Regrettably, America deals with this pandering and posturing from our political leaders and regulators all too often. While Americans are being told one thing, what are the regulators telling the banks? Hold cash.

I am not shocked, but certainly disappointed, that American financial periodicals failed to run this story detailing these recommendations from our bank regulators. The London based Financial Times highlights this bombshell in writing, Regulators Tell U.S. Banks to Hold Funds: >>>>

US regulators have told banks not to increase dividends or buy back shares until political and economic uncertainty surrounding the industry dissipates, in a move that will delay by months the return of capital to shareholders.

Some investors in financial stocks argue that winners of the credit crisis, such as JPMorgan Chase and Goldman Sachs, have profitable businesses and strong balance sheets and should consider raising dividends or buying back stocks.

Executives at the two companies have talked in public and with regulators about the possibility of returning cash to investors after taking action to conserve resources during the turmoil. But they say they are not in a rush to go ahead, especially if their watchdogs oppose such moves. “Regulators are gun-shy at this stage, partly because they fear that giving the green light to healthier banks to return cash to investors would prompt demands from more troubled institutions to do the same,” one senior Wall Street executive said.

People close to the situation said government agencies, led by the New York Federal Reserve and the Treasury, told banks they would have to wait until the economic and legislative picture became clearer before returning funds to investors.

In a letter sent in December, officials reminded financial groups they would have to meet criteria, such as “stress-testing” their balance sheets and achieving sustainable profitability, before releasing funds to shareholders. The New York Fed and Treasury declined to comment.

Mike Mayo, an analyst at CLSA, said: “The word banks have used the most … is ‘fragile’.

Economic growth is predicated on the flow of money, otherwise known as the velocity of money. With news like this, we should expect that velocity to remain at a trickle.

The burden will remain on the Fed to keep its Fed Funds rate low so these banks can continue to recover. The burden should also remain on the regulators and bank executives to not allow the Fed liquidity to walk right out the front door of these banks in the form of big fat bonuses.

LD

In late January, we witnessed a massive lawsuit filed on behalf of the Federal Home Loan Bank of Seattle against a large number of Wall Street banks. To reference that suit, read here. Today, The Wall Street Journal highlights Connecticut Attorney General Richard Blumenthal to Sue Moody’s, S&P, the pillars of the Wall Street ratings game:

Connecticut Attorney General Richard Blumenthal will announce a lawsuit Wednesday against rating firms Moody’s Investors Service and Standard & Poor’s alleging that they knowingly assigned “tainted ratings” for “risky investments” backed by subprime loans.

In a press advisory, Mr. Blumenthal’s office said the attorney general will discuss the lawsuit at a press conference in Hartford at 11:30 a.m. EST.

The practices outlined in the lawsuit enabled the worst economic downturn in the nation since the Great Depression, Mr. Blumenthal said.

Mr. Blumenthal told Dow Jones Newswires in November that he was planning to sue the major credit raters over ratings that he alleges enabled the “structured finance debacle” in recent years.

At the time, Mr. Blumenthal said he may pursue a lawsuit on behalf of state pension funds or as an extension of investigative actions by his office.

In 2008, Mr. Blumenthal’s office separately sued Moody’s Corp., the parent of Moody’s Investors Service; McGraw-Hill Cos., the parent of Standard & Poor’s; and Fimalac SA’s Fitch in state court in Connecticut.

In those lawsuits, Mr. Blumenthal alleged that the major rating firms “systematically and intentionally” gave lower ratings to states, municipalities and other public entities than corporate and other forms of debt with similar or worse default rates. Those suits are pending.

While Blumenthal is filing suit, what have financial regulators and our leaders in Washington done to address the inherent conflicts in the ratings game? De nada.

In fact, the ratings game is nothing short of the great enabler and facilitator for Wall Street. I highlighted as much last June in writing, “Wall Street’s Great Enabler Dodges a Bullet”:

Did Barack Obama and team give a sly and subtle wink to Wall Street that ‘the game goes on’ and the ‘fix is still in?’ I believe they did.

Many analysts, myself included, view Obama’s proposed regulatory reforms as a combination of ‘reshuffling the deck chairs’ and ‘cosmetic surgery.’ In the process of those maneuvers, the rating agencies – Wall Street’s Great Enabler – went largely untouched.

