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In Bed with Wall Street
The Conspiracy Crippling Our Global Economy
By Larry Doyle
Palgrave Macmillan Copyright © 2014 Larry Doyle
All rights reserved.
"I agree with Madoff whistleblower Harry Markopolos' claim that FINRA is corrupt and incompetent [and] in cahoots with the large broker-dealers at the expense of the investing public."
— Joseph Sciddurlo, in an article by John Crudele in the New York Post, June 27, 2011
The year 2008 was unlike any other Wall Street had experienced in a long time — if ever. The demise of the once-proud underdog Bear Stearns and its fire sale to J.P. Morgan for $2 a share touched off more anxiety than most people in the markets could stomach. Yet Bear's decline was mild compared to what lay ahead.
The government takeovers of mortgage giants Freddie Mac and Fannie Mae were cataclysmic and indicative of the serious structural issues in our nation's housing market. An expedited $85 billion bailout of insurance giant AIG may have temporarily calmed the waves on Wall Street, but it only stoked the rage burning on Main Street as investors watched their retirement accounts plummet.
The failure of Lehman Brothers in September 2008 rocked the world and led to a shotgun marriage of Merrill Lynch and Bank of America. The pace of developments on Wall Street was mind numbing. The market volatility was even worse.
With barely time to catch one's breath, this tumultuous year was capped off when the largest Ponzi scheme ever perpetrated on Wall Street came crashing down. Bernie Madoff may have been the face of this particular scam but, for many people in America, "Wall Street" as a whole had become dirty words.
In the midst of this turmoil, brokers, bankers, traders, salespeople, and back office reps scrambled to keep their own heads above water. Getting business done became exceptionally difficult, if not impossible, as market liquidity dried up. The once proudly displayed badges of honor that went to top firms for providing that liquidity and best execution became objects of ridicule. Senior management on Wall Street went into full crisis mode to protect their franchises and firms' capital. International investors were aghast at the tsunami overwhelming their own markets. Add it all up, and late 2008 was about one word: survival.
The American public felt their trust had been violated and expressed their disdain at a Wall Street that seemed to run one way. The trust between investors and their banks, financial planners, and advisers was seriously ruptured if not totally broken. The rage fueled the launch of both the conservative Tea Party and liberal Occupy Wall Street movements. In the midst of these uprisings, America's collective disgust with both Wall Street and Washington intensified.
As in any relationship, before trust can be rebuilt and integrity restored, questions need to be asked, and truths revealed. Chief among these truths are the effects of the crash, more than five years after the first tremors of the economic crisis:
1. Long-term unemployment figures indicate approximately one in seven eligible workers in our nation is unemployed or underemployed. The overall rate of labor participation in America is the lowest in 35 years.
2. More than one in five children in America now lives in poverty.
3. Record numbers of our fellow citizens are now subsisting on food stamps.
Are these statistics merely indicative of an economy slow to recover from a cyclical decline? Not by any logical reasoning.
The issues strangling any sort of meaningful economic recovery in America are truly structural. To properly address them, we must expose those on Wall Street and in Washington who profited handsomely from the major cracks in our financial regulatory foundation. These cracks were built into the system long ago, and have widened — by design — over the years. And what have our central bankers, policy mavens, and political heavyweights been doing instead of addressing the cavernous holes in our financial regulatory framework? They've been propping up the same opaque financial artifice that profits financial institutions while burdening investors and consumers. Examples of the financial gamesmanship that continues on Wall Street include:
Excessive hidden fees and expenses in investor retirement accounts
Equity, commodity, and derivatives markets operating with little to no transparency
Investment funds that remain littered with poorly underwritten loans
Investors shortchanged by the manipulation of benchmark indices, including an array of overnight interest rates (e.g., Libor), currencies, and commodities
Lack of meaningful credit availability even for creditworthy customers
Predatory credit card rates
A repressive monetary policy implemented by the Federal Reserve that punishes savers and fixed income investors for the benefit of banks and other financial institutions
And while all this goes on, the adjudication of even the most egregious financial fiascos remains token at best. The Securities and Exchange Commission (SEC) pursues and the US attorneys prosecute numerous individuals engaged in insider trading in little more than show trials, hoping the public will be distracted and confuse these efforts with bringing justice to Wall Street. In reality, the deep institutional crimes perpetrated on Wall Street have gone largely unpunished. The fines imposed on the firms represent nothing more than a cost of doing business — pennies on the dollar. And penalties for individual senior executives? Not in our current system of payoffs from Wall Street to Washington. Among the widespread institutional frauds that went unchecked:
Improper foreclosure practices within the mortgage industry, including the use of a heinous practice known as "robo-signing" (i.e., rubber stamping) of documents
Misappropriation of customer funds at commodities broker MF Global
Money laundering at Wachovia Bank, HSBC, and Standard Chartered Bank et al.
