FINRA defends its role in Madoff scandal | Reuters
Reuters is reporting that there is an email from FINRA floating around. There is nothing at FINRA's web site. I have never seen, nor heard, of FINRA or its predecessor, the NASD, sending out press releases by emails.
So, I don't have the email, but apparently Reuters does, and the Financial Times does. FT has the story completely backwards, claiming that there is a gap in regulatory coverage, which allowed the fraud to go on. FT is apparently drinking the FINRA cool aid, since the fraud was run through the broker-dealer, and if it wasn't run through the broker-dealer, the states and the SEC had jurisdiction over the operation.
It is true that FINRA does not have jurisdiction over investment advisers, but Madoff's firm was NOT a registered investment adviser. Madoff ran his entire operation from the broker-dealer. That puts his advisory business under the jurisdiction of FINRA - in fact, running an investment advisory business at a broker-dealer without registration as an investment advisor is a violation of FINRA rules!
He had his advisory clients mixed in with his broker-dealer client. Their money and investments were all in the broker-dealer.
This is not the case of there being two separate operations, one under SEC jurisdiction and one under FINRA jurisdiction. FINRA has jurisdiction over the broker-dealer. And to claim that the broker dealer was not involved is just plain wrong.
The broker-dealer was clearing the trades, it was executing the trades (to the extent any trades actually existed) and it was carrying the accounts for many of these customers. FINRA clearly had jurisdiction over the entity that was putting out the account statements, and holding the customer funds. FINRA was reviewing the entire operation's financial statements.
According to the SEC and the United States Attorney's office, and information that we have obtained during our investigation, Madoff only had one financial operation, his broker-dealer. He ran his investment advisory business through the broker-dealer. He gave investors account statements that were created by the broker-dealer. Investors funds were held at the broker-dealer.
The broker-dealer has been shut down because Madoff ran his scheme through it.
The SEC has alleged that Madoff and the broker-dealer, operated a Ponzi scheme, and violated the federal securities laws. They have shut down the broker-dealer because of this alleged fraud. The SEC has also alleged, quoting from their court papers in support of an injunction - "[t]hrough the investment adviser services of BMIS [Madoff's broker-dealer] Madoff has conducted a ponzi-scheme, whereby he has false [sic] represented to investors that returns were being earned on their accounts at BMIS..."
That alleged conduct is directly under FINRA's jurisdiction. FINRA is the primary regulator for the broker-dealer. FINRA is responsible for oversight of its account statements, which the SEC alleges were fraudulent. FINRA is also responsible for reviewing the firm's financial statements. If the customer account statements were fraudulent, the firm's financials were fraudulent, since they incorporate financial information from the customer accounts. In order to produce fraudulent account statements, the firm's back office and clearing operations had fraudulent information.
While it may be true that no one told FINRA that there was a Ponzi scheme going on at Madoff's broker-dealer, clearly the allegations "deal with the activities of the broker-dealer or come under the jurisdiction of FINRA."
If anyone has this email I would love to receive a copy. Either Reuters is misunderstanding, the SEC is wrong or FINRA is fibbing.
"None of the fraudulent activities that have been alleged deal with the activities of the broker-dealer or come under the jurisdiction of FINRA."Reuters provides this quote which it claims comes from an email from FINRA. Interesting timing, on the eve of Mary Shapiro's confirmation hearings.
Reuters is reporting that there is an email from FINRA floating around. There is nothing at FINRA's web site. I have never seen, nor heard, of FINRA or its predecessor, the NASD, sending out press releases by emails.
So, I don't have the email, but apparently Reuters does, and the Financial Times does. FT has the story completely backwards, claiming that there is a gap in regulatory coverage, which allowed the fraud to go on. FT is apparently drinking the FINRA cool aid, since the fraud was run through the broker-dealer, and if it wasn't run through the broker-dealer, the states and the SEC had jurisdiction over the operation.
It is true that FINRA does not have jurisdiction over investment advisers, but Madoff's firm was NOT a registered investment adviser. Madoff ran his entire operation from the broker-dealer. That puts his advisory business under the jurisdiction of FINRA - in fact, running an investment advisory business at a broker-dealer without registration as an investment advisor is a violation of FINRA rules!
He had his advisory clients mixed in with his broker-dealer client. Their money and investments were all in the broker-dealer.
This is not the case of there being two separate operations, one under SEC jurisdiction and one under FINRA jurisdiction. FINRA has jurisdiction over the broker-dealer. And to claim that the broker dealer was not involved is just plain wrong.
The broker-dealer was clearing the trades, it was executing the trades (to the extent any trades actually existed) and it was carrying the accounts for many of these customers. FINRA clearly had jurisdiction over the entity that was putting out the account statements, and holding the customer funds. FINRA was reviewing the entire operation's financial statements.
According to the SEC and the United States Attorney's office, and information that we have obtained during our investigation, Madoff only had one financial operation, his broker-dealer. He ran his investment advisory business through the broker-dealer. He gave investors account statements that were created by the broker-dealer. Investors funds were held at the broker-dealer.
The broker-dealer has been shut down because Madoff ran his scheme through it.
The SEC has alleged that Madoff and the broker-dealer, operated a Ponzi scheme, and violated the federal securities laws. They have shut down the broker-dealer because of this alleged fraud. The SEC has also alleged, quoting from their court papers in support of an injunction - "[t]hrough the investment adviser services of BMIS [Madoff's broker-dealer] Madoff has conducted a ponzi-scheme, whereby he has false [sic] represented to investors that returns were being earned on their accounts at BMIS..."
That alleged conduct is directly under FINRA's jurisdiction. FINRA is the primary regulator for the broker-dealer. FINRA is responsible for oversight of its account statements, which the SEC alleges were fraudulent. FINRA is also responsible for reviewing the firm's financial statements. If the customer account statements were fraudulent, the firm's financials were fraudulent, since they incorporate financial information from the customer accounts. In order to produce fraudulent account statements, the firm's back office and clearing operations had fraudulent information.
While it may be true that no one told FINRA that there was a Ponzi scheme going on at Madoff's broker-dealer, clearly the allegations "deal with the activities of the broker-dealer or come under the jurisdiction of FINRA."
If anyone has this email I would love to receive a copy. Either Reuters is misunderstanding, the SEC is wrong or FINRA is fibbing.
8 comments:
I listened to one of the hearings on the Madoff scheme, I don't remember if it was a house or senate hearing, but the panel included an Inspector General (of the SEC?) and he said that they were not aware of any issues with Madoff until recently (the SEC never forwarded the letters or complaints to the Inspector General). Apparently the regulatory structure has been systematically undone in a way that some parts are still in place, and some are disconnected, not in the regulatory loop.
Madoff's ponzi success is likely due to this systematic deregulation and his ability to sit on various boards and change rules. I read somewhere that Madoff volunteered many hours with the SEC and that he was the principal author of an SEC rule that exempted market makers from various regulations governing short sellers, and that this rule change made it possible for hedge funds and others to get away with illegal naked short selling (selling shares you don't actually have possession of.) The rule, the option market maker exception to Rule 203(b)1 is referred to as the "Madoff Exception". Some think this rule change has done very serious harm to our economy by destroying healthy companies, setting them up with rumors, etc. to be shorted for profit.
You are confusing the roles of the various departments at the SEC. But it is not your fault, incredbily, members of Congress are also confused. You also may have been sipping Patrick Byrne's kool-aid
The Office of the Inspector General is an independent office within the SEC. It conducts audits of the SEC and investigations into Staff misconduct. It DOES NOT have anything to do with the SEC's role in oversight of the markets and market participants, and would not have known anything about any Madoff complaints or letters. That is not what the OIG does.
Why the IG testified at Congress is something of a mystery. He would not have known anything about Madoff, and no one would expect his office to know anything about Madoff. They are the SEC equivalent of a police department's internal affairs department. They investigate the investigators. They do not investigate brokerage firms or fraud in the markets.
So, the fact that they did not know about Madoff is not surprising or unusual, nor is it evidence of something wrong with the regulatory structure, or the regulations. The structure is fine. We have enough regulations. Everything Madoff is accused of doing was in violation of dozens of regulations and statutes.
Regarding short selling, the comments that you are making first appeared two days ago at a blog sponsored by overstock.com. Overstock.com has something of a credibility issue when it comes to allegations regarding short selling, and has been on a major crusade about naked short selling over the years.
Of course, the Madoff Mess has nothing to do with short selling, or at least not yet. But the blog post that you apparently read is so full of mistakes as to be incredible. First, in all my years in this business I have never heard of anyone refer to the short selling exemption for market makers as the Madoff Exemption. My quick Google search reflects that the first time the phrase appears is in a different blog post in December 2008 after Madoff was arrested. It of course, was referring to a different exemption than the one you are referring to.
I did some checking, and found no document or statement anywhere that supports the view that Madoff was the principal author of ANY short selling rule. I did find comment letters from him on various rules, but writing a comment letter is not the same as authoring the rule. Any can submit a comment letter on an SEC rule proposal. I myself have submitted several.
However, it would not surprise me if Madoff was involved in getting rules written regarding market making. His firm was a significant market-maker, and industry participants are often consulted on rule making. It would be irresponsible to do otherwise.