The rating agencies business model presents massive conflicts of interest for all involved. The greatest conflict centers on the fact that the rating agencies’ stream of revenue remains beholden to the Wall Street banks. Without addressing that issue, any dialogue on this topic holds no water.

While I respect Blumenthal for bringing this suit to address issues within the ratings agencies, I am not optimistic this action will bring real change. Why? How have the courts and regulators handled issues regarding investor protection? To a very large extent the message to investors is a resounding “CAVEAT EMPTOR”, that is “BUYER BEWARE”. You had better be looking out for yourself.

Sense on Cents will try to help you along the way!!

LD

Investors do not trust the valuations of the assets on the books of these banks. I highlighted this very point the other day in writing, “Where is Wall Street Hiding Hundred Plus Billion in Lo$$es?”

A recently released report from the American Banker addresses this point of questionable asset valuations, or what I define as ’smoke and mirrors’.

When you do not know or are not comfortable with how an entity is evaluating an asset, just how comfortable are you in investing in that company?  At that point, I would define putting money into such an entity is more speculating and less investing. The AB writes, Bank Books Reveal Depth of Problems:

Investors have been heartened to see troubled banks replace leadership or repay bailout money, but they still are finding hard numbers deep in the books that are reinforcing their more surface perceptions of the industry’s “haves” and “have-nots.”

Concerns about credit quality, depressed returns and the accounting methods applied to hard-to-value assets are holding down price-to-book ratios for some banks, which by this point probably need no reminder of the consequences of poor lending decisions.

Meanwhile, the list of bank stocks trading at or above book value – or total assets minus intangible assets and liabilities – tends to read like a rehash of the companies seen coming through the crisis in a relatively strong position.

“Investors are trying to separate the survivors from those that might be permanently impaired,” said Brad Evans, a portfolio manager with Heartland Advisors, a Milwaukee fund manager that specializes in value investing. “You still have banks perceived to have high financial risk because of the employment of debt or leverage in their business model combined with very high perceived operational risk. You put those two things together and that results in very depressed multiples by book value” for stocks inviting the most investor concern.

A low price-to-book ratio sometimes is the sign of a stock that is simply underappreciated by the market.

But that may not be the case for Citigroup Inc., Bank of America Corp. and Zions Bancorpand other institutions currently trading at steep discounts to book value.

Meanwhile, JPMorgan Chase & Co. has a price-to-book ratio of 1.07, meaning shareholders are giving the company full credit for its reported book value, and then some. Wells Fargo & Co., U.S. Bancorp, BB&T Corp. and New York Community Bancorp are among the other institutions trading at more than one times book value.

Money managers and analysts say that in this environment, bank stocks that trade with low price-to-book ratios most likely are being penalized either for credit quality trouble or low returns. There also is a possibility that stated book values are simply mistrusted by a market that has had a hard time making sense of how banks account for assets, leading investors to dock the share prices of companies suspected of keeping items on the balance sheet at inflated prices.

That’s the line of demarcation that Joe Peek, a finance professor at the University of Kentucky’s Gatton College of Business and Economics, sees in the price-to-book ratios of different bank stocks. He noted that Goldman Sachs Group Inc., which trades at 1.45 times book value, marks nearly all its assets to market. Citi, in comparison, has a mix of assets — some marked to market under fair-value accounting rules and others held at amortized cost. In any case Citi investors have complained they are perplexed as to how the values are determined and whether they can be considered reliable.

Citi’s price-to-book value of 0.65 “is saying investors aren’t being fooled by the accounting,”Peek said. “The banks don’t have to mark everything to market, but investors do, so they’re marking the banks to market.”

Jason Polun, a bank industry analyst at T. Rowe Price Group Inc., agreed that low price-to-book valuations may indicate that “some people out there just don’t believe book.” But he said skepticism over the accounting used to arrive at book value “was much more of a presssing story in 2007 and 2008, when there was much more of a disclosure issue.”

The financial crisis prompted changes in accounting standards that improved the clarity with which banks report asset valuations, Polun said, making skepticism over the veracity of reported book value a smaller, though still plausible, reason for the low price-to-book ratios assigned to certain bank stocks.

