A new report by a group of securities arbitration attorneys calls into question FINRA's ability to protect investors given alleged conflicts of interests on its board.

The report was issued Wednesday morning by the Public Investors Arbitration Bar Association, whose members represent investors in legal disputes with FINRA member firms. The group raises concerns about five of FINRA’s 13 public governors and one recently departed governor who now sits on the Federal Reserve’s Board of Governors.

FINRA's board is comprised of 24 members. Among them, 10 have open industry ties consistent with the nonprofit's public-private status as a self-regulator of the financial industry. Another 13 seats are designated to public members, intended to represent investors. The remaining seat is for FINRA's CEO.

PIABA alleges, however, that of the 13 public members, five are tied too directly to financial services firms to represent investors’ interests.

Phyllis Borzi, Assistant Secretary, Labor Department (The Institute for the Fiduciary Standard)
Two critics of FINRA's governance propose that the self-regulator appoint former Labor Department official and fiduciary champion Phyllis Borzi to its board.

Among their concerns, PIABA notes that FINRA board chairman William Heyman also serves as an executive for The Travelers Companies. Other public governors, including Eileen Murray, Shelly Lazarus, Carol Anthony "John" Davidson and Joshua Levine either work at financial services firms or sit on the boards of financial companies.

The authors of the report, PIABA President Andrew Stoltmann and Benjamin Edwards, a law professor at the University of Nevada, Las Vegas and PIABA board member, call on FINRA to replace those five board members with investor advocates, whistleblower advocates or former whistleblowers, instead.

In response to the allegations, FINRA spokeswoman Michelle Ong said the organization has a “robust appointment process” in place to determine its board. FINRA is currently in the process of reviewing PIABA’s views on the issue, as well as other letters that were submitted after FINRA issued a request for comments in March, Ong says.

“Each governor, regardless of his or her affiliation or classification, is responsible for serving in an unbiased and objective manner, and voting on matters for the good of the investors, industry and marketplace,” Ong wrote in an email. “Board members need to have an understanding of the issues facing FINRA and an ability to apply their knowledge and expertise to those issues.”

PUBLIC DIRECTORS, INDUSTRY PEDIGREE
The PIABA report found the following about FINRA’s public board members:

  • Heyman, the board's chairman, is also the chief investment officer of The Travelers Companies, one of the largest insurance companies in the nation.
  • Murray is co-CEO of the world's largest hedge fund, Bridgewater Associates.
  • Lazarus is a director with private equity and financial services firm Blackstone.
  • Davidson sits on the board of FINRA-member and global asset management firm Legg Mason.
  • Levine founded the single family office Kita Capital Management.

In addition, Randal Quarles, recently appointed to the board of the Federal Reserve System, was a FINRA public board member up until this summer. While at FINRA, he also served as a director for the U.S. Chamber of Commerce, which filed a lawsuit last year to prevent the Department of Labor from implementing the new fiduciary rule.

Quarles could not be reached for comment. FINRA did not make the five public board members in question available for an interview.

'HOW CAN WE TRUST YOU?'
"It's just a disgrace," says corporate and nonprofit governance expert Nell Minow. "These conflicts of interest are a monstrous issue. It destroys any credibility that the organization has at all."

Minow, who is vice chairman of ValueEdge Advisors in Portland, Maine, was not involved in PIABA’s report. "This is exactly the reason that we don't like to see industries regulate themselves," she says. “Normally it takes a government agency at least a generation to become completely captive to industry. But in a self regulatory system, it takes five minutes."

During confirmation hearings on Capitol Hill in July, a senator pressed Quarles about how he could be effective as a regulator, given his industry ties.

"The Chamber of Commerce has repeatedly sued regulatory agencies to overturn investor protections on behalf of its Wall Street members," Sen. Catherine Cortez Masto, D-Nevada, said to Quarles. "If confirmed to a position at the Fed, how can we trust you to balance the public interest against the interests of Wall Street given the obvious conflicts in your current role?"

