Seeking Alpha (March 9, 2022) - FINRA stands for the Financial Industry Regulatory Authority, Inc. and it is an independent, self-regulatory organization that oversees member brokerage firms and exchange markets.

What is FINRA?

FINRA is the successor to a previous organization, the National Association of Securities Dealers, Inc. (NASD), and the member regulation, enforcement, and arbitration operations of the New York Stock Exchange (NYSE).

FINRA's purpose is to protect investors from potential abuses and ensure ethical conduct within the financial industry. Currently, FINRA oversees 3,435 security firms, including 152,861 branch offices, and 617,549 security professionals.

FINRA vs. SEC

The ultimate regulator of the U.S. securities industry, including FINRA, is the Securities and Exchange Commission (SEC). It differs from FINRA in that FINRA is a non-governmental, not-for-profit entity, while the SEC is a governmental organization that is tasked with protecting individual investors and maintaining the integrity of both formal and over-the-counter (OTC) exchanges.

The SEC was created with the passage of the Securities Act of 1933 and the Securities Exchange Act of 1934. The SEC can initiate civil actions and it works with the Justice Department on criminal cases. The SEC can:

  • Levy civil money penalties
  • Issue injunctions
  • Suspend individuals from being officers or directors of a company
  • Issue cease-and-desist orders
  • Impose bars or suspensions of employment.

FINRA History

In July 2007 with the approval of the SEC, FINRA was formed by the consolidation of the NASD and the member regulation, enforcement, and arbitration operations of the New York Stock Exchange. The NASD was founded in 1939, and in 1971, it created a computerized stock trading system called the National Association of Securities Dealers Automated Quotations, or NASDAQ. In 1998, the NYSE and the American Stock Exchange merged, and in 2006, the NASDAQ became independent from NASD.

What Does FINRA Do?

FINRA oversees more than 3,500 brokerage firms, 154,000 branch offices, and around 625,000 registered securities professionals who trade in:

  • Equities (stocks)
  • Corporate bonds
  • Securities futures
  • Options.

By contract, FINRA regulates the New York Stock Exchange, the NASDAQ Stock Market, Inc., the American Stock Exchange LLC, the International Securities Exchange, LLC, and industry utilities, including Trade Reporting Facilities and other over-the-counter operations.

Besides licensing individual brokers and firms, FINRA supplies regulatory services and products to the American Stock Exchange, the International Securities Exchange, as well as other stock exchanges and stock markets. FINRA operates the largest arbitration forum for resolving disputes between its member brokerage firms and their customers, and between the brokerage firms and their employees.

When FINRA's rules, which are designed to protect the public, aren't followed, it can take disciplinary actions including levying fines, ordering restitution to investors, and suspending and expelling member firms and individuals. FINRA refers cases involving fraud or insider trading to the SEC and other government agencies.

FINRA creates and administers the qualifying exams that securities professionals must pass, including the Series 7 General Securities Representative Qualification Examination and the Series 3 National Commodities Futures Examination.

FINRA also provides a tool, BrokerCheck, that allows investors to search its database of brokers, investment advisors, and financial advisors to view their education, the certifications they hold, and any disciplinary actions taken against them.

FINRA is headquartered in New York and Washington, D.C., and has 16 regional offices across the U.S. Its board of governors is comprised of a FINRA chief executive officer, the chief executive officer of the NYSE Regulation division, 11 public governors, and 10 industry governors. Industry governors include a floor member governor, an independent dealer/insurance affiliate governor, an investment company affiliate governor, three small firm governors, one mid-size firm governor, and three large-firm governors.

FINRA arbitration involves binding arbitration contracts and mandatory arbitration agreements, where the parties, such as investors and brokerage firms, waive their right to trial in a court of law. However, some class action cases have been allowed to go to trial.

Since brokerage firms typically bring attorneys into the arbitration proceedings, investors can bring their own attorneys. An organization whose members specialize in representing investors against brokerage firms in FINRA arbitrations is the Public Investors Arbitration Bar Association (PIABA). In July 2008, when Congress was considering passing legislation preventing mandatory arbitration clauses, and again in 2011, FINRA amended the composition of its arbitrator panels to include all public members.

Who Is Subject to FINRA Regulations?

  • Broker-Dealers: businesses that buy or sell securities on their own behalf, on behalf of their customers, or both
  • Capital Acquisition Brokers: is a Broker-Dealer who engages in a limited range of activities and is subject to a narrower rule book
  • Funding Portals: a crowdfunding intermediary

FINRA Rules & Regulations

The FINRA Manual is provided to investment professionals and lists all the organization's rules and regulations that are designed to ensure a safe and fair market. Examples of FINRA rules include:

  • Rule 5310: requires that broker-dealers "use reasonable diligence" to find the best market and obtain the best possible price for a security so that the customer gets the most favorable price possible under current market conditions
  • Rule 4210: requires that a customer's equity in a margin account must not fall below 25 percent of the current market value of the securities in the account or the customer may be required to deposit more funds or securities to maintain equity at the 25 percent level (referred to as a margin call)

FINRA also verifies compliance with the Anti Money Laundering Act of 2020 and the Bank Secrecy Act of 1970.

Bottom Line

FINRA plays a vital role in regulating the U.S.'s financial markets and its financial services institutions. FINRA'S BrokerCheck tool allows investors to make informed decisions about which brokerage firms and brokers to use.