THE BLOG
06/01/2010 08:34 pm ET Updated May 25, 2011

The Ugly Side of FINRA

FINRA, the Financial Industry Regulatory Authority, loves to portray itself as an advocate for investors. It's the "self regulatory authority" of 4700 brokerage firms and 635,000 registered securities representatives.

Its Board of Governors is a who's who of the securities industry. It includes representatives from mutual funds and major brokerage firms. Many former Chairmen of the Board were affiliated with large securities firms.

What we have in this country is a securities industry regulating itself. As Dr. Phil would say: How is this working for you?

Not well for holders of seven affiliated bond funds issued by Morgan Keegan & Company. In a press release issued April 7, 2010, FINRA proudly announced it had filed a complaint against this firm. It charged them with marketing and selling seven affiliated bond funds to investors using "false and misleading sales materials", allegedly costing investors over $1 billion.

The funds were invested in risky structured products, like sub-prime mortgage-backed securities. The funds collapsed in 2007.

The essence of the complaint is Morgan Keegan represented these funds (and particularly the Regions Morgan Keegan Select Intermediate bond Fund) were "safe and conservative fixed income mutual funds." In fact, they were highly risky.

According to the complaint (the allegations of which remain unproven), Morgan Keegan knew the underlying investments put the funds "at risk of periodic underperformance when these areas are out of favor." Nevertheless, investors were told investments in the fund were "safe and conservative."

A May 15, 2007 private e-mail from the Director of Investments at Morgan Keegan to a Morgan Keegan broker noted: "I'd bet that most of the people who hold that fund have no idea what's [sic] it's actually invested in. I'm just as sure that most of our FAs [Financial Advisers] have no idea what's in that fund either. If people are using [the Intermediate Fund] as their core, or only bond fund, I think it's only a matter of time before we have some very unhappy investors."

The advertising materials for these funds compared their safety to money market investments.

FINRA's complaint seeks monetary sanctions and restitution for investors. However, as a practical matter, investors seeking to recover their losses have to bring individual claims against Morgan Keegan.

You would think their chances of winning would be pretty good. Think again.

Investors who suffer losses due to misconduct of their brokers are barred from the Courts and from a trial by a jury of their peers. Instead, they must submit to mandatory arbitration administered by ...none other than FINRA itself.

According to Jeffrey R. Sonn, a securities arbitration attorney who has represented a number of investors in these funds, "the overall win-loss ratio for these cases, is about 50/50." While this is pretty dismal, the reality is actually worse. Sonn says even when investors do prevail, many recover only a fraction of their losses.

Let's see if I have this right. FINRA is suing Morgan Keegan over gross misconduct concerning these funds. But investors who were harmed by this very conduct can't get a fair shake from arbitration tribunals administered by FINRA.

Supporters of FINRA's mandatory arbitration system note that it is subject to oversight by the Securities and Exchange Commission. The current chairperson of the SEC is Mary L. Schapiro. She is the immediate past chairperson of -- you guessed it -- FINRA!

There will be no meaningful financial reform until FINRA's mandatory arbitration system is abolished. Investors should not be treated as second-class citizens, compelled to humble themselves before an industry appointed arbitration tribunal, and beg for mercy.

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