Investing With Bernie Madoff: How It Happeneed, What Happened, And What Might Be Done. Part III.

            So, as said, the SEC was a 16 year (or maybe a 45 year) perfect storm of the most thorough, willful negligence, if not de jure or defacto complicity.  But it was not the only agency which failed the public.  There is also FINRA, the Financial Industry Regulatory Authority and its predecessors.

            FINRA’s website says that its “overarching objectives” are “investor protection and market integrity.”  FINRA was formed in 2007, as a combination of two prior investor protection bodies, the regulation and enforcement branch of the New York Stock Exchange and the NASD, which had a regulatory function.  Its president is Mary Schapiro, who was an SEC Commissioner from 1988-1994, was head of the NASD until 2007, became head of FINRA when it was created in 2007, and is now slated to become head of the SEC. 

            My understanding is that FINRA, unlike the SEC, is a private self regulatory organization, not a governmental organization, and that its members pretty much constitute the whole brokerage industry.  That was the case with its predecessor organizations, I gather, and is the case with their successor, FINRA.  If this is right, as I believe it is, it could be a crucial fact for reasons discussed below. 

            FINRA investigates broker dealers, as did its predecessors, the NASD and the regulatory arm of the NYSE.  In 2007 FINRA investigated Madoff, as had the NASD before it, most lately in 2005.  (Representative Kanjorski said at the January 5th hearing that FINRA, obviously meaning FINRA and one of its predecessors, had inspected Madoff’s broker-dealer operation at least once every two years since 1989, and it has subsequently been confirmed that Madoff was inspected every two years since he started his business.)  I also gather that FINRA found little wrong with Madoff in 2007, concluding only that he violated some technical rules and had not reported some transactions on a timely basis.  It found nothing with regard to Madoff’s Ponzi scheme.  Let me again quote Karen Scannell of the WSJ on January 5th:

FINRA . . . . conclude[ed] in 2007 that it [Madoff] violated technical rules and failed to report certain transactions in a timely way.

* * * * *

A predecessor to FINRA conducted its own review in 2005 and found no violations.

* * * * *

FINRA’s full-scale examination in 2007 indicated that parts of Mr. Madoff’s firm had no customers.  It doesn’t provide an explanation for this finding.”

            So FINRA, for whom an “overarching objective” is ‘investor protection,” found nothing significant to be wrong, and said some part of his business had no customers when he had thousands?  What part of his business supposedly had no customers?  This is some kind of incredible hogwash.  It is obvious that FINRA was as willfully, grossly negligent and incompetent as the SEC.

            It is claimed on behalf of FINRA that it could not detect the fraud, the Ponzi scheme, because it has authority only over the broker-dealer side of Madoff’s business, not the investment management scale.  This excuse is hogwash, as a number of Congressmen pointed out on January 5th.  Madoff was one single overall company, even if it was organized in three parts, proprietary trading, broker-dealer and investment management.  If FINRA had so much as competently checked whether the company had the securities and money it claimed, it would have uncovered the fraud. 

            That is the major point.  Moreover, if FINRA could deal only with the broker-dealer part, how could it have known some other part had no clients?  Or was it saying the broker-dealer part had no clients -- that would be an amazing conclusion.  If it was saying the proprietary trading part had no clients, well, the firm itself was the client and, anyway, why would FINRA have bothered to mention this if it regarded the proprietary trading part as being without clients, since the same would be true of every proprietary trading desk on Wall Street.

            And did FINRA, like the SEC, think it was hunky dory to have a one man accounting shop as the auditor for a major broker-dealer? -- for a broker-dealer claiming to FINRA and the SEC to have 17 billion dollars in assets?  Gawd!

            The bottom line is that FINRA and the NASD before it -- private regulatory organizations who were supposed to protect investors -- fell down on the job just as badly as the SEC.*

TO BE CONTINUED.

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