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Overhauling SROs in Capital Markets: Unveiling Conflicts and Advocating for Reform

December 14th, 2023

Fair Markets Now brings to the forefront the pressing need to overhaul Self-Regulatory Organizations (SROs) in capital markets, a subject of paramount importance for all citizens, not just seasoned investors.

As gleaned from the congressional hearing “Examining the Agenda of Regulators, SROs, and Standards-Setters for Accounting, Auditing” and the SEC’s “Concept Release Concerning Self-Regulation,” there exist fundamental issues, such as conflicts of interest and the “revolving door” phenomenon, within these regulatory entities.

This need for reform resonates more today than ever, as the advent of digital trading platforms like Webull, Robinhood, and E-Trade has democratized access to the capital markets, drawing in a vast swath of Americans, many of whom are first-time investors.

Moreover, the integrity and fairness of these markets are crucial for the millions of Americans whose retirement savings and future financial security are tied up in 401(k)s and other work-related programs.

This is not just an issue for the affluent; it’s a concern that touches the lives of everyday people who see the capital markets as a key to financial stability and success. Now, with more individuals participating in these markets than ever, the call for a fair, transparent, and accountable regulatory system becomes relevant and essential for safeguarding the greatest wealth-building tool available to the public.

The Revolving Door and Conflicts of Interest:

The report critically examines the “revolving door” issue, where professionals move between roles in regulatory bodies and the industries they regulate. This practice raises concerns about impartiality and market oversight effectiveness, potentially compromising market integrity.

The SEC’s concept release reinforces these concerns, emphasizing the need for more robust regulatory mechanisms to prevent conflicts of interest. 

Fair Markets Now addresses the inherent conflict of interest in the “revolving door” practice within SROs. The analysis presents an analogy akin to a scenario where a police officer, sworn to uphold the law, simultaneously engages in criminal activities. This situation creates an inherent conflict, as the officer tasked with enforcing the law is also a violator, casting doubts on their ability to administer justice impartially.

Similarly, in SROs, when individuals move between regulatory roles and positions within the industries they regulate, it raises serious questions about their ability to enforce rules and regulations impartially.

This dynamic is akin to a wolf guarding a hen house, where the entity tasked with oversight also has vested interests in the outcomes, potentially leading to biased decision-making and undermining the integrity of regulatory actions.

Case Study: The MMTLP Issue and SRO Ineffectiveness: 

The MMTLP saga, overseen by FINRA, demonstrates the critical shortcomings of SROs. MMTLP, a preferred dividend from Torchlight Energy Resources and Meta Materials, was traded on the OTC market without issuer consent. On December 9, 2022, FINRA imposed a U3 halt, while MMTLP was listed on the OTC threshold list for 41 days, raising concerns about enforcing regulations.

This action left shareholders without recourse, highlighting a systemic breakdown.

FINRA’s claim of absolute immunity in legal challenges blocks any remedy for investors, underlining a critical gap in investor protection and accountability within the regulatory framework.

Now, 371 days later, shareholders remain in financial purgatory with no resolution in sight.

Adding to the complexity and controversy surrounding the MMTLP issue is FINRA’s approach to communicating and justifying its actions regarding the trading halt. FINRA, in its role as a Self-Regulatory Organization, has released several FAQs aimed at addressing the concerns surrounding the MMTLP situation. However, these FAQs have been critiqued for their numerous inaccuracies and perceived disingenuous responses. Rather than clarifying the situation, these FAQs have often deepened the confusion and frustration among investors.

For instance, shareholders have pointed out discrepancies in FINRA’s explanations regarding the timing and reasoning behind the trading halt. The gaps in these responses have fueled skepticism about FINRA’s transparency and its commitment to investor protection. This situation has further highlighted the inherent problems within the SRO framework, where a regulatory body’s actions and communications are not sufficiently scrutinized or held to the standard of clarity and truthfulness expected by public stakeholders.

Moreover, FINRA’s repeated invocation of absolute immunity in legal challenges has effectively barred shareholders from seeking judicial redress. This stance by FINRA has left MMTLP investors in a state of uncertainty and has raised more significant questions about the accountability mechanisms in place for SROs.

When an SRO can unilaterally make decisions impacting thousands of investors without fear of legal repercussions, it underscores a significant imbalance in the financial regulatory system.

As we approach the one-year mark since the MMTLP trading halt, shareholders’ plight remains unresolved, emblematic of the systemic issues plaguing SROs like FINRA. Thus, this case study serves as a clarion call for an in-depth examination and overhaul of the SRO framework to ensure that it genuinely serves the interests of investors and upholds the integrity of the capital markets.

Accountability and Executive Oversight:

In the context of SROs like FINRA and the SEC, Fair Markets Now raises concerns about their lack of direct accountability to voters, as highlighted during the hearing. This issue is underscored by the SEC’s concept release on self-regulation, which questions the effectiveness of such a model when SROs are not directly accountable to the public.

