by Dr. David E. McClean
Regulatory Affairs
Manhattan Alternative Investment Network
How does regulatory creep work? 1. Regulator budgets swell, often due to appropriate or misguided legislation. 2. “Systems” and staff are added. 3. The staff is given more work to do. 4. The staff needs to show they are doing that work. 5. The staff adds new requirements (some being, frankly, ultra vires) and “goalposts” move. 6. The regulated, believing they have no choice, capitulate. 7. A “new normal” is then established. 8. The industry then operates pursuant to the “new normal” with a “Just give them what they want!” mantra resounding across the industry. 9. Compliance costs go up. 10. Review times of regulatory applications and exams stretch out, even for simple businesses or simple business changes. 11. Owners, principals, and firm staffs spend more and more of their time on minutiae, worried about caution letters, fines, and enforcement actions. 12. Lobbyists swing into action.
Recently, during audit season, several of my clients were told by their financial auditor that the auditor was going out of business and, ultimately, after stringing the firms along, told the firms that they would not be able to conclude the audits. The firms informed FINRA of the situation. FINRA convened a panel of lawyers to tell the firms, via Zoom, that “their” failure to file audited reports on a timely basis would result in an enforcement action. (Fortunately, the firms were able to find new auditors, though the reports were filed late — with fines.)
The membership application process at FINRA has become baroque. Going above and beyond the requirements for new member applications (NMAs) and Continuing Membership Applications (CMAs), e.g. for change of business control or adding or removing business lines, odd requests are made. Lots more examples of this to share in Part II, but here are a few for now. Recently, for a modification to allow a firm to broker corporate bonds a client was asked to submit a raft of procedures concerning EQUITIES. It’s no longer sufficient during a CMA or NMA process to provide evidence that a firm has adequate capital to run a business for a year; FINRA wants to micromanage the managers. FINRA examiners require a full set of shadow “pro forma” financials and net capital computations (with haircuts on chimeric inventory positions), 12 months out. This, despite adequate licenses, capital, and industry experience.
During a client exam, FINRA examiners told a client firm, which was only engaged in marketing private investment funds and having no customer accounts, that they should have had independent AML exams done for each of the past three years, when the rules require no such thing. Enforcement action was threatened. An off-the-record call to me by an examiner was apologetic, and I was told that my reading of the rules was correct. That fiasco required the firm to call in a white shoe law firm, at significant cost, to argue a point that was beyond dispute.
Be on the lookout for Part II.