Widespread manipulation of the overnight interest rate known as Libor
Improper sales practices utilized in the distribution of a wide array of structured products that would be easily recognizable as violations of the Securities Exchange Act of 1934
The token fines levied in these and other situations have revealed Wall Street's regulators as little more than meter maids.
Meanwhile, with each passing day our economy languishes, our citizens suffer, and the world's confidence in America wanes. The dichotomy between what passes for justice on Wall Street and on Main Street has given rise to a palpable disgust — laced with an unhealthy but increasingly prevalent cynicism — with the crony capitalism that permeates our nation. To stop it, we must face the truth about our structurally impaired financial regulatory system, a truth the folks on top have been desperately covering up for decades now.
What was really going on in our financial markets?
Where were the SEC and other financial regulators, and what were they really doing?
How could things on Wall Street have gotten so far out of control that the American taxpayer needed to step in with trillions of dollars in subsidies and bailouts?
While Wall Street itself tried to weather the storm with Washington bailouts, global investors searched in vain for safe harbors. Even after the bailout funds came through, Wall Street firms kept the hatches battened down. Investors were left to wonder what had happened to the regulatory lifeguards, and if or when real guardians of investors and the public interest might reappear.
President-elect Barack Obama stepped into this fray in January 2009 with his mantle of hope and change. Certainly, our nation as a whole and our markets specifically needed plenty of both to clean up the mess. To lead this charge, President Obama nominated career regulator Mary Schapiro to be the new head of the SEC.
Two days prior to Schapiro's scheduled confirmation hearing on January 15, 2009, the Wall Street Journal ran a scathing review of Schapiro and her tenure at the Financial Industry Regulatory Authority (FINRA).
Who is FINRA? In its own words:
The Financial Industry Regulatory Authority (FINRA) is the largest independent regulator for all securities firms doing business in the United States. FINRA's mission is to protect America's investors by making sure the securities industry operates fairly and honestly. All told, FINRA oversees nearly 4,270 brokerage firms, about 161,765 branch offices and approximately 630,345 registered securities representatives.
FINRA has approximately 3,440 employees and operates from Washington, DC, and New York, NY, with 20 regional offices around the country.
FINRA serves every U.S. investor — from newlyweds planning to buy a home, parents saving for a child's college education to seniors depending on a secure retirement.
Every one of the 57 million American investing households FINRA serves has unique needs, but all rely on one thing: fair financial markets. That is why FINRA works every day to ensure investors receive the basic protections they deserve.
Every investor deserves fundamental protections when investing in the stock market. Whether Americans are investing in a 401(k) or other thrift, savings or employee benefit plan, or in a mutual fund, ETF or variable annuity, FINRA works every day to ensure that:
1. Anyone who sells a securities product has been officially tested, qualified and licensed.
2. Every securities product advertisement used is truthful, and not misleading.
3. Any securities product promoted or sold to an investor is suitable for that investor's needs.
4. Investors receive complete disclosure about the investment product before purchase.
FINRA touches virtually every aspect of the securities business — from registering and educating industry participants to examining securities firms; writing rules; enforcing those rules and the federal securities laws; informing and educating the investing public; providing trade reporting and other industry utilities; and administering the largest dispute resolution forum for investors and registered firms.
When rules are broken, we take action — meaning we can fine, suspend or expel firms or individual brokers from the business. We frequently require firms to return money to investors who have been harmed. In this role of "cop on the beat," FINRA ensures that all investors receive the basic protections they deserve — regardless of what kind of financial product they buy or who sells it to them.
FINRA is dedicated to investor protection and market integrity through effective and efficient regulation of the securities industry.
Under Schapiro's watch at this Wall Street self-regulatory organization (SRO), fines collected and cases brought had dropped significantly. Yet, with most eyes in America focused on the abysmal track record compiled by the SEC, FINRA slipped below the radar. Schapiro was not only nominated for the top post at the SEC, but she also sailed to an easy confirmation.
As a career regulator, Schapiro appeared to be anything but the take-no-prisoners sheriff many believed was badly needed to clean up our financial industry. She seemed to be more a part of an old problem than part of a new solution. But indeed, FINRA itself was a great unknown. To those on Wall Street trading desks, FINRA are the folks you don't want to cross, for fear of having your securities licenses suspended or revoked.