A particular point of contention is their claim of immunity in critical situations, leading to roadblocks for shareholders seeking justice. This creates a deadlock in the financial market system, leaving investors without recourse. To illustrate the depth of this problem, the hearing featured discussions on the effectiveness of regulatory bodies and the need for enhanced oversight.

One notable moment was a query about FINRA’s ability to ensure compliance with U.S. securities laws by foreign entities, highlighting the complex challenges SROs face in a globalized market.

This dialogue underscores the urgent need for reform, emphasizing that SROs should be held to higher standards of accountability and transparency to protect investor interests effectively.

Proposing Structural Reforms:

1. Mitigating Conflicts of Interest:

A critical concern identified in the SEC’s concept release is the growing dependence of SROs on large member firms for funding, potentially leading these members to exert significant influence over their regulators.

This situation raises the potential for regulatory failures, particularly in enforcing rules against influential members or developing rules that might disrupt their business practices​​. The proposed reforms aim to dismantle this dynamic by establishing a more independent funding mechanism for SROs, ensuring that their regulatory actions are not influenced by the financial clout of the entities they oversee.

2. Enhancing Oversight and Transparency:

Fair Markets Now also emphasizes the need for more stringent oversight of SROs. This includes increasing transparency in their regulatory processes and decision-making.

The congressional hearing highlighted concerns about the scope and limits of SROs’ authority, as illustrated by FINRA’s limited capacity to regulate direct or indirect owners of its member firms or to extend its enforcement reach beyond U.S. borders​​. To address these limitations, the proposed reforms include expanding the oversight capabilities of SROs and enhancing their authority to enforce compliance, both domestically and internationally.

3. Aligning SRO Actions with Public and Investor Interests:

The proposed reforms also seek to realign the actions of SROs with the interests of the public and investors.

This involves revising the rules and guidelines that govern SROs to prioritize investor protection and market integrity over the business interests of regulated entities. The reforms would ensure that SROs operate with a clear mandate to safeguard the financial market’s health and the interests of its participants.

The Time for Reform Is Now:

Fair Markets Now emphasizes the urgent necessity for a thorough overhaul of the Self-Regulatory Organizations (SROs) framework. Drawing from the insights shared in the “Examining the Agenda of Regulators, SROs, and Standards-Setters for Accounting, Auditing” congressional hearing and the SEC’s “Concept Release Concerning Self-Regulation,” it’s evident that the existing system of self-regulation is fraught with conflicts of interest and lacks sufficient accountability.

A revamped system is essential for ensuring a robust, transparent, and equitable financial market environment.

The need for reform is not just a theoretical consideration; it’s a practical imperative to restore trust, ensure market integrity, and protect the interests of all market participants, especially the retail investors who often bear the brunt of regulatory inefficiencies.

Call to Action:

Fair Markets Now calls on readers, stakeholders, and concerned citizens to actively engage in this critical discussion and support the movement for reforming SROs. Individuals can create a healthier and more equitable financial market environment by raising awareness, participating in dialogues, and advocating for change. It’s time for collective action to address the systemic issues highlighted in the MMTLP saga and similar cases.

Fair Markets Now, a non-partisan advocacy group, stands as a voice for retail investors seeking fair markets and equal access. The organization encourages involvement with platforms like Fair Markets Now, which offer tools to effectively communicate with congressional members, supporting initiatives that aim to overhaul SROs in the capital markets.

Together, we can strive towards a financial system where regulations are not just in place but effectively enforced, conflicts of interest are mitigated, and every investor has a level playing field. Join us in this endeavor to reform SROs, ensuring a fair and transparent market for all.

Download the Fair Markets Now Article To Share With Your Congressional Rep.

Overhauling SROs in Capital Markets: Unveiling Conflicts and Advocating for Reform

https://drive.google.com/file/d/1nemu26wqUqXmu7QkVNewdyHs91H-Fw0x/view?usp=sharing

Author Information

Fair Markets Now is a community-driven organization started by members directly affected by the irregularities surrounding MMTLP. Our mission is to advocate for fair treatment and equal access for retail traders in the equity markets. All investors should have a level playing field regardless of their size or resources.

We aim to hold hedge funds, shorts, market makers, and brokers accountable for their actions and ensure they adhere to the same regulations as other market participants. By advocating for the enforcement of existing rules and penalties for rule breakers, we strive to create a transparent and equitable market for everyone.

References

On Tuesday, December 12, at 2:00 p.m. (ET) Subcommittee on Capital Markets Chair Wagner and Ranking Member Sherman will host a hearing entitled, “Examining the Agenda of Regulators, SROs, and Standards-Setters for Accounting, Auditing.”

SECURITIES AND EXCHANGE COMMISSION

Concept Rule
Concept Release Concerning Self-Regulation

https://www.sec.gov/rules/2004/11/concept-release-concerning-self-regulation#:~:text=This%20release%20examines%20a%20number,%2C%20its%20shareholders%3B%20(2)

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