Foxes, Henhouses and SROs

Very few people have ever heard the abbreviation SRO, let alone know what it stands for or means.

For those happy natives in SFCA who read, the letters mostly conjure up Single Room Occupancy, as in SRO Hotels, which are hotels that serve as residences for people without a lot of money, often in The Tenderloin or the Sixth Street area and its environs.

But for people who are licensed within The Financial Services Industrial Complex, a/k/a the FSIC (pronounced EFF’ sick), the abbreviation means only one thing: an SRO is a self-regulatory organization.

And what’s a self-regulatory organization, you might ask?

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So picture this: you are in an industry that, by general consensus, is one upon which the well-being of the entire population, in part, depends. Let’s use air travel as an example.

Now picture this: the airlines, together, decide to create an association that, the airlines argue, will be best-positioned to monitor, police and, in general, regulate, the conduct of the airlines. So the head of, say, United Airlines, and the heads of the other airlines and other various components of the airline industry, get together to run the association which, in turn, regulates the industry.

Now if you’re thinking that this sounds an awful lot like the fox guarding the henhouse, you would not be alone in this opinion.

The powers that be (whomever they might be), however, very much like the idea: they think that the consequences of a failure to regulate — say, a cluster of planes falling prey to gravity and thousands of people dying — would be so powerful a disincentive that the airlines would, for-sure, behave (oh, behaaaave).

So how d’ya s’pose that would work out?

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It’s hard to know how that would work out because we’ve never tried it here, and I don’t have the time to research whether any other country has tried this approach.

But I do know that, within The FSIC, the model has been alive and well for many years.

And I do know that, on October 23, 2008, about five weeks after September the 15th, no less a Biggie-Deal FSIC-fellow as Alan Greenspan had this to say in 2008, as the world around him — the financial component of which he had overseen for 20 years and had his design indelibly stamped upon it — burned:

I made a mistake in presuming that the self-interests of organizations, specifically banks and others, were such that they were best capable of protecting their own shareholders and the equity of the firms.

And also this:

Those of us who have looked to the self-interest of lending institutions to protect shareholders equity, myself in particular, are in a state of shocked disbelief.

So, at least in 2008, self-interest wasn’t working. The logical conclusion from that episode was that, when push comes to shove — or, more particularly, when avarice comes across a largely unnoticed opportunity which promises an out-sized windfall and which can also stay out-of-sight long enough to be fully reaped — SROs would not work either.

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Today there is a big SRO knock-down, drag-down fight going on within The FSIC, a big-time fight, ladies and gentlemen, a big-time fight indeed. In one corner we have FINRA, which is the SRO for stock brokerages and the people within them, and which is a somewhat new entity, formed in 2007, as the regulatory sloughing off of a merger between two for-profit, shareholder-owned stock exchanges (yup, as part of the financial engineering of the 2000s, it became possible for anyone with a few dollars to own shares in some of the stock exchanges).

In the other corner we have the SEC, which currently regulates most investment advisers and the people within them, and which has been the part of the government doing this sort of work since the 1930s when we — ahem — had some problems in that particular part of our economic system and passed a lot of laws to try to make sure history did not repeat, including a law to create the SEC.

The problem, you see, is that when you look at its budget, the SEC has been drowning in a bathtub for — my guess — oh, about thirty-five years, when Alfred Kahn and Jimmy Carter launched the deregulation wave in earnest (yup, it started during Carter’s administration). And now that the SEC is near-drowned and the SRO-movement ever-more empowered, FINRA, the aforementioned SRO, has its sights set on bringing investment advisers into its own little SRO-fold.

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Now, some other time I’ll discuss in here the differences between the stock brokerages and investment advisers; it’s of the essence, and it’s something that I help clients understand as The First Thing about how the investing industry is set up. Suffice for now to say that stock brokerages and investment advisers are not at all coming from the same place. Not at all. They are in many ways in opposite corners.

Law students in California in the 80s (me, for instance), learned a lot about the decades-long and apparently still-going-strong regulatory war between ophthalmologists and optometrists. Both professions work on eye health, but they have different approaches, and each, naturally, thinks their way is better. They fight for turf; they try to exclude the other. They parry and lunge at each other all the time.

Something akin to that is going on between stock brokerages and investment advisers, but, by all accounts, the old-line brokerages are losing the battle against the investment advisers. So the very idea that FINRA — regulator of stock brokerages — might end up regulating the investment advisors is, to use Greenspan’s phrase, one which leaves many investment advisors shaking their head in shocked disbelief.

Personally (and, yes, I know I am about to make a political statement here), when it comes to big, huge organizations with power, I much prefer the organization with power to be within the government rather than within the hands of large for-profit organizations. I prefer this because the former is, by definition and often in practice, by and for the people as a whole, while the latter, by definition and usually in practice, is by and for its constituents, which, when it comes to corporations, is its group of shareholders (in theory). So I see lots of instances (asbestos and tobacco to just name a few) in which for-profit corporations have been truly evil — as in intentionally causing death via very un-Golden-Rule behavior and decision-making — and not many, if any, parts of our current federal government which have shown anything even approaching the outright antipathy towards doing the right thing that those two examples highlight.

And as for competence? I think we have a draw there, in that both for-profit organizations and governments can be run well and both can be run incompetently; it just depends on who all is involved. Still, painting with a very broad brush, I view government workers as starting from a place of providing service to the community as a whole, while I see workers in for-profit organizations starting from a place of maximizing profits for the organization exclusively.

So if FINRA does indeed get the nod for regulating investment advisers, then you’ll have the fox watching the henhouse watching the worm farm — you’ll have a private enterprise (FINRA) regulating, in essence, itself (stock brokerages and the people inside of stock brokerages), and at the same time regulating the worms that the hens in the henhouse would love to eat (investment advisers and the people inside of investment advisers, a group that stock brokerages currently feel some opthamo vs optomet sort of animosity).

Howd’ya s’pose the worms would feel about that prospect?

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Stay tuned here to follow the comings and goings of the FINRA vs. SEC imbroglio.


840 words when first published

1106 words final


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