A new regulation that brought off-balance-sheet assets onto banks’ books this year might have complicated investors’ independent calculations of book value, but bank executives were forthcoming enough about the expected effect that many analysts said they remain confident in their book value estimates for banks most heavily affected by the rule change.

That may help banks rebuild faith in their reported numbers. But the best thing a bank can do to lift its price-to-book ratio may be the thing that takes the longest: waiting out the credit cycle and proving that assets suspected of being valued under “delay and pray” or “extend and pretend” — the strategy of reworking loan terms and hoping for the best — are in fact worth their reported values.

“There’s a very high level of fear regarding the commercial real estate market and the later-stage credits as we come through the cycle,” Heartland’s Evans said. “If the credit situation turns out to be less bad than people expect, then I would guess that the banks are probably pretty attractive here” on a price-to-book basis.

What is the key takeaway here? Don’t believe everything you see and only half of what you read. Investing requires accurate information and analysis. If you’re not sure what an entity owns and where they have it evaluated, navigate accordingly.

LD

As if those crippled by the Madoff scam have not already gone through hell and back, today we learn that an impostor to the Securities Investor Protection Corporation (SIPC) has sprouted up targeting the investors victimized by the Madoff scam. The Wall Street Journal exposes this scum in writing, Copy-Cat Web Site Targeting Madoff Victims:

The Securities Investor Protection Corp., a securities industry group formed by Congress to help customers of failed brokerages, warned of an imposter Web site mimicking its own page to target victims of convicted swindler Bernard Madoff.

The site for an “International Securities Investor Protection Corp.” asks victims of Mr. Madoff’s multiyear Ponzi scheme to submit claims, which the real SIPC warned could be an attempt to harvest sensitive data for identity theft.

“We know. .. that this bogus group is already attempting to obtain funds and confidential financial information from investors in the U.S.,” SIPC President Stephen Harbeck said. He warned investors against sharing data via the bogus site or trusting its information. “We intend to use every available means to shut down this illicit operation,” he said.

The false site mimics the true SIPC’s page in both artwork and structural design. The fake group claims to be based in Geneva with links to the United Nations and International Monetary Fund. One page has a photo of a huge stack of U.S. currency with the claim the group worked with Interpol to recover $1.3 billion in Madoff money from a Malaysian hideout.

The real SIPC pays up to $500,000 to investors when brokerages fail, using money raised through fees charged to more than 5,000 members firms.

For those entangled by the Madoff scam, please do not allow yourself to be scammed again. Please share this story so every Madoff investor is aware of this operation.

There is a special place in hell for those behind this scheme.

LD

That simple piece of wisdom is both timeless and precious. Regrettably, too many in our media fail to uphold it. Where do I see evidence of it today?

The Wall Street Journal today runs a book review of Harry Markopolos’ recently released No One Would Listen. The reviewer is Richard J. Tofel of ProPublica, a nonprofit investigative-journalism newsroom. Tofel does not denigrate Harry’s work, but he emasculates Harry from a personal standpoint.

Tofel writes:

A crusading legislator who had made a considerable reputation following up on whistleblower charges once told me that nearly all the whistleblowers she had met shared two qualities. First, they were onto something—that is, there was at least some truth to what they were saying. Second, they were “a little bit nuts.” The jacket of “No One Would Listen” identifies Harry Markopolos as “the Madoff Whistleblower.” He would seem to fit the pattern.

The author of “No One Would Listen” is fond of describing himself as “slightly eccentric,” but he is not exactly self-aware. By his account, the fault for his having been ignored throughout eight years of warnings is everyone else’s. But that conclusion requires ignoring much of his story.

The possibility of self-interest probably heightened the skepticism of those he sought to persuade.

Mr. Markopolos tells us that for years, fearing for his own and his family’s safety, he checked for bombs under his car; he also carried a loaded gun and slept with it at his bedside. He did so because he believed—though he offers no evidence—that Mr. Madoff’s clients included Russian mobsters and Latin drug cartels. Even after Mr. Madoff had been jailed, Mr. Markopolos, a longtime Army reservist, feared that the SEC would invade his home, eager to capture and suppress evidence of the agency’s failings: “I loaded a 12-gauge pump shotgun with double-ought buckshot, attached six more rounds to the stock, and draped a bandolier of 20 more rounds on top of my locked gun cabinet. Next I got out an old army gas mask in case they used tear gas.”

