Wasting Away Again In Regulatorville…

Another day, another new Regulator or Czar appointed by the government.  The latest creation is the new and improved super regulator that will over see the SEC and FINRA as well as the institutions themselves.  Before we get into this latest and greatest Regulatory overhaul, I think is important to take a trip down memory lane. Let’s start with November 2006 when the folks at the NYSE and NASD Regulatory arms decided to merge into one Single super regulator known as FINRA… (more…)

By Larry Doyle

Everybody knows Auction Rate Securities (ARS) were cash or cash-like, right? FINRA certainly did NOTHING to protect investors from the ARS sales and marketing scam perpetrated on investors.

FINRA spokesman Herb Perone would like to wash his hands and those of FINRA of any negligence or incompetence in regard to FINRA’s investments in Auction Rate Securities. The easiest manner of washing one’s hands is to point the finger at the entity which initially made the investment, in this case the NASD (National Association of Securities Dealers). If you recall, FINRA was formed in mid-2007 from the regulatory arms of the NYSE and NASD. In any event, Perone tries to deflect culpability on FINRA’s part in the recently reported Bloomberg story (FINRA Oversees Auction-Rate Arbitrations After Exit) highlighting FINRA’s sale of their Auction Rate Securities prior to the market’s implosion leaving thousands of investors and billions of dollars frozen… (more…)

Let’s assume you own a broker dealer.

And lets also say that you have an Advisor who helps you manage your money, as most in your position would. Now -

What would you say if your Investment Advisor told you that his well considered opinion is that you should take your entire portfolio and allocate it like this: 55% Toxic Assets, and the remaining 45% into High Risk Hedge Funds?

Would you begin looking for a new Advisor? That is, after asking him for some of whatever it is that he must be smoking? (more…)

Linked Articles: “Was FINRA A Madoff Investor” (the SIPA)
“FINRA Oversees Auction Rate Arbitrations After Exiting Market”
(Bloomberg)

FINRA is currently processing 344 investor arbitration cases over losses generated by the complete collapse of the Auction Rate Bond market.

But FINRA itself actually had owned some $862 Million of the toxic assets prior to the collapse of the market, and exited the position months ahead of the market’s catastrophic failure. The good fortune of exiting the market at that time is proving to have been somewhat unique, as managers everywhere watched the market implode and watched their client investors lose everything. At least the FINRA Endowment, which is really money actually owned by FINRA Member firms, is being managed well – or so it would seem.

Yet serious ethical issues are raised by this and other recent disclosures. As we have reported previously in an article titled “WAS FINRA A MADOFF INVESTOR ?” we noted that the FINRA’s investment allocations model included some 45% of the total $1.5 Billion portfolio in hedge funds. If the FINRA was indeed a Madoff Investor, serious ethical issues arise. And likewise, if indeed, the FINRA became aware that the auction rate markets were unsustainable, did the FINRA not have an obligation to disclose this to the Public?

According to FINRA spokesman Herb Perrone in a recent Bloomberg article, Finra did not know the auctions were poised to weaken. Nevertheless, the FINRA did liquidate it’s holdings well before the fall, and some investors are concerned that not enough was done.

The Regulator did, however, eventually issue guidance for investors hamstrung in the market on March 31, 2008. But this was more than a month after the failure rate of the auction hit upwards of 80%.

And it is also well to note that the FINRA did not lead the charge toward warning investors. Massachusetts and New York were first in going after the banks that sold the securities.

Another Failure To Spot Disasater:

Although the FINRA’s portfolio managers were priescent enough to recognize the danger these assets posed to themselves, they failed to timely notify the markets at large or to indicate any warning that the auction rate market was in any danger.

But FINRA spokesman Perrone also reminded that the FINRA didn’t have anything to do with the market’s collapse, according to Bloomberg. The organization doesn’t regulate “over-the-counter securities transactions” such as trades in auction-rate bonds, which aren’t listed on an exchange, he said.

This author is reminded of the FINRA’s claim that they did not regulate banks, and so had nothing to do with the massive toxic positions accumulated at the broker dealers which later became banks as part of the bailout efforts. And this author is reminded of the FINRA’s comments that it had nothing to do with the failures at Madoff’s Hedge Fund, because the FINRA didn’t reglate Hedge Funds, althogh it did regulate Madoff Securities, the Broker Dealer doing all the trades for the Madoff Hedge Fund, and audited it many times.

Nevertheless, the FINRA had been involved in investigations into more than two dozen firms that conducted auction rate securities business. Perone said FINRA Enforcement has returned some $2 Billion of investor money, and the States and SEC have recovered more than $50 Billion so far. Leaving this author more than a little confused. Is that to say that FINRA knew there were systemic problems in the Auction Rate Market?

