the officer said.

The proposal is likely to limit the life insurance companies with which independent-adviser firms can do business, said Michael Flower, a managing partner of Financial Principles LLC, an advisory firm in Fairfield, N.J., that manages about $175 million.

Once a broker-dealer begins supervising sales of insurance products, "it's not like you can easily go and form relationships with a broker-dealer that offers, say, equity index annuities. What happens then is, [the broker-dealer enters into a single] relationship that everyone has to use," Mr. Flower said.

So instead of having a choice of several firms from which to buy products, as it now has, Financial Principles, for instance, is likely to be left with a relationship with just one insurance company because supervision would be too difficult otherwise, he said.

"[The insurer] can change compensation because we're stuck with that one relationship," Mr. Flower said.

The firm would offer fewer insurance products as well. "All of a sudden, if [broker-dealers] have to supervise these things, we're no longer able to offer everything," Mr. Flower said.

The Financial Planning Association of Denver is concerned about the effect that the proposal would have on supervision of investment advisory and financial planning activities.

"It's something that potentially has a big impact," said Dan Barry, director of government relations in the FPA's Washington office, adding that the association is concerned about expanded broker oversight of outside advisory activities.

"We don't think that brokers should be responsible for non-securities activities," he said. "Non-securities activities are really beyond their scope of responsibilities and expertise."

If Finra's board approves it, the proposal will require Securities and Exchange Commission approval.

Under the proposal, brokerage firm principals would be required "to supervise each type of business in which the firm engages, regardless of whether registration as a broker-dealer is required for that activity," according to the Finra regulatory notice.

"We think a broker-dealer should supervise all of its business," said Marc Menchel, executive vice president and general counsel of Finra. "If it puts equity index annuities into its business mix, it ought to be supervised."

Finra's just and equitable principles of trade, its standard for brokerage firm dealings with customers, is "not just confined to securities," Mr. Menchel said. "We're just expressing what we think is implicit in the just and equitable principles of trade."

Also, under the rule change, supervision would include non-securities businesses in which registered representatives are engaged."There are a lot of outside activities that [registered reps] are involved in," said David Hwa, attorney in the Washington office of Boston-based Bingham McCutchen LLP.

"Sometimes it is real estate, sometimes it is insurance," he said. "It could be a lot of things."

Under existing rules, registered reps are required to notify their broker-dealers and get written approval for outside business activities. However, firms haven't been required to supervise that activity. Public comments on Finra's proposal are due by June 13.

E-mail Sara Hansard at shansard@investmentnews.com.