None of this behavior makes Mr. Markopolos’s case against Mr. Madoff any less convincing. Nor does it excuse the SEC. But it does provide a fuller picture of the author than the cardboard cut-out of the lonely hero we’ve been hearing about for the past 15 months. With his book, Mr. Markopolos sheds more light than he intends on just why no one would listen.

Why does Tofel slam Harry and paint him as being a nut? Tofel writes in self-defense because he worked for 15 years, including two years as assistant publisher (2002-2004), at The Wall Street Journal, one of the periodicals which failed to pursue the lead on the Madoff story.

I think The Wall Street Journal is an outstanding periodical, but it is hardly perfect. As further evidence of questionable and selective journalism, I would share with my readers that in January 2009 when I unearthed the fact that Wall Street’s self-regulator FINRA owned $647 million in auction-rate securities, I brought those details initially to The Wall Street Journal. After ten days to two weeks of conversation with representatives of the WSJ, for whatever reason they chose not to pursue the story.

I then brought the news to Bloomberg, and to its credit a reporter there pursued the story and broke it late last April including the fact that FINRA liquidated its ARS holdings in mid-2007.

I share that tidbit not to draw attention to Sense on Cents, but rather to highlight that the media needs to be more demanding of itself in upholding its charge to pursue truth, transparency, and integrity everywhere on our economic landscape.

I do not expect The Wall Street Journal, Bloomberg, Sense on Cents or ProPublica to be perfect, but they can be and should be a lot better than this slanderous drivel put forth by Mr. Tofel today.

LD

Related Sense on Cents Commentary

Wall Street Journal Goes in the Tank for FINRA (September 25, 2009)

A similar dynamic plays out in the high and mighty halls of international finance. The Financial Times writes a captivating story on how the abuse of derivatives has overwhelmed cities and towns across Italy. This article, entitled An Exposed Position, is a riveting view as to how the abuse of financial derivatives will have untold costs for years to come.

As with any prescription medicine or financial product, the first question a potential buyer/investor needs to ask is whether to trust the ‘doctor.’ Who would knowingly ingest medicines or products if you thought the provider was less than totally ethical? The FT addresses this very point:

The scandal also raises bigger questions about the ethics of the financial industry in relation to complex products. In recent years, most bankers assumed they were allowed to sell anything they wanted to non-retail clients, since it was presumed that “sophisticated” investors would be able to protect their own interests.

However, what has become clear in Italy is that many public sector clients were unable to understand the maths of complex finance risks. This is likely to force investment banks to rethink their definition of “sophisticated” clients; it could also encourage politicians in Europe and elsewhere to clamp down much more aggressively on the entire derivatives trade.

Once again, Caveat Emptor is the order of the day. As the buyers of the products became more ‘hooked,’ the marketing and pricing became that much more aggressive.

The FT highlights this development:

The more complex the deals became the less the local authorities understood them, claim several lawsuits against the banks. Derivatives specialists and some political sources dispute this and say local politicians chose to ignore the risks because of the potential gains. Domenico Siniscalco, then finance minister, warned back in 2004 that local authorities were using derivatives “like hard drugs”.

I do not absolve the users of these hard drugs from their responsibilities and obligations. By the same token, not every distributor of the ‘hard drugs’ is necessarily unethical. Very simply, the risks of the derivatives do not come with sufficient transparency. Additionally, what is plainly obvious is that not only in Italy but literally everywhere around the globe, the pushers and distributors of these ‘hard drugs’ are not properly regulated. Why not?

All too often we see that the regulators are in bed with the pushers.

Who bears the ultimate costs? Society, that is the taxpayers of the towns, cities and states, not only in Italy but in every other country where these hard drugs have established a foothold.

What a world.

LD

U.S. Rep. Barney Frank (D-MA)

Banks are increasingly healthy, right? Our nation’s accounting rules promote real transparency and integrity in our financial reporting, right? Housing is bottoming, right? No, no, and no!

Why so pessimistic, you may ask? I am not pessimistic at all. I am merely searching for the truth in the midst of the smoke and mirrors on Wall Street and in Washington.

