Finra still struggles to meet rising costs with less revenue

The Financial Industry Regulatory Authority Inc. faces many of the same challenges as its member firms — including meeting rising costs in the face of stagnant revenue.

Finra’s biggest revenue source, regulatory fees, remains depressed, according to the self-regulatory body’s latest annual report, released June 28. At the same time, however, costs — particularly its employee compensation — continue to rise.

That’s sparked complaints from member firms about how Finra is being managed and about its pay levels, especially for executives.

“The number of broker-dealers has been declining every month,” said Jim Biddle, founder of The Securities Center Inc. “Yet they maintain [chief executive Richard G.] Ketchum’s million-dollar salary.”

KETCHUM’S PAY PACKAGE

Overall, Mr. Ketchum’s pay fell 2% last year to a total of $2.63 million, compared with $2.69 million in 2011. His salary held steady at $1 million, while his bonus rose to $1.25 million, from $1.2 million in 2011. His deferred compensation dropped to $340,201 from $451,174 in 2011.

“You do have to pay a bit of money to get good people,” said Neal Nakagiri, chief executive of NPB Financial Group LLC. “But I don’t know what the [Finra] board uses for comparison purposes.”

According to the Finra annual report, the organization competes against financial services and law firms for talent, and has to offer long-term incentives to key executives to remain competitive.

Finra executives were not available for comment.

Like many of its members, Finra also is struggling with flat revenue.

Its biggest revenue line, regulatory fees, encompasses a trading activity fee, gross-income assessments against firms, personnel assessments for registered persons and branch-office assessments.

REGULATORY FEES

Regulatory fees remain stuck at about 10% below their 2008 peak, at $406.9 million last year.

Lower trading volumes are one contributing factor. But the number of broker-dealers, branch offices and registered representatives continues to shrink, as well. As of the end of May, Finra had 4,248 member firms, down 13.2% from 2008. The number of branch offices and registered representatives are off 6% and 5.3%, respectively.

“Now I understand the push that Finra is making in Congress to take on the oversight of RIAs,” Donald Rice, president of Money Management Services Inc., said after seeing Finra’s latest financial results. “They’re doing it for the revenue.”

Mr. Rice has lobbied against Finra overseeing investment advisers.

A spokeswoman for Finra refuted Mr. Rice’s comments.

“Finra continues to believe that the current levels of investment adviser oversight and examinations are unacceptable … and that this significant gap in investor protection needs to be addressed,” spokeswoman Nancy Condon wrote in an e-mail.

She added that Finra will support an adviser fee to fund more supervision “if it becomes an achievable solution,” but with the lack of consensus in Congress, Finra is not currently pursuing such legislation.

A year ago, as a result of the continuing losses, Finra announced a series of fee increases for member firms worth $60 million a year. The fee hikes, along with cost cutting and improved investment returns from its $1.6 billion portfolio, helped Finra eke out a profit of $10.5 million last year, reversing an $84 million loss from 2011. The organization, however, posted an operating loss of $89.2 million last year, slightly better than the $89.8 million operating loss it suffered in 2011.

By the end of last year, head count had reached 3,400, up 100 from the beginning of 2012. Employee compensation grew to 63% of total expenses last year. It was 56.1% in 2008.

“Head count is up because of contractor conversions to permanent staff,” Ms. Condon wrote.

Compensation and benefits costs have been growing 3% to 4% annually as a result of “increases related to employee merit, promotion, equity and incentive compensation,” Finra said in the report. Head count has risen in recent years due to a migration of Finra’s market regulation functions from an outside vendor to a new in-house center, and from bringing on former NYSE employees.

Last year’s $59.1 million gain on its investment portfolio put the organization in the black, but investment income may be muted in the future.

Finra dramatically reduced risk in its portfolio following huge losses after the financial crisis in 2008. As of year-end 2012, 63% of its investment assets were allocated to high-quality bonds and cash, 20% in equities and 13% in alternatives.

The $1.6 billion portfolio is invested in HighVista II Limited Partnership, a “broadly diversified multiasset fund” managed by HighVista Strategies LLC, according to Finra’s latest report. The fixed-income portfolio is run by Wellington Management Co. LLP.

Some members wonder what Finra is doing with all that money.

“Why [doesn’t Finra] give it back to members?” said Yaron “Ron” Reuven, chief executive of Reuven Enterprises Securities Division LLC.

“Finra uses its portfolio each and every year to subsidize its operating costs,” Ms. Condon wrote.

Related Topics: Financial Industry Regulatory Authority