Most people don't know that Wall Street as a whole is largely a self-regulated industry. While the SEC is the government's officially designated financial police, FINRA is an industry-funded, self-regulatory organization — Wall Street's own private police detail.
In what can only be defined as a coronation, the congressmen and congresswomen at Schapiro's hearing spent little time reviewing her experience at FINRA but plenty critiquing the former chairman of the SEC, Christopher Cox. Major periodicals and the mass financial media had a field day skewering the SEC for its failures not only to pursue high-profile cases, including Madoff and Stanford Financial, but also a wide array of insider trading and abusive sales practices on Wall Street. With very few exceptions, the media played right along with the Washington power base in tarring the SEC under Chris Cox while neglecting to thoroughly investigate Wall Street's self-regulator FINRA under the leadership of Mary Schapiro. While there was certainly plenty to critique about Cox's tenure, the United States learned little of substance about Schapiro and FINRA amid a healthy dose of pontificating and posturing from both the committee and the prospective chairwoman herself. Chris Cox was yesterday's news. Mary Schapiro was today's main course.
America deserved to hear Schapiro answer the hard questions about the true relationships between the SEC and FINRA and the bankers they were charged with monitoring. If the SEC under Cox was being scrutinized for its failures, clearly FINRA deserved the same scrutiny, if not more, given that it was funded by the very banks it oversaw. Despite President Obama's campaign promise of change, this confirmation hearing was an indication that things were far more likely to stay the same.
Although FINRA may talk a good game, actions speak louder than words. Largely unknown to the American public, FINRA was clearly ground zero for much of the 2008 earthquake that rocked Wall Street and roiled our nation and the world. The obvious question hanging over FINRA, given that it is funded by the industry it monitors and is charged with protecting investors, is, can a regulator serve two masters?
As a frame of reference, FINRA was formed only in 2007, as a result of a merger between the longstanding National Association of Securities Dealers (NASD) and the regulatory arm of the New York Stock Exchange (NYSE). If you dive deeply into FINRA's most recent annual reports, you will learn that this nongovernmental, not-for-profit SRO has a balance sheet ranging between $4 billion and $6 billion, and has maintained a large, diverse investment portfolio for its own benefit.
As you can imagine, this causes some very real conflicts of interest.
A multibillion-dollar balance sheet is not exactly small, especially for a regulatory organization. Where did all that money come from? Over and above that, what did FINRA hold within its own investment portfolio? While most regulatory organizations would typically place their cash in Treasury bills or an equivalent sector to avoid even the slightest appearance of a conflict of interest, FINRA has had an array of investment positions including holdings in equities, bonds, hedge funds, private equity, and even auction-rate securities (ARS).
Talk about conflicts of interest. FINRA likes to think of itself as the cops on the Wall Street beat, but this regulator was also playing in the games along with the institutions it was supposed to be overseeing.
It's not a stretch to think that Wall Street's private police might gain preferential treatment from the banks in managing their investments. FINRA's internal compliance and controls could not claim the appearance of no conflicts of interests, much less that they had no actual conflicts of interest.
This is the line of questioning Mary Schapiro should have faced during her hearing. Regrettably, Senators Chris Dodd (D-CT) and Chuck Schumer (D-NY) and other committee members (both Democrats and Republicans) never touched these sensitive topics. The committee clearly wasn't interested in a contentious interrogation. And so investors lost out, again. Well, I thought if our elected representatives aren't going to demand transparency, we'll have to open the doors to this private police organization ourselves.
My review of FINRA's annual report revealed a wealth of details about its investment portfolio, but none more astonishing than FINRA's holding of approximately $650 million of ARS.
For those of you unfamiliar with the massive ARS debacle, allow me to give you a quick overview. On February 14, 2008, the ARS market had totally frozen. These once highly liquid securities, which had been marketed and distributed as the equivalent of cash, were really little more than another Wall Street-engineered Ponzi scheme. The success of the regular auctions at which existing ARS holders could liquidate their positions was predicated upon new buyers entering the market. Unbeknownst to most investors, many ARS auctions had been manipulated by Wall Street banks for a number of years to give the appearance of a healthy market. In February 2008, reacting to the stress and strain running across all market segments, the banks totally backed away from the $330 billion ARS sector. The ARS auctions failed, and investors' cash was frozen. Many individual investors, both large and small, had been encouraged to park their retirement funds in ARS and were now unable to access their cash. Panic ensued, and anxiety still persists for many thousands of these investors. The Madoff scam pales in comparison to the size and scope of the ARS debacle.
Excerpted from In Bed with Wall Street by Larry Doyle. Copyright © 2014 Larry Doyle. Excerpted by permission of Palgrave Macmillan.
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