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From Securities Regulation Daily, March 3, 2016

Senators grill regulators about consolidated audit trail and industry misconduct

By Jacquelyn Lumb

Senators Mike Crapo (R-Idaho) and Mark Warner (D-Va) peppered Division of Trading and Markets Director Stephen Luparello and FINRA Chair and CEO Richard Ketchum with questions about delays in implementing a consolidated audit trail (CAT) and a maker/taker pilot program, while Senator Elizabeth Warren (D-Mass) grilled Ketchum about FINRA’s response to misconduct by financial advisers. Luparello and Ketchum were called to testify before the Senate Subcommittee on Securities, Insurance, and Investment about regulatory reforms to improve equity market structure. Warner said that Luparello should take back to the Commission the notion that after six years, his patience is wearing thin on the CAT project.

Consolidated audit trail. Crapo, the subcommittee chair, asked Luparello about the current time frame for launching the CAT. Luparello said that Chair Mary Jo White wants the CAT to be approved in 2016. To do so, he said the plan would have to be published for public comment in the coming weeks. In his prepared remarks, he noted that there would likely be a 60-day comment period, followed by a staff recommendation which could include modifications, before it goes to the Commission for approval. The self-regulatory exchanges are expected to begin reporting within one year of the effective date, with a longer phase-in period for smaller broker-dealers.

Maker/taker pilot. As for the maker/taker pilot, Luparello said a subcommittee of the SEC’s Equity Market Structure Advisory Committee (EMSAC) is expected to make a recommendation to the full committee at its meeting in April. Ketchum, a member of EMSAC, agreed that no project was more important than CAT and that it was time to look at maker/taker pricing. Warner said he did not believe it would take months of preparation for a maker/taker pilot.

Study on industry misconduct. Warren referred to a recent study (The Market for Financial Adviser Misconduct) which found that a large percentage of financial advisers in the industry had a documented history of misconduct, many of which she said serve less sophisticated investors. She questioned whether the self-regulatory system is working, given that one in five financial advisers reportedly have a misconduct-related item on file with FINRA. Ketchum said he too had read the study and was dismayed that firms would hire individuals with such records. About 44 percent of financial advisers who lost their jobs due to misconduct found employment in the industry within a year, according to the study. He added that FINRA focuses its exams on situations such as those.

Warren also cited the large amount of awards granted in arbitration proceedings that go unpaid. Since almost all brokerage customers must sign mandatory arbitration agreements, she asked what FINRA is doing to ensure that those who prevail in the proceedings get paid. Ketchum advised that if they continue to be FINRA members and have not paid the required arbitration awards they will be barred, but Warren asked how that could be the case with so many still in the industry. Ketchum noted that if a member is insolvent and leaves FINRA, there is little it can do to enforce payment.

Warren suggested that more regulation may be needed, and perhaps higher capital requirements to ensure that there are adequate resources to pay the awards. Ketchum agreed that more should be done to address the problem.

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