By Suzanne Barlyn
Aug 15 An alleged extortion and bribery scandal involving a former Arkansas state treasurer and a local brokerage firm is bringing attention to the way the Financial Industry Regulatory Authority (FINRA) elects members to its board.
The self-regulator reserves three of its 22 positions for representatives of small brokerage firms. And that can cause problems, because at those firms, there are fewer degrees of separation between top executives and underlings. When one of those executives gets named to the FINRA board and a lower-level employee gets into trouble, it can reflect on the board member - and on FINRA as a whole.
Most recently, Robert Keenan, chief executive of St. Bernard Financial Services Inc in Russellville, Arkansas, was elected to the industry-funded regulator's board on Aug. 6. Less than two weeks later, he was fielding questions about a cloud that has been hanging over his firm since 2011.
That is when securities regulators launched investigations into alleged kickbacks paid by a St. Bernard broker to Arkansas' then-treasurer, Martha Shoffner. Federal authorities allege the broker, who has since left the firm, gave at least $36,000 to Shoffner while she was in office - some of it in a pie box - so she would steer coveted business from the state treasury his way.
Keenan is not accused of any wrongdoing, though some compliance experts suggest he could eventually get hit with a civil "failure to supervise" complaint if the broker is formally connected to Shoffner's alleged crimes. The broker believed to be involved has not been identified in federal court documents, or charged.
"It made me sick that potentially one of my people was involved," Keenan told Reuters. Shoffner was arrested in May and later indicted on federal bribery and extortion charges. Shoffner, who is pleading not guilty, resigned in May. A trial date is set for March 2014.
Shoffner will "vigorously defend" against the charges, said Chuck Banks, her Little Rock, Arkansas-based lawyer. A federal judge rejected an earlier guilty plea from Shoffner in May after finding she did not fully acknowledge certain key elements of the alleged crime.
This is not the first time that questions have been raised about small firm board members because of problems at their firms. But industry-watchers say the issues have more to do with the characteristics of small firms themselves than with FINRA's election process or ability to govern itself.
Subjecting candidates who run for board seats to a vetting process would not likely eliminate the problems that often go hand-in-hand with running small brokerages, they say.
The Keenan situation would be a bad test case for challenging FINRA's board election procedures, because he has not been charged with anything.
The scandal, which was known among Keenan's small firm peers, did not deter 489 small firms from supporting his candidacy in a three-way race earlier this month. The alleged link between Keenan's firm and Shoffner's legal problems was not an issue until it was reported last week by Investment News, small firm executives told Reuters. That piece led to some speculation that FINRA should do more to check out board candidates.
There have been other controversies involving small-firm FINRA board members. One stepped down last year after settling a disciplinary case alleging that he failed to supervise a broker at his firm. Another stepped down in 2008 after he was barred from the securities industry for fraud. The bar was reversed by a federal appeals court last year.
"When you work for a brokerage firm, there could be all sorts of stuff going on," said Jill E. Fisch, a corporate governance expert and professor at the University of Pennsylvania Law School. "I'm not sure that's problematic or disqualifying," she said.
When things go awry, it is easier to blame leaders of small firms - typically those with up to 150 licensed brokers - because they have fewer layers between them and employees than large firms do, said Jervis Hough, founder of Taurus Compliance Consulting LLC in Aventura, Florida.
Most of the 22 members on FINRA's board are appointed. But seven of the 10 slots reserved for securities industry representatives are elected positions. A board committee can nominate a candidate to run, or licensed individuals can submit their own petitions to run.
While FINRA vets nominees and appointees by checking their professional histories and involvement on FINRA committees, among other things, it does not vet those who petition to run. But broker disclosure records, which can include information about customer complaints and disciplinary actions, are always publicly available for anyone to review.
A more formal vetting process in Keenan's case would not likely have been a game-changer, say compliance professionals.
SMALL FIRM SPOTLIGHT
A board vetting process that goes beyond the candidate's own background and focuses on a firm's history could end up excluding a large number of contenders, said Joel Blumenschein, a former FINRA board member who resigned last year with less than three months before his term was to end.
Blumenschein, president of Wisconsin-based Freedom Investors Corp, had just settled a disciplinary case alleging that he failed to supervise a broker at his firm. "I thought it was the right thing to do," he said.
In a larger firm, however, that type of disciplinary action may have been initiated against a lower-ranking manager instead of a small-firm entrepreneur who has multiple roles, Blumenschein said. "If that was the litmus test - your firm could never have done anything wrong - none of the large firm governors would be on the board."