A FINRA spokesperson who recently gave a lecture on Leadership And Ethics In Regulation had the following to say: “Many institutions understood the risk in terms of their own investments. But the question is: Was that information freely shared with individual investors?… There was both a legal and ethical obligation to do so.”

This author would agree. And so, given that there was an ethical obligation to inform the Public, this author humbly asks the following of the FINRA:

what did you know, and when did you know it?

Today the Treasury Secretary began outlining his vision of a new Regulatory structure to replace the old one. This new system will save us all from another catastrophic meltdown in our financial system and make sure corruption and greed is caught early on. The SIPA response? Yadee Yadee Yadee…

With all due respect, why create a new broke system when we can enjoy the fruits of our old broke system? All the rules in the world are wonderful and make politicians and regulators alike feel like they re protecting investors but at the end of the day  if NOBODY enforces them what’s the difference?

Lets take a step back to our past to see why a ‘New” regulatory system is a waste of time unless there is fundamental changes in the mind set. Years ago I worked in operations for a wire house and would remember Brokers and correspondents running to the back office at 2:05 pm begging to get their mutual fund purchase/sale in. At this firm we required all Mutual fund tickets be in OPERATIONS HANDS by 2:00 pm eastern. Some where around 2003 the after hours mutual fund scandal broke due to the efforts of Elliot Spitzer (not a securities regulator). Billions and Billions were made by firms running tickets at 6, 7, sometimes 10:00 pm. The market closes at 4:00 pm yet for some reason, not one Securities regulator had a problem with a Mutual fund ticket time stamped at 8:00 pm? Since when is 4:00 not 4:00? This illegal and fraudulent behavior occurred for 10+ years yet we had to rely on Spitzer to out it.

Let’s look at the research scandals that also plagued Wall Street. I remember working Compliance and handing out the restricted list of securities the firm was involved with. We would prohibit any buy or sale until the updated recommendation was published. Yet for many years some of the larger firms on the street were putting out fraudulent reports about liking certain stocks while at the same time unloading their positions. They did this for many years yet once again it was the Attorney General who found the crimes. Think about some of the other scams and scandals that plague Wall Street and then ask your self if a new regulatory system would solve the apathy regulators tend to carry toward the elite Wall Street firms.

Now think about this: Lehman brothers , Bear Stearns and several other elite firms were so over weighted down with CDO’s and other toxic assets, yet no securities regulator ever questioned their risk management, their FOCUS reports or anything else. Once again, I draw upon my own previous experience when my examiner let me know during an audit that the firm currently had 12% of its total holdings in ABC stock. They informed me of the potential risk and we began restricting the stock and lowered our exposure. However, for some reason this same regulator sent employees into Lehman, Bear, Goldman and Merrill and saw absolutely no risk with holding billions in toxic assets or did they see the risk and just refused to say something?

Naked shorting of stock then cannot be readily borrowed has always been illegal, yet it wasn’t until last summer when the largest firms on Wall Street were being crushed by shorters that the SEC finally jumped in to enforce Short sale rules. Our Government is not without fault either in this mindset. For instance, the SEC took over Sanford Financial as well as several other small firms and hedge funds in the past year. A receiver was immediately appointed to oversee the day to day operations. Our government announces that AIG is broke and puts hundreds of Billions into the company but didn’t send a receiver be appointed? So now the Government wants to talk tough and take a 90% tax out of greedy bonuses that were given with the Fed Chairman’s consent?

At the end of the day it’s obvious that selective regulation does not work. Yet we have seen no indication of that mind set changing anytime soon. In fact, we fear the scandals can get worse then ever before for one simple reason: The large Elite firms now have ‘can’t fail status” due to tax payer money totaling 2 trillion and counting. Do you really think the Wall Street elite is now concerned that if they screw over investors with bad prints, bad research and inside information that it will have any effect on them? Chew on this for a moment: how are you going to levy a huge fine for future fraudulent behavior of you already have trillions invested in them? Imagine a fine of 100 Million for bad acts against Merrill for some atrocity all the while knowing they have a line of credit with the government and if they did pay, it would delay repayment of the TARP money. A new Regulatory overhaul will change what? Nothing.

I’m gonna start by saying that I am totally outraged the Bernie Madoff gets to go straight to jail without a long tedious exposure at trial, and I think it stinks to high heaven.

And I’ve had a real difficulty understanding why auditor after auditor found nothing awry at Madoff, when a 7th grader would have got it. And why the SEC refused to look into it, when presented with the hard evidence on multiple occaisions.

One can imagine that it could have been human fallibility; simple incompetence… Or even maybe a series of unfortunate coincidences… Occurring repeatedly, spanning more than a decade… Like a coin toss landing not on heads or tails – but on it’s edge… Ten times in a row…

But my mind rejects that as a possibility. My mind – simple and lacking grace – is a trader’s mind. Probabilities, odds, game theory, percentages  – are what bubble up in my head. I’m no genius, wish I were. All the same this simple mind understands that it is unlikely to see a coin land on it’s edge. Let alone four, five times in a row. Unlikelier still 8 times in a row. Experience and Natural Law informs that when one witnesses results like those, the game is likely rigged, the results are likely corrupt.

But what possible reason could there be for corruption to occur and then to continue and to actually expand in the Madoff case? Conspiracy theories are great entertainment, but we cannot rely up anything until it becomes 8 1/2 by 11…

And so I posit for your reading entertainment, an 8 1/2 by 11  potential clue to the mess. This “Clue” is in all probability noise, not signal – but then again, it is probably as likely as flipping an edge ten times in a row. Probably a lot more likely…

I recently saw an ad for the position of “Investment Associate” for the FINRA’s (estimated) $1.5 billion warchest. What was not readily apparent to me, but was pointed out by my associate is that the ad contained a job description; the investment methodology expected to be employed.

The Investment methodology would employ a significant allocation in “Alternative Investment Vehicles”. The percentage of the desired allocation in “Alternative Investments” was substantial, at 45%…

“The Investment Associate provides support for investment related work in private and marketable alternative investments for FINRA’s endowment portfolio. Alternative investments are targeted to be 45% of total endowment assets. The Investment Associate will work closely with the Director of Alternative Investments as it relates to private equity and real assets and the  Director of Marketable Alternative Investments as it relates to certain marketable alternative investments (hedge funds). ”

In fact, a review of the public record does indeed show a very significant investment by the FINRA in hedge funds… But it does not go so far as to say which …

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Simply put: Could it have been Madoff?

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And if so, if the NASD had put a large number of eggs in the Madoff Basket  – could that have influenced the regulatory oversight?

Could the NASD, potentially skewered and hamstrung by Madoff – have not been physically able to extract the necessary funds to make a pay-out of more than $35,000 to members as part of the merger?

Was the FINRA’s alleged fraudulent misrepresentation that the $35,000 was “non-negotiable”, and the claim that the amount was allegedly “determined by the IRS as the Maximum Amount Possible” predicated by and based on the “reality” that they really did only have enough cash to do $35,000 – because they were up to their eyeballs in Madoff’s fraud?

And if the FINRA was indeed a Madoff Victim, wouldn’t they have been in a conundrum… Pull out funds and they would be front running the public. Bust the scam and they might lose that money forever… As well as have some serious egg on their faces. Whoa!

Okay, this is purest speculation; salacious entertainment value for feeble minds like my own.

But dear reader, my simple mind has a simple question: Where do YOU put the odds?

Release in PDF <here>
Court Order in PDF <here>

New York, March 18, 2009. Today, the Second Circuit Court of Appeals revived a  previously dismissed class action complaint in Standard Investment Chartered Inc v. NASD, et al, Appeal # 07-3372-cv.  The defendants in the suit are the NASD now known as FINRA, former FINRA CEO (and now Chair of the Securities & Exchange Commission) Mary L. Shapiro, NYSE Group, Inc. (”NYSE”), Richard F. Brueckner and Barbara Z. Sweeney. Standard is a California-based broker dealer and a member of FINRA. The members of the Class are the approximately 5,000 broker-dealers who were members if the NASD and not currently members of the New York Stock Exchange.

The class action Complaint accuses the defendants of, among other things, misrepresenting to members of the Class why only $35,000 was paid to each of them in connection wth the now-consummated merger of the regulatory arm of the NYSE with NASD to form FINRA in 2007.   Standard claims that snce the NASD members’ equity was in excess of $1.5 billion as of the date of the NASD proxy statement seeking member approval for the transaction, each Class member was entitled to receive well in excess of the $35,000 one-time payment. The defendants deny plaintiff’s claims.

The case will now return to District Court Judge Shirley Wohl Kram for further proceedings.

