SEC, NASD, FINRA & SIPC: New SEC Report Card on Madoff Catastrophy Further Reveals How Investor Protection Is Severely Flawed!

A new report by the Inspector General at the Securities Exchange Commission recounts 16-years of failures at the SEC which led to the financial crime of the century perpetrated by Bernard Madoff and his firm. The report states that the agency “never properly examined or investigated Madoff’s trading and never took the necessary, but basic, steps to determine if Madoff was operating a Ponzi scheme.”

The IG confirms that the SEC failed to heed direct warnings and warning signs as early as 1992 which “could have uncovered the Ponzi scheme well before Madoff confessed” to the $50 billion fraud, leading to his 150 year prison sentence.

Critics of cecurities regulators and the securities regulatory system have for years complained that the system is not only inept but perhaps corrupt. Accusations have included that regulators overlook wrongdoing by Wall Street insiders while “rounding up the usual suspects” to appear as if they are doing their jobs. Madoff may be the poster child for this theory.

In the 1930’s, after the crash of 1929, securities laws were passed to protect investors which had recently grown from mostly east coast financial types to a broader group of wealthier Americans nationwide who invested through “wire houses.” In the second half of the 20th century, as more and more of us were drawn into the securities market, many claim that investor protection became more diluted allowing fraud to proliferate. SInce 2000 securities fraud has exploded.

The system of securities regulation works (or not) as follows: Congress delegated oversight of the industry to the SEC. The SEC then delegates day to day regulation of securities firms to “Self-Regulatory Organizations, or “SRO’s.” The largest of the SRO’s was the National Association of Securities Dealers, or NASD, which last year took over the regulatory authority of the second largest SRO, the New York Stock Exchange, and became the Financial Industry Regulatory Authority, or FINRA.

Yet, FINRA is neither the regulator of the entire financial industry, nor an “Authority.” It continues to be a non-profit corporation owned by securities firms, with a charter similar to that of a country club. FINRA makes rules and reports to the SEC regarding its rule changes and enforcement, but it is run by none other than the securities firms it purports to regulate. The NASD, now FINRA, then delegates regulation of each firm’s activities to the firm itself. Each firm designs its own regulatory system then submits this to FINRA for approval. “At least annually” a firm is supposed to be audited by NASD/ FINRA, with further action taken as complaints arise.

Thus, while the SEC is properly feeling heat over the Madoff mess, it was the NASD which had primary power to regulate its member, the Madoff Securities firm – “at least annually.” Here is some interesting info: Bernie Madoff was not only a prominent member of the securities industry, but served as vice chairman of the NASD, a member of its board of governors and chairman of its New York region. He was also a member of NASDAQ Stock Market’s board of governors and its executive committee and served as chairman of its trading committee. Anyone else thinking about foxes and henhouses?

For almost a decade, the head of NASD enforcement, which had responsibility to audit Madoff Securities “at least annually, was Mary Shapiro. Ms. Shapiro left that job just this year when appointed by President Obama as Chairman of the SEC. Does this not comfort you as an investor?

If a brokerage firm fails, investors are protected by something called SIPC insurance. Protection by the Securities Industry Protection Corporation merely means that “what you see is what you get” in a securities account. If a brokerage firm goes out of business coverage for investors is $100,000 of cash in their account and up to $500,000 total, including securities. One problem is that investors are not covered for being defrauded into buying worthless securities. If the firm closes you get your securities, even if these have become worthless.

Yet, in the Madoff mess SIPC did not even want to pay for what was listed in accounts, saying these were just false entries. Perhaps because of the great notoriety, SIPC was forced to pay up. Thirty years ago, SIPC was set up to pay the above limits, which have not been raised with inflation. Instead, premiums paid by brokerage firms had been reduced from a small percentage of their revenues to only $150 annually by each firm. Thus, SIPC barely had the funds to even pay the difference in that recovered from Madoff and the tiny fraction covered by SIPC (less than 5% of the total lost!)

In a previous installment we covered the “race to the bottom” in securities regulation. Wall Street decries that if regulations are not further relaxed it can not compete with other countries. We feel this is a sham and further insult to an already beleaguered investing public.