I say “got away with it” because – were he not to have turned himself in, and were he to not have been totally broke and inches from the fire – he would probably have never turned himself in and kept going as long as he could have. Such is the nature of that particular kind of greed.
But HOW did he get away with it for so long? This author believes that there are several important contributing factors - and they all contain failures of the regulatory element. But to say that is not enough; we need to understand what was broken so that we may fix it. This author argues that the failures to regulate – at the Broker Dealer level, which should have exposed everything - are directly attributable to the FINRA’s consolidation effort.
Many have pointed out that the Madoff fraud happened at the Investment Advisory, which was run separate and apart from the broker dealer; separate books, employees, and a separate location on the 17th floor. As the argument goes, the FINRA could not possibly have been responsible – as the FINRA does not cover IAs or Hedgies… This argument fails, however, when one examines the actual role that the auditors play at the FINRA. In fact, the rules of regulation have been specifically designed to set multiple reference points as fail safes.
To make matters plain - the numerous FINRA audits of Madoff Securities (NOT the Investment Advisory) should have uncovered the Fraud at the IA. The regs are designed to do this. But most folk who are outside of compliance accept the common story without giving it much critical thought. They are wrong to do so and here’s why:
To keep it simple; when one audits a firm, one of the first things looked at are, say, the ten largest firm accounts. The IA business would have been an account at the broker dealer, through which trades wold take place. Any cursory examination of this account would have turned over significant issues; trades not matching results, not matching the market time and tick, strange unexplained wires, position violations, erroneous confirms etc. Simple, right? Like even a non-accounting type would understand this stuff. So why, would trained auditors repeatedly miss this basic audit 101 stuff?
Remember, we’re talking about a lot of money here; $50BL – the kind of money that you simply cannot keep under the radar. One cannot move that kind of money without an audit trail. And keep in mind that the above examples are patently obvious examples of auditing SOP, and would have uncovered discrepancies no matter if he cooked the books or not. But there much more sophisticated methodologies are routeinly employed by your average forensic examiner.
So the expectation might be that the auditors could not fail to catch a Bernie Madoff. But this expectation must be tempered by the reality that the authorities cannot uncover every fraud. Nor can they be expected to. Uncovering every misdeed is an ideal which will simply never be realized. There is simply too much to look at and too little time. More eyes certainly help – but there are practical limitations. The regulators are of course fully aware that this is a numbers game and that you cannot catch all the frauds all of the time. As a reglator, you go with a risk adjusted approach, and as a matter of policy, adjust your focus to achieve maximal result.
The biggest priorities, insofar as audits of firms dealing with the public, is to ensure and support the Public Trust. The Public Trust must be courted, coddled, handled most delicately – otherwise you lose it – and with the loss of the Public Trust, the deluge…
“Why Rob Banks? ‘Cause That’s Where The Money Is”
So one way of framing policy (from a focus perspective) is to focus on areas where the public trust could be damaged. Ie firms dealing with the public. Firms trading on a discretionary basis with funds invested by the Public. Focus on those areas where the most harm could be done (ie Firms responsible for managing loads of money). Size matters. And this, of course, should have put Madoff at the top of the list.
Yet the FINRA made the policy decision to focus on Small firms and particularly on rule based violations at small firms. Rule based violations do not affect the public directly (an example of a typical rule based violation is the failure to file a focus report in timely fashion. Being two days late might generate a $15000 fine). Under this policy, small firms were treated aggressively, while the Big Firms were largely left to their own devices. This Policy has proven, in hindsight, to be a failure of monumental scale.
One might wonder why the FINRA would employ this policy when there are others that would arguably serve the public trust better. Well, there are reasons – and what the reasons all point to is an even greater failing; one that was designed not with the public interest in mind, but rather with a bureaucratic institution run amok. Visions of the old Octopus representation of the Soviet Political Apparatus. The Institution was in the midst of a huge power grab, and was determined to grow and assimilate other institutions into itself. And the policy was implemented for the worst of reasons – to go after the low hanging fruit of rule based regulatory violations at small firms. There is much more on this subject in other articles on this site.
So while it may be comforting to know that these failures were largely attributable to a re-focusing of the regulatory enforcement regime, it is less than comfortable to realise that there were indeed audits, and there were indeed warnings. Audits should have uncovered wrongdoing that would be obvious to a 7th grader – for example, Madoff the brokerage’s biggest account (ostensibly the $50BL hedge fund) apparently may have had no trades executed in it… That’s right, no trades, in decades – but lots of wires in and out (this according to the NY Times)… Surely it is a stretch to imagine that the auditors missed this simple fact repeatedly for decades? Not a snowball’s chance in hell. So was the problem really confined to a simple lack of eyes due to the merger? Or is there corruption of a more… direct nature? Speculation is only that until it becomes 8 1/2 by 11. More on this to come…
The SIPA wishes a heartfelt congratulations to Mr. Alan Davidson of Zeus Securities, upon his election to represent the interest of small firms in the National Adjudicatory Council (NAC). The NAC reviews FINRA disciplinary decisions. The election is of special significance because it was contested and Mr. Davidson ran as an independent candidate. 
Mr. Jones and ask him if he would like to post a message to the thousands of Broker Dealer Owners and Brokers who are now members. It has always puzzled me as to why FINRA (formerly NASD) felt the need to ‘nominate’ a candidate for members. Are members incapable of accomplishing this feat on their own? It’s a little puzzling that a owner of a Broker Dealer can file a focus report, Manage his firm, Produce commissions, handle FINRA audits and WSP’s, Take and pass series 7,24,63,55 exams and dozens more….yet FINRA thinks they would be overwhelmed if they had a sheet of paper in front of them with a half dozen names on it to choose from????
RSS
Loading ...