Regulatory Double Standard: Dissing your Settlement

March 24, 2008

Let's take a brief stroll down sordid memory lane. On April 28, 2003, the SEC announced landmark enforcement actions against ten of Wall Street's largest broker-dealers for failing to ensure that the research they provided their customers was independent and unbiased by investment banking interests. The settlements were brought in conjunction with proceedings by the NASD, the New York Stock Exchange (NYSE), the New York Attorney General (NYAG) and other states, and imposed significant monetary relief on the firms, including $1.4 billion in penalties that rank among the highest ever paid in civil securities enforcement actions. 

On May 2, 2003, the New York Times reported (MORGAN STANLEY DRAWS S.E.C.'S IRE by Floyd Norris) that the day after the announcement of the $1.4 billion settlement, then Morgan Stanley CEO Phillip J. Purcell had attended an investors conference where he appeared to dismiss the allegations (Morgan's contribution to that settlement was $125 million) by stating that
"I don't see anything in the settlement that will concern the retail investor about Morgan Stanley. Not one thing."
As Norris reported, then SEC Chairman William H. Donaldson wrote a letter to Purcell:
'First, your statements reflect a disturbing and misguided perspective on Morgan Stanley's alleged misconduct,'' Mr. Donaldson wrote. ''The allegations in the commission's complaint against Morgan Stanley are extremely serious. They include charges that Morgan Stanley paid other firms to provide research coverage, compensated its research analysts, in part, based on the degree to which they helped generate investment banking business, offered research coverage by its analysts as a marketing tool to gain investment banking business and failed to establish adequate procedures to protect research analysts from conflicts of interest. ''In light of these charges,'' Mr. Donaldson continued, ''your reported comments evidence a troubling lack of contrition and lead me to wonder about Morgan Stanley's commitment'' to complying with the law. Mr. Donaldson noted that the settlement required Morgan Stanley not to deny the allegations, and added that that requirement applied to Mr. Purcell. ''I caution you that the commission would regard a violation of that obligation as seriously as a failure to comply with any other term of the settlement,'' the chairman wrote. . . . NASD, the nation's largest self-regulatory organization, also expressed concern about Mr. Purcell's comments at the conference on Tuesday. A spokeswoman for NASD said: ''Chairman Donaldson's letter is clear. We share his concerns and we're in communication with Morgan Stanley about that meeting.''
I have found absolutely no indication that either Morgan Stanely or Mr. Purcell were sanctioned in any manner by the apparently outraged SEC, states, or NASD (now FINRA). 

Now, for some modern day regulation. 

The Financial Industry Regulatory Authority (FINRA) just announced that James Robert Kelly entered into an Offer of Settlement (2006005457801/March 2008) in which Kelly consented to the finding that he had failed to provide complete and timely responses to FINRA requests for information. He willfully failed to amend his Form U4 with material information, and filed an amendment to his Form U4 that included an optional comment regarding an AWC which constituted a public statement denying directly or indirectly an allegation in the AWC, and created the impression that the AWC was without factual basis, which was in violation of the terms of the AWC. Offers of Settlement and Acceptance, Waivers and Consent Agreements (AWCs) are entered into without admitting or denying the allegations, but consent is given to the described sanctions and to the entry of findings). 

In accordance with the terms of Kelly's Offer of Settlement, FINRA imposed upon him a $10,000 fine and an eight-month suspension.

Regulators must enforce the sanctity of their settlements. I fully appreciate the principle upon which Chairman Donaldson rebuked Purcell. Nonetheless, whatever James Robert Kelly did, it could not have risen to the enormity of the public comments by Morgan's CEO. At best, Kelly seems to have taken an ill-considered shot at his AWC. Not the smartest move in the world, but not exactly the stuff of headlines in the next day's news. And while the SEC, the states, and the self regulators could not have done much to stop Purcell from publicly dismissing the seriousness of their research case, FINRA could have read Kelly's proposed U4 amendment, sent it back to him with an admonition, and demanded that he promptly re-file a conforming update. 

Odd, isn't it? -- that the Kellys of Wall Street always seem to wind up getting fined and suspended for much the same misconduct that the CEOs of major firms merely get testy letters or telephone calls. I am oh so heartened that the SEC Chairman penned a nasty-gram to CEO Purcell, and that FINRA's predecessor (NASD) shared the SEC's concerns and was "in communication" with Morgan Stanley. It's nice to know that when you're really, really big on the Street that the regulators take the time to explain to you how upset they are--maybe even invite you downstairs for a Venti at Starbucks? 

All of which begs the question: Why couldn't FINRA have just communicated with Mr. Kelly rather than fine and suspend him? Is it because he wasn't deemed important enough for such consideration, or that as a little guy he got what he deserved? Either answer is disturbing. 

Word is that Congress is finally talking about overhauling our system of securities-industry regulation. Perhaps the House and Senate might consider the inequities of the Purcell and Kelly cases as a launching pad. For too long, Wall Street's "big fish" got all sