Thursday, January 15, 2009

FINRA Claims No Jurisdiction over Madoff Fraud?

FINRA defends its role in Madoff scandal | Reuters

"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.
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