Fiduciary advocates expressed concern after FINRA member firms elected a "dissident" candidate to its board of governors after he said he would represent brokers, but not investors -- the core constituency FINRA says it exists to serve.

Brian Kovack of Kovack Securities beat out FINRA's endorsed candidate John Muschalek, vice chairman of First Southwest Company, to represent mid-sized broker-dealers with 151 to 499 advisors.

When asked last month if we would represent investors on the board, Kovack said simply, "No. I would not."

"I think he's just being honest," says Melinda Steuer, a securities lawyer, based in Sacramento, Calif. "I don't think FINRA's purpose is to represent investors. I think the system is set up to hurt investors."

Knut Rostad, president of the Institute for the Fiduciary Standard, says he wishes more FINRA leaders were as honest as Kovack. "I disagree completely with his view of his role, yet I applaud his candor," Rostad says. "He appears to simply say what he means."


In response to a series of follow-up questions, Kovack issued the following statement:

"It is regrettable that certain members of the media have chosen to distort and misrepresent the facts as they relate to my commitment to FINRA's core mission of protecting investors and preserving market integrity," it reads. "As with any FINRA board member drawn from the industry, I am committed to both uphold these goals and to represent a certain segment of the broker-dealer community, and to suggest that these twin responsibilities are somehow mutually exclusive is unreasonable. I look forward to working with the other members of the board and with FINRA's member firms to identify regulatory solutions that work both for investors and for the industry."

Indeed the website for the self-regulatory organization describes its purpose as follows, "FINRA is dedicated to investor protection and market integrity through effective and efficient regulation of the securities industry."

It also seeks to ensure that "every investor receives the basic protections they deserve."

However, what is less clear is the fact that FINRA is run by the same firms who end up in arbitration and court cases fighting investors the agency says it exists to protects – a fact that many in the industry see as an insurmountable conflict of interest.


"I can't think of any other system that is set up where people are forced to arbitrate in a forum that is run by the same people they are suing -- not just run by, but owned by the broker-dealers," Steuer says.

To be sure, many of the 24 members of FINRA's board of governors belong to firms that FINRA has disciplined. For Kovack's part, he personally shows no disciplinary record with FINRA but his firm has paid out $725,000 to clients over the course of five arbitration cases between 2002 and 2011.

"I'm just appalled" by Kovack's statement last month, says Sheryl Garrett, founder of the Garrett Network, a fee-only and fiduciary financial planning firm, which President Barack Obama singled out for praise earlier this year for its fiduciary advocacy in the industry.

Kovack, a securities lawyer who has represented cases before FINRA arbitrators and served as an arbitrator himself, says one of his top goals would be to allow FINRA arbitrators to throw out frivolous claims from investors.


Investors can file complaints at minimal cost, alleging losses ranging from a few thousand dollars to millions, Kovack said last month. And the minimal cost for a firm to begin defending itself starts at around $3,000 and rises to $10,000 for larger monetary damages, he says.

"As a firm, you don't have the option of an effective manner of a motion to dismiss," Kovack said. "You don't have an effective tool in frivolous cases to seek attorney fees from the claimants. The client doesn't have a whole lot of risk and has a whole opportunity for reward."

The problem with this idea, Garrett says, is that arbitration allows for very limited discovery compared to the courts, meaning that arbitrators would have scant information to go on in determining if a case is frivolous.

"How would the arbitrators know enough?" asks Garrett, who has served as an expert witness in FINRA arbitration. "Arbitrators would not have the full scope of the case without hearing both sides of the story in detail."

By contrast, state and federal judges can review substantial evidence to help them make a decision to allow or to dismiss a case. 


Garrett said that she herself once faced a frivolous claim from a client that the CFP Board took a year to review before deciding to throw it out.

"Frivolous [cases] do happen," Garrett says. "I've been the recipient of one and I'm saying I don't like the sounds of [Kovack's idea] at all because it sounds like a broker protection."

Kovack did not respond to a series of follow-up questions about this issue.

"Many brokers have wonderful records and wonderfully satisfied clients," Garrett says.

But the fact that Kovack prevailed in the election, after saying he would not represent investors, raises the question of whether or not that declaration actually helped his candidacy, she says.

"We have enough difficulty getting investors a fair shake as it is," Garrett says. "This disturbs me to the core." 

Read more:

Register or login for access to this item and much more

All Financial Planning content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access