Not Breaking News: Regulator Just as Dumb as Ordinary Investors!


This post originally appeared The Financial Decoder blog on CBS MoneyWatch.com.



You probably don't realize it, but there is a mammoth securities regulator that is not a government entity. The Financial Industry Regulatory Authority (FINRA), is the largest independent regulator for all US securities firms, overseeing nearly 4,800 brokerage firms, about 173,000 branch offices and approximately 647,000 registered securities representatives.
(iStockphoto)

Why should you care about FINRA? Because it is the regulator that oversees licensed brokers and their firms. FINRA was created in July 2007 through the consolidation of National Association of Securities Dealers (NASD) and the member regulation, enforcement and arbitration functions of the New York Stock Exchange. Its funding comes from the folks it regulates, hence it's referred to as a SRO, or self-regulating organization.

FINRA manages about $1.6 billion of its own money and here's the not-so-breaking news: the regulators who say that "investor protection begins with education," should head back to school, because they are just as dumb as the rest of us when it comes to investing. According to the Wall Street Journal, FINRA lost 26.5% in 2008 because of its high concentration in stocks, private equity and hedge funds. (Evidently the folks there thought they were managing the Yale endowment!)

Hello FINRA - did you not read this part of your own web site? Guess not.

For many people, it's best to manage risk by building a diversified portfolio that holds several different types of investments. This approach provides the reasonable expectation that at least some of the investments will increase in value over a period of time. So even if the return on other investments is disappointing, your overall results may be positive.


Your chief defense against systematic risk, as you'll see, is to build a portfolio that includes investments that react differently to the same economic factors. It's a strategy known as asset allocation. This generally involves investing in both bonds and stocks or the funds that own them, always holding some of each. That's because historical patterns show that when bonds as a group—though not every bond—are providing a strong return, stocks on the whole tend to provide a disappointing return. The reverse is also true.

After FINRA took the beating, it sold out its risky investment on the lows (way to lock in those losses!) and missed the subsequent rally. In other words, FINRA employed the buy high, sell low strategy. This amateurish mistake on both the upside and downside not only cost money, but it has made FINRA member-firms furious. One has filed a lawsuit against FINRA, accusing the organization of being "reckless in pursuing high-risk strategies inappropriate to preservation of capital."

Nice to know that regulators are just as dumb as the investors it's supposed to protect.


(CBS)
Jill Schlesinger is the Editor-at-Large for CBS MoneyWatch.com. Prior to the launch of MoneyWatch, she was the Chief Investment Officer for an independent investment advisory firm. In her infancy, she was an options trader on the Commodities Exchange of New York.
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    Jill Schlesinger, CFP®, is the Emmy-nominated, Business Analyst for CBS News. She covers the economy, markets, investing and anything else with a dollar sign on TV, radio (including her nationally syndicated radio show), the web and her blog, "Jill on Money." Prior to her second career at CBS, Jill spent 14 years as the co-owner and Chief Investment Officer for an independent investment advisory firm. She began her career as a self-employed options trader on the Commodities Exchange of New York, following her graduation from Brown University.