Thank you to our friends at 12th Street Capital for sharing a recently released letter from Congressman Barney Frank imploring the four largest banks involved in mortgage originations to write off second liens they are holding on their books at inflated values.

Why does Congressman Frank believe these loans need to be written off? The liens must be largely written off so that Washington can then compel banks to engage in writing down principal on first liens in an attempt to keep people in their homes. Keeping people and families in homes is certainly a worthy cause, but the process is fraught with all kinds of violations of moral hazards and assorted unintended consequences. When you hear that your neighbor receives a principal reduction, how long will it take you to go to your bank and demand the same?

Let’s review Frank’s brief, two-page letter (click on image below to access pdf document). Focus on Frank’s comment that the second liens have no real value but accounting rules allow the banks to carry them at artificially high values. Can you say, “cooking the books”?

What are the projected losses in these second liens? Well, how much of this paper is outstanding? The Wall Street Journal provides a bar graph in an article this morning, Home-Savings Moves Afoot:

So, with $1 trillion in outstanding second liens on the books, the question begs as to how much of this indebtedness is current, how much is delinquent, and how much is truly worthless but not yet acknowledged. In discussions with those in the industry, suffice it to say, the most optimistic assessment is that the industry has at least a few hundred billion in losses yet to be acknowledged.

The larger banks addressed by Congressman Frank are the largest holders of these second liens. These banks do have earnings power given the free flow of liquidity provided by the Fed and accompanying capital markets activities. That is not the case with smaller institutions. How many of those institutions are already dead, but not yet buried?

Wonder why banks are reluctant to provide credit? They need to increase capital knowing these second liens are truly an ongoing sinkhole. Don’t even start to ask about setting aside capital for those big bonuses.

LD

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The latest AG to feel the wrath of ARS investors is New York AG Andrew Cuomo for his recent settlement with Oppenheimer Holdings. Rather than reading my opinion of Cuomo’s settlement, let’s listen to an investor (who remains nameless for obvious reasons). In my opinion, this individual’s letter speaks volumes and echoes the sentiments of thousands of investors who continue to hold the $150 BILLION in frozen ARS.

Wall Street, Washington, state AGs, and to a very large extent the media have done these investors an enormous disservice in not addressing and rectifying the fraud involved in the distribution of ARS. The investor writes:

Cuomo sold us out. As an Oppenheimer ARS victim and a New Yorker and someone who was manipulated out of more than a million dollars by Oppenheimer I was thrown under the bus. First we had too big to fail now we have too small to regulate.

Can anyone in the financial sector be found guilty of anything? What other industry allows criminals, when they get caught, to give back what they took, only if they have the money, over a very long period of time, possibly pay an insignificant fine, and neither admit nor deny any wrong doing? They get to go back to their companies as if nothing ever happened. They are free to dream up the next product they can scam us with. Knowing that the cycle will just repeat itself. If Madoff didn’t basically give himself up he would still be out there pillaging and plundering investors. What chance does the average investor have out there?

The part that really sticks in my gut is this. Right before the ARS market crashed the CEO and other top executives, knowing the market was going to crash and keeping this info to themselves, were selling their own ARS. They were using their brokers to dump their own personal ARS on me, using the guise of “cash equivalent” until the very end. They got most of their money out, because they had inside information, and have full use of their money today while our money will be stuck for decades. By the summer this will all be forgotten by everyone except the victims. I can picture Lowenthal (Oppenheimer CEO) at his country club having a good laugh about this. After all, the hardest part of this settlement for Oppenheimer is to figure out how to prove to Cuomo every 6 months they have no extra money. Hardly a chore in this business environment and with their particular skills.

Some more food for thought. For the past 2 years Oppenheimer has been collecting fees daily for the auctions that still go off and fail. That’s fees on $960 million. In reality, the Cuomo settlement is costing Oppenheimer little or nothing of their own money. If you subtract the fees they collect from the amount they owe it’s close to a wash. Every AG across the country that got an ARS settlement settled for full redemption for the people of their state.

Cuomo is the only AG that got a settlement that favored the company that misrepresented the sale of ARS and did as close to nothing as you can get for the people of his state.

Remember, it’s their money. They deserve it back. They should be first in line. Fraud is fraud. Theft is theft. America is supposed to be better than this.