Contact: Jonathan W. Cuneo, Esquire       202-487-8546 (cell)
202-789-3960 (office)
Richard D. Greenfield, Esqire     410-320-5931 (cell)

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Truth Is In The Eye Of The Beholder

Last week the SIPA released documents that clearly contradict what NASD told member firms regarding the buy your vote sham merger of 2007.  Today we release even more shocking documents that once again hit at the nerve of regulation and forces all of us in the industry to reassess whether FINRA,  in its current form, should be disbanded entirely.  In December 2006 the NASD went on a 25 city tour touting the benefits of the merger of NASD and NYSE regulation.  Despite their efforts and “sell job” there was still much resistance and a little group of dissidents started to break down the proposed offering and began debating publicly whether this was all just a sham. Last week we released actual board minutes in which it is clear the $35,000 payment was not derived at by an IRS ultimatum as NASD claimed, but rather was the result of the NASD board meeting in which they agreed the “whatever figure we come up with it must not be negotiable”

NASD staff and sell job employees like Bill Alsover of the ‘Small Firms Advisory Board” took this to the road like they were selling an IPO in a Chinese pharmaceutical Company.  The NASD even created a site and a special link called ASSERTIONS AND FACTS.   They took each and every ‘Assertion” made by dissidents like the FIA and responded with supposed FACT.  The problem is that their FACTS were not facts at all. The IRS did NOT rule about the 35k payment until 3 months AFTER the vote took place.  The more shocking aspect of this sell job is that top ranking NASD employees KNEW they were misleading, misrepresenting and presenting FALSE facts.  For instance, here is an actual e-mail from some of the top executives at NASD on January 8th 2007, almost one month after a special web site was set up.  This e-mail can be found on page 13 of the linked documents (which we encourage you to read in full):

This is shocking to say the least.  In other words, they KNEW that their web site contained false information.  How many times did we hear leaders of NASD claim over and over that the IRS will not let us pay more then $35k?  You were presented with a fraudulent proxy and the powers that be not only knew it but attempted to cover up their mess.  The dissidents often stated that not only could more be paid but that they did not believe an IRS ruling existed.  NASD , knowing the dissidents were correct instead took it upon themselves to tarnish and bash those that questioned them.  Need more proof? 

NASD did not even have an IRS ruling letter while making these IRS claims.  In fact in a March 13th 2007 letter to the board they breathe a sigh of relief that they finally got an IRS ruling.  This letter can be found in its entirety on page 14 of the linked documents (which we encourage you to read in full)*.

Notice anything funny?  The NASD blocked out the ‘range” of payments that can be made but clearly MORE could have been paid.   In fact we would urge all members to read the actual IRS ruling letter and decide for yourself if the IRS was even given all the facts by NASD.   As you read through these documents think about how many times dissidents were called liars and how they were constantly depicted as not being truthful.  Now ask yourself after reviewing these documents whether you think our SRO needs to be overhauled?

CLICK HERE FOR ENTIRE DOCUMENT   *(Such as we have it… There are missing pages and redacted items; all of the omissions and redactions were done by the FINRA prior to turning the docs over).

The bigger question is who knew and when did they know it?  Clearly, two of the Executive Vice Presidents of FINRA knew on January 8th 2007 that they had put False information up on the web site and into offering materials as well as in road show questions and answers.  Clearly they had a ethical responsibility to at least admit the mistake and to create a new offering memorandum.  Imagine if a Broker Dealer distributed and offering in which he claimed a government agency was limiting the amount of dividends a company could pay and then FINRA examiners found e-mails in which the Broker Dealer knew the information was false but kept right on selling it that way?

Your company would be expelled from membership.  Maybe its time to expel more then just brokers from membership?

The 64 Thousand Dollar Question (isn’t that quaint? $64K? Try $1.25 Quadrillion on for size… No, $64K just sounds better. Sounds manageable)  nowadays is what should be done. The SIPA has polled members and has had conversations with many small firm owners compliance professionals regarding this issue. We are still a ways from a formal proposition, but working on it. Your thoughts and comments are greatly appreciated. And you really ought to give it some thought. Remember – Congress has a tendancy to step in and come up with solutions. These solutions are often regulatory overkill which does not accomplish the actual job of regulation, and often comes with unintended consequences – think SarBox… What is really necessary is for average folks who are responsible for the day to day compliance operations of firms to come forward with what works and what doesn’t. In any case, here are the most popular suggestions so far:

1) The Regulatory process is already overburdensome. What needs to be done is NOT whosale re-writing of the regs, but effective, principal based enforcement and streamlining of the regs – to focus on what is most important: protection of the investor and the preservation of the Public Trust. To that end, there are ways to do this which would not require massive infrastructure changes. So far, the following are suggested by members:

2) Regarding Management: The division governing Broker Dealers should be run by an individual who is:

• Honorary And Temporary; Chief Regulator should be a Two Year Maximum Position- this will prevent, to a certain extent, the creation of a fiefdom where personal agendas and politics gain serious ground
• FINRA Chair should be elected by membership on a refferendum of current membership basis – this is easy, despite the apparent difficulties; there are only 5000 firms…
• Individual should be barred for several years from revolving doors (no going to work as head of Merrill on the heels of being the Chief regulator) Eliminate these obvious conflicts of interest 
• Pay Scale For FINRA Chief Should Not Exceed That Of SEC Chair. Reasonable salary – not Wall Street Salary. This would keep the Chief honest (if overworked)
• Bonuses Should Be Eliminated For Chief Regulators; destroy the incentive to overlook big problems
• Chief should come from an enforcement background associated with financial crime: FBI, Secret Service – in short, we need enforcement that understands the scams that affect the public trust- and who aren’t beholden to realationships built over many years at Top Wall Street Firms. But the Enforcement angle is key; we don’t need the former head of a brokerage house to be charged with enforcement against friends; this would be a conflict of interest.
• We Most Emphatically Do Not Need An Individual Who Has Previously Failed In The Role Of Chief Regulator In The Past. Meritocraccy, not buerocracy, get it?

3) Regarding Policy:

• A Policy Change to unbiased Principal Based regulation at all levels. We need to understand that there is a distinction between minor adminstrative failures and failures that affect the Public. In other words, a firm should not be fined $25,000 for a tardy focus report (which doesn’t affect the Public- so long as there was no fraud involved) while another gets fined $50,000 for running a scam that bilks investors of $500 Million; a situation highly damaging to the Public Trust. And – if the appropriate response is a 30 day exit order only policy, this should be applied at the biggest firms as well as the smalles. Being “BIG” should not be a pass for anything. Currently, the Policy is based on rule based violations- to the detriment of the Public Trust. This must change.
• Net Capital does not provide adequate customer protection, nor will it provide adequate protection if it is increased. Should stay same.
• RecordKeeping requirements should be streamlined. Ask any Compliance Person. You’ll understand. The irony is that in the days of electronic automation, recordkeeping requirements have become increasingly burdensome. 
• An exemption to some of the regulatory recordkeeping requirements should be made for firms that do a de-minimus business as “finders”. No need to create a new “BD Lite” – rather, create an exemption for certain kinds of business. This can be done quickly, cheaply, and will provide immediate benefit.
• Policy Change towards assisting firms to comply with regs – not simple rule based enforcement. Eliminate gatekeepers who are more interested in locking in discovery of an error than assisting an honest broker do the right thing. GIVE GUIDANCE. No more “I need to know your firm and your crd number before I can answer any questions”. 

Okay – Your Turn. Comments Please.  

One of the smaller but nevertheless interesting informational items contained in the internal FINRA documents provided to the SIPA is that the FINRA, in planning it’s “Sell Job” for the amendments which would allow the merger is that the FINRA made use of so-called “Friendlies”. These were individuals at organizations who  promised support to the FINRA for the merger – and willingness to help the cause. What this “help” would consist of was spreading the good word of the merger, and, apparently, noting individual’s opinions regarding the proposed merger – and then turning any dissenting individuals in to the FINRA, which would classify them as “Dissident”, and then surveille, track and otherwise try to convert the so-called dissident to the FINRA’s plan. But the FINRA had noted that these Friendlies were also very good at clarifying the true information, and discrediting the disinformation regarding the merger.

But we’ve since learned that the truth, in this case, might as well have come from “The Ministry Of Truth” where everything is a lie. And the “disinformation” being spread by the “dissidents”? . In hindsight, the objections raised seem completely validated…

So – just what were those “friendlies” up to? Did they really not understand what was going on, and what they were a part of? Even when informing on innocent members? Even when speaking out to discredit them or their views? Or were they simply suckling up to the pig, trying to get their share in the power grab? Whatever the case, this author recalls Ricky Ricardo -

“LUCY!? YOU GOT SOME ‘SPLAINING TO DO!!”  

As indicated by the FINRA, these are the organizations that apparently were participants in the surveillance machine, helpers in the “Sell Job” (FINRA’s Own Words). Were this author a member of any of these organizations, I would ask for my money back immediately and cancel my membership. I am not saying everyone should do this; this is just my personal opinion and what I would do.  Whatever the explanation, it is really too late/

American Council Of Life Insurers
Investment Company Institute
Financial Services Institute
SIFMA – Securities Industry And Financial Markets Association
SIFMA – Small Firms Committee
NAIBD – National Association Of Independent Broker Dealers
NASAA – North American Securities Administrators Association
STA – Security Traders Association