However, Rule 203 is not substantively a new rule in this regard. That rule, and its companions which comprise Regulation SHO, were written to replace and enhance the short selling rules that existed at the NASD and the NYSE. The adoption of SHO made the existing rule a Commission regulation, rather than an SRO rule.
There was some change in substance, to tighted up the short selling requirements, but the rule did not create a market maker exemption. That exemption has existed for decades, and is a recognition of an important aspect of the function of the stock markets, and the role of a market-maker.
But I digress. There is nothing that connects Madoff to the rule, the rule has existed for decades, and in fact there is nothing in any press report that I have seen that says that Madoff was illegally short selling anything. In fact, the current thought is that he was not buying, or selling, anything!
IMHO, there is nothing wrong with the exemption for short selling by market makers. It does not promote, or assist naked short selling by hedge funds. BTW, has anyone ever established that there is rampant naked short selling by hedge funds? Every regulatory report I have seen has found that the abuses of the short selling rules are rare and statistically insignificant.
But, it is certainly not something that Madoff has been accused of.
I just read this from Reuters:
Madoff's name was so well known around the SEC's offices that his efforts to give market-makers a broad reprieve from short selling restrictions led SEC officials to call the measure the "Madoff Exemption."
~~~~~~~~~~~~~~~~~ you can read the entire article at
http://www.reuters.com/article/ousiv/idUSTRE4BG6US20081217
~~~~~~~~~~~~~~~~~
Is the Reuters article wrong?
Maybe the problem is with the way I mistakenly referred to it in my first comment as the "Madoff Exception", when the correct phrase is the "Madoff Exemption". Here's another reference to it from a memorandum from the Chicago Stock Exchange from 2004, you have to download the pdf file and search it, but here's the link:
http://www.chx.com/content/participant_information/Downloadable_Docs/MarketRegulation/1_InformationMemoranda/2004/MR_04_20_Short_Sale_Requirements.pdf
or
http://tinyurl.com/ck8jfq
I got 21 hits from google with a search of Madoff Exemption in quotes.
You are right about my apparent confusion regarding the gov't. organizations, who is responsible for what, etc. I am just an ordinary American with no expertise in these area who wants to know more about the apparent corruption throughout our political process, political leaders, corporate board rooms, CEOs, etc.
I really appreciate your thoughtful response to my comment. It's blogs like yours that help me to become better informed.
Reuters is not wrong, that is what I said, the first time I hear the term was in December 2008.
What is wrong is the original article that you were extracting from. As I said, I never heard of anything called a Madoff Exemption or Exception. That is not surprising, as there are a complex web of rules and I don't pretend to know them all.
It appears that the Madoff exemption is the rule that allowed market makers to short stocks without an uptick. Nothing shocking there, that was the rule for decades, and had nothing to do with naked short selling, which is what the original overstocked.com article was arguing.
And again, the Madoff Mess had nothing to do with shorting (at least so far. Who knows what they will find).
I certainly wasn't drawing a distinction between the use of the word exemption vs. exception. We lawyers can be sticklers for words, but not that much!
Glad to be of some help.
FINRA, and NASD, always had jurisdiction over Madoff's brokerage arm, as his accounts were singular brokerage accounts wherein he merely had power of attorney to effect trades. Shapiro was obfuscating the truth!
Bottom line . . . FINRA & NASD [as well as SEC] failed to review the Madoff brokerage financials over decades, told NOT to by the regulators and politicos, or $bribed with cash and/or promises of Wall Street employment?
I expect a 100+ person midnight FBI roundup soon, to include the most senior of current & ex-politicos & regulators . . . watch their passport renewals, Visa applications, travel agency travel plans, and private aircraft flight plans, to escape the net. If they do escape, send in the Marines and Blackwater to physically retrieve them!
The FINRA rep at the House Financial Services Committee hearing last week wasn't skewered nearly as much as the SEC folk. The fellow who was reporting the Madoff ponzi scheme to the SEC for years, Harry Markopolos, said that FINRA was entirely corrupt and "in bed with the industry," but it was primarily the SEC's incompetence which was the cause of not uncovering the scandal. While I was watching C-SPAN's rebroadcast of the hearing, I put up some not very insightful comments at http://AdvisorsCafe.com. Two things Markopolos said I am puzzled haven't gotten as much airtime: the first is that Madoff's ponzi schemes in Europe are larger than in the US but have not yet become public, and also that he has seen reports of other fraud investigators wherein they uncovered other Madoff-type schemes (and sent same to the SEC), and those also haven't yet become public. What's up with that?
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