LD

Related Sense on Cents Commentary

Oppenheimer ARS Investor Rails on NY AG Cuomo re: OPCO-ARS Settlement (March 3, 2010)

Raise your hand if you do not trust Wall Street and Washington.

Raise your other hand if you do not trust the financial media.

Why do I viscerally envision a lot of hands being raised all over America? Because given developments of the last few years, Americans — at an ever increasing rate — are less trusting of Wall Street, Washington, and the media.

What is one to do? Where can one go to embrace honest dialogue focused on real transparency and integrity? You have come to the right place as tonight from 8-9pm ET No Quarter Radio’s Sense on Cents with Larry Doyle Welcomes Daryl Montgomery.

Daryl Montgomery is the organizer of the New York Investing Meetup, a group of 2500 independent investors and traders that provides the public with unbiased economic and market information. The New York Investing meetup has become the largest investing meetup in the world because of its highly accurate and timely predictions, which include the credit crisis was about to blow up in July 2007, a major bear market was about to begin in September 2007 and that a recession was starting in December 2007. The group also called a top in gold and silver in March 2008 and the exact day of the oil bottom in February 2009. You can find out more at New York Investing Meetup, (the group is free to join).

Montgomery writes the popular Helicopter Economics Investing Guide and is one of the originators of the term ‘helicopter economics’. He is a former professor and now uses his research as a full time trader. Montgomery has never worked for nor has any association with the securities industry. This allows him to bring a fresh perspective to market analysis. The slogan for his group is “A profitable alternative to Wall Street hype”.

Daryl Montgomery is currently working on a book on inflation investing.

I truly look forward to this conversation. One of my goals in launching Sense on Cents has been to bring expertise to those who come here and harness the power of the public in the process. This interview with Daryl Montgomery does exactly that.

For our newer readers and listeners, join us live at the BlogTalkRadio (BTR) website tonight at 8pm ET. You can also mix it up in our always energized chat room, which runs simultaneously with the show at the BTR site. As a reminder, all of my radio shows are archived and previous episodes can be listened to right here at Sense on Cents by clicking on the No Quarter Radio tab located under the page header. (FYI, I keep an audio player of my most recent episode in the right sidebar). In addition, all No Quarter Radio programming is available as a free podcast on iTunes. From the iTunes Store, type “NQR podcasts” in the search window.

Please join us and spread the word. Together we can and will effectively navigate the economic landscape.

LD

The executives of Wall Street’s self-regulatory organization FINRA should not think that the recent dismissal of one legal complaint is reason for celebration. Why? Those who care for transparency measure success not in terms of judicial victories but to a much greater extent by public pressure and awareness. On that note, at long last real progress in creating transparency into FINRA is occurring.

From the highly regarded government watchdog Project on Government Oversight to now the leading weekend business periodical Barron’s, FINRA’s stench is attracting attention from more than the blogosphere and a few selected journalists (Bloomberg’s Susan Antilla, The Washington Examiner’s and Baltimore Sun’s Marta Mossburg, and also Barron’s Jim McTague).

The news in an article this weekend by Barron’s is not news to regular readers of Sense on Cents, but to most of America FINRA remains a foreign entity. Those days are changing. 

Barron’s excoriates Wall Street’s self-regulator today in writing, FINRA, First Heal Thyself:

IN 2007-08, regulators at FINRA were so distracted with empire-building and lining their pockets, they overlooked the world’s two largest Ponzi schemers: Bernie Madoff and, allegedly, R. Allen Stanford. So what’s the deeply flawed Financial Industry Regulatory Authority up to now? Building itself an even bigger empire.

The quasigovernmental body, which advertises itself as the white knight of 90 million investors, is lobbying Congress for the power to regulate 11,000 investment advisors who now fall under the jurisdiction of the Securities and Exchange Commission and state securities regulators. The states regulate those with less than $25 million in assets, but want Congress to bump that to $100 million. Why? The SEC does such a poor job, it visits an average of one advisor every nine to 11 years!

Finra currently regulates Nasdaq and New York Stock Exchange brokers and securities dealers, and pays its executive staff high-on-the-hog salaries, despite abysmal performances. This is the same behavior that contributed to the failure of big financial firms that operated under Finra’s purview. If Congress accedes to its power grab, the kingdom of Finra will be able to fatten its coffers with millions more dollars in fees from its new charges. Given Finra’s sorry enforcement record, there’s little reason to believe investors would be any better off.

