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Exam scores and failures belong on BrokerCheck

Jun 1, 2014 @ 12:01 am

By Ben Edwards

brokercheck, adviser, finra
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(Phil Disley)

A fierce struggle continues to play out over whether the Financial Industry Regulatory Authority Inc.'s BrokerCheck website should give investors a full view or a sanitized and less salient version of a broker's background. Because BrokerCheck is intended to be an investor protection tool and not a marketing device, Finra should make it easier for investors to get the gritty truth.

(See: Financial industry groups oppose adding exam scores to BrokerCheck)

In early March, the Public Investors Arbitration Bar Association released a study arguing that Finra's BrokerCheck system should disclose all material public information about a broker that it possesses. (Full disclosure: I co-authored the study with Jason Doss, PIABA's president, and Christine Lazaro, chairwoman of the association's legislation committee.)

DEPOSITORY DATA

The study highlighted categories of information, such as brokers' exam scores and failures, within Finra's Central Registration Depository database that are not disclosed through BrokerCheck, although that system extracts its data from the CRD.

Some have said that including the information on BrokerCheck would be unfair to brokers or that the information is not truly material, but it is already public, and likely useful, input for investors — presumably competent adults who should be able to make their own decisions.

Brokers' exam scores, exam failures, terminations and other details that are currently omitted are already public information. The CRD database, developed by Finra and the North American Securities Administrators Association Inc., consolidates duplicative state-by-state licensing systems. NASAA's position is that the CRD information is a state public record.

STREAMLINING THE SYSTEM

Certain states, such as Iowa and Florida, already provide investors with nearly all of the CRD data under their freedom of information laws. Even though investors already may be able to access much of that information through state regulators, the process can be cumbersome. Both the Securities and Exchange Commission and NASAA want to change that. They have called for Finra to make more CRD information available through BrokerCheck, which is easily accessible and widely promoted.

In any event, BrokerCheck should include brokers' examination scores and test failures because the information is indisputably material. For example, a recent Wall Street Journal study found that brokers “who failed the test at least three times ... were about two-thirds more likely than brokers who passed the first time to have three or more red flags on their record.”

Not surprisingly, brokers who flunk basic exams repeatedly end up with more black marks on their record. Investors would benefit from knowing about these repeat flunkers.

Moreover, Finra's outline for the fundamental exam every broker must pass to sell stocks — the Series 7 — also suggests that a higher score indicates a greater degree of competency. It notes, for example, that the exam “seeks to measure the degree to which each candidate possesses the knowledge, skills and abilities needed to perform the critical functions of a registered representative.”

Because a higher score points to something — perhaps greater mastery — many investors probably would deem the information material, and there is no good reason for obscuring it.

Investors should see this information because most lack the ability to evaluate the quality of a broker's advice independently. After all, if they knew how to allocate their assets, why would they pay for a broker's advice?

The inclusion of exam scores should not trigger a panic. A broker who entered with a low score a decade ago should not fear having a conversation about it with a client. A reasonable investor would expect someone to get better over time.

WHY FLUNK?

Yet in cases where an industry veteran keeps flunking exams by wide margins, investors might want to exercise a bit more caution. Although some people struggle with tests for various reasons, some flunk them because they do not know the material being tested.

Once rolled into BrokerCheck, exam scores and failures will be placed in context with other information that will allow investors to better evaluate whether they want to work with a particular broker.

Of course, some industry representatives would prefer to keep investors in the dark about brokers' exam outcomes, but their rationale appears weak.

For instance, some argue that it would be unfair to disclose these scores on BrokerCheck because brokers took the tests trying to pass rather than to get a high score.

But exam scores have always been public, so BrokerCheck disclosure wouldn't be making any new information public. It would just be making existing public information more accessible to those who need it. (As an aside, the idea that it is OK for brokers to scrape by knowing the bare minimum is troubling. If that's the culture, it could do well to change.)

Finra's BrokerCheck system offers investors a powerful tool to do a little due diligence on their broker. Including more comprehensive information — especially when that information is already in the database — would make it more powerful at a marginal additional cost. Investors should be able to view all public information and make their own decisions.

Ben Edwards is a professor at Michigan State University College of Law, where he runs a law clinic focused on protecting the interests of small investors. He is a co-author of the PIABA study that called for Finra to disclose additional information on BrokerCheck.

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