A recent Bloomberg News report has raised serious questions about (i) the independence and objectivity of the Financial Industry Regulatory Authority (“FINRA”) and (ii) the closeness of relationships between brokerage firms and FINRA which is responsible for regulating brokerage firms. The report questions how and why FINRA disposed of some $862.2 million of auction rate securities in the months before the auction rate securities markets froze and thousands of investors were left holding illiquid securities.
FINRA is charged with overseeing 5,000 brokerage firms and 659,000 brokers and protecting the investing public. FINRA’s web site logo states: “Investor Protection. Market Integrity.” FINRA also administers securities arbitrations brought by customers. Hundreds of those arbitration cases involve auction rate securities that were misrepresented as cash equivalent investments.
It turns out that FINRA itself owned as much as $862.2 million of auction rate securities between July 2006 and the Spring of 2007, when it sold all of its auction rate securities, according to an April 29, 2009 article by Darrell Preston.
“[I]nstitutional investors and companies were dumping their shares” of auction rate securities in 2007, according to Mary Shapiro, FINRA’s former chief executive and the current Chairman of the U.S. Securities and Exchange Commission (“SEC”). The auction rate securities market “froze” in February 2008. Between the Spring of 2007, when FINRA sold out, and February 2008, many small retail investors held auction rate securities believing them to be safe and liquid.
Why did not FINRA sound the alarm? Some investors believe that FINRA failed to protect them and that it should have done something to warn investors about the true risks and nature of auction rate securities.
The article quotes Ms. Shapiro as saying: “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.”
Bankers knew the market was going to fail, said Ms. Shapiro’s successor at FINRA, Richard Ketchum, according to the article. Mr. Ketchum is quoted as saying: “The impending scarcity of new buyers at auction was, at some point, no real secret.”
“FINRA didn’t know the auctions were poised to weaken,” according to its spokesman Herb Perone. Why then did FINRA dump its auction rate securities in the Spring of 2007? Why, in July 2006, did the NASD (FINRA’s predecessor) reclassify its auction rate securities as “trading securities” instead of “available for sale,” which signaled that they could less easily be converted into cash, according to the article? What did FINRA know and when did it stop knowing it? Was FINRA really acting to protect investor interests and insure market integrity?