Why would investment advisors want to shell out money for the privilege of being regulated when the SEC does it free? The state regulators oppose Finra’s grab because they say there’s no adequate oversight of the organization.

“They aren’t accountable to anyone but their own members,” says Texas Securities Commissioner Denise Voigt Crawford. As for being investor-friendly, she points to their “abhorrent” mandatory system of dispute resolution by arbitration, a process she says is stacked in favor of the firms.

FINRA’S STORY is that had it been regulating investment-advisory firms in 2007, it might have caught on to Madoff. Although Madoff’s brokerage business was regulated by Finra, his investment-advisory business, where the fraud took place, was regulated by the equally hapless SEC.

Says Finra spokeswoman Nancy Condon, “The absence of a comprehensive examination program for investment advisors impacts the level of protection for every member of the public who entrusts funds to one of those advisors. It’s clear that dedicating more resources to a regular and vigorous examination program and day-to-day oversight of the investment advisors could improve investor protection for their customers, just as it has for customers of broker-dealers.”

Finra’s critics find this argument risible, pointing out that there’s scant evidence that the regulator examined Madoff’s brokerage business in recent years. Furthermore, they contend Finra failed to properly regulate a host of firms at the center of the financial meltdown, including Bear Stearns, Lehman Brothers, and Merrill Lynch.

The nonprofit Project on Government Oversight says an internal Finra review shows Finra missed key opportunities to uncover alleged fraud by Stanford, in part because it is too cozy with Wall Street.

Finra is what is known in the securities world as a self-regulatory organization, or SRO. Congress wrote a provision in the Securities and Exchange Act of 1934 permitting exchanges to create SROs to regulate member conduct and punish scofflaws. The SEC conducts regular inspections of Finra. But there are no regular oversight hearings by the Congress.

In 2006, the NYSE and the Nasdaq each had an SRO. In 2007, the two exchanges agreed to create Finra, to realize cost efficiencies and regulatory harmony. The merger required emendation of the Nasdaq market’s bylaws by some 5,000 members.

Its SRO decided to prod the change by offering members $35,000 apiece from $2 billion in members’ equity it had amassed as a result of the public listing of the Nasdaq stock market between 2001 and 2006. The SRO had owned shares of Nasdaq stock. In a prospectus and in road shows, Finra contended that the Internal Revenue Service threatened to yank its nonprofit status if it paid Nasdaq’s members $35,000 each.

Several broker-dealers subsequently sued Finra, alleging the officers had lied and subsequently had used some of the money to give themselves exorbitant pay raises. Mary Schapiro, who led Finra then, received $7.3 million in salary and accumulated benefits when she left; now chairman of the SEC, Schapiro makes $158,500 a year. This month, Judge Jed Rakoff of the U.S. District Court for the Southern District of New York dismissed the lawsuits, not on their merits, but because under the law, Finra and its officers enjoy “absolute immunity” from private actions challenging their official conduct as regulators. The judge’s action startled the investment-advisory community.

“I don’t think Finra is accountable to anyone,” says David Tittsworth, executive director of the Investment Advisor Association in Washington. He’s right. Congress should change this, not give Finra an expanded kingdom.

Perhaps the board at FINRA will be much more aggressive in not only opening up the books and records of FINRA going forward but will grow a conscience and provide further transparency about activities in the past.

FINRA must not only be transparent but they also must be accountable. If the executives, both past and present, are not held accountable, then the board must be held accountable.

America is now finally being introduced to the organization that I believe is the nexus of the Wall Street-Washington incest. Thank you Jim McTague and Barron’s for drawing further attention to FINRA’s stench which needs to be aired out.

LD

Related Sense on Cents Commentary

To access all of my writing on FINRA over the last 14 months, click here. I also appeared on a Fox Business segment covering FINRA last September. That post is truly enlightening: “Attorney Claims Wall Street’s Cop, FINRA, Invested in Madoff.” That’s right. Watch the 18 minute clip embedded in that post. Your view on Wall Street and its oversight or lack thereof may be forever changed.

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