In response, Quarles said he would do what he'd done at FINRA.
"In the same way that in representing the public on the FINRA board I have done that, without any influence from or even discussion with the Chamber of Commerce," he said.

Stoltmann, one of the PIABA report’s coauthors, says that kind of hat-switching fails to serve American investors.

"Non-conflicted board members provide the crucial check against Wall Street domination at a self-regulatory organization," he says.

PRAISE FOR FINRA CEO
Stoltmann's coauthor, Edwards says FINRA's still-new CEO Robert Cook deserves praise for releasing more detail about FINRA's governors. Prior to Cook joining FINRA last year, Edwards said the regulator released scant, if any, details about its public governors.

Public governor Levine, for example, had been described for years simply as "retired," without any mention of his work for a single family office, Edwards says.

"This is very important to be able to look at the people serving on the board and observe whether or not there are conflicts," he says.

'OVERBOARDING' RISK
The report also cites another potentially critical fiduciary risk relevant to most of the board members: "Overboarding" refers to directors holding so many positions on different boards that, in the event of a crisis like an economic downturn, they are unable to fulfill all their obligations.

Overboarding is an issue that has been of increasing concern to investors in recent years. Institutional Shareholder Services recommends that investors vote against "overboarded" directors like FINRA's chairman Heyman, the report says.

The report found the issue is a problem with four of the governors in question:

  • Heyman holds six governance and advisory roles at the same time, including his role as FINRA's chairman. In addition to managing Traveler's $70 billion portfolio as CIO, Heyman is also a director at Bank Leumi USA and sits on the advisory board of Atlas Merchant Capital, among other duties for prominent organizations including Princeton University.
  • Lazarus serves on a total of ten boards, the most of any of the governors cited in the study. It found she maintains board commitments or affiliations with entities including Merck & Co., General Electric, the World Wildlife Fund, Lincoln Center for the Performing Arts, among others.
  • Levine serves on or is affiliated with six entities, including Fresh Direct, Fantex Holdings and Classroom Inc.
  • Davidson serves on at least five boards, including Pentair, DaVita and the University of Rochester.

"An overboarded public governor on FINRA’s Board of Governors cannot devote substantial time and attention to mitigating systemic risks or to ensuring that FINRA’s management vigorously protects public investors," Stoltmann and Edwards write in the report.

The report also claims FINRA broke its own bylaws with respect to Heyman. While FINRA only allows public governors to serve two consecutive three-year terms, the report says, Heyman has served on FINRA's board for 14 years.

BORZI ON BOARD
PIABA’s report proposes five individuals as alternatives for the jobs, including: Phyllis Borzi, the former Labor Department official credited with the shepherding the fiduciary rule into law last year; securities lawyer Jill Gross who ran an investor rights clinic at Pace University for 16 years; Jordan Thomas, a former SEC official who now represents whistleblowers in his legal practice, and two others.

The new revelations about FINRA's governors are not surprising, says Minow, especially in light of instances when, for example, critics said the regulator appeared to follow the lead of one of its largest members, JPMorgan, in becoming an instrument of retaliation against JPMorgan whistleblower Johnny Burris.

JPMorgan retaliated against Burris in firing him, according to a Department of Labor finding.
After Burris continued to talk publicly about fiduciary breaches to which the bank later admitted, FINRA then launched a new investigation into Burris over a mere $624 client loss that had already been refunded.

At the time that FINRA probed Burris, JPMorgan's former general counsel, Stephen Cutler, had just joined FINRA's board as an industry member.

FINRA did not make Cutler, who still sits on the board, available for an interview, to answer questions about the investigation.

"That's only to be expected from a group that in reality is so far from its stated rhetoric and purpose," says Minow of FINRA's handling of the Burris case, noting that the investigation may have scared other whistleblowers into silence.

"This is not the fox guarding the henhouse," she says of FINRA's governance issues. "This is the fox eating all the hens."

Ann Marsh

Ann Marsh

Ann Marsh is a senior editor and the West Coast Bureau Chief of Financial Planning. Follow her on Twitter at @Ann_Marsh.