A Special Review Committee (the “Special Committee”) appointed by the Board of Governors of the Financial Industry Regulatory Authority (“FINRA”) issued a report finding that FINRA missed opportunities to detect the Ponzi Schemes perpetrated by Bernard Madoff and Allen Stanford, according to an October 2 article in InvesmentNews by Sue Asci. The fraudulent schemes perpetrated by Stanford and Madoff are striking due to their size and duration. The Madoff scheme spanned decades, defrauded thousands of investors, and caused an estimated $64 billion in investor losses. According to the SEC, Stanford sold numerous investors approximately $7.2 billion of fraudulent products, purported to be certificates of deposit (“CDs”), over at least a decade. Despite conducting examinations of the Madoff and Stanford firms, FINRA did not uncover these frauds.
Between 2003 and 2005, when Mary Shapiro was FINRA’s Chief Executive Officer (she is now Chairman of the Securities and Exchange Commission), multiple sources warned the NASD (now FINRA) that the certificates of deposit being sold to Stanford clients were potentially fraudulent, and one of those sources was the Securities and Exchange Commission’s Fort Worth, Texas office.
In the Madoff case, while the Special Committee did not find that FINRA received any tips from the SEC or private whistleblowers about Madoff’s investment advisory business (Madoff concealed it from FINRA), FINRA examiners did observe, but failed to fully investigate, records of substantial, recurring payments by Madoff to one of the feeder firms that funneled investors to Madoff. Most notably, however, the Special Committee found that FINRA examiners were unsure of their jurisdiction and authority to investigate, and were not adequately trained in this regard.
The Special Committee further found that FINRA does not set criteria for advancing an issue to senior management based on the “gravity and substance” of allegations, nor does it have a centralized database where examiners could get access to all complaints about a member firm. Moreover, the Special Committee found that FINRA examiners did not have access to Madoff’s investment advisory information that was provided to the SEC’s Investment Advisor Registry Depository, even though FINRA operates that program for the SEC.
The Special Committee’s report made a number of recommendations for improvements, and FINRA has reportedly launched a new Office of Fraud Detection and Market Intelligence. That may, however, amount to rearranging the deck chairs on the Titanic, in light of these gigantic regulatory failures that leave one to wonder whether regulators take their jobs seriously and are truly independent from, and not captives of, the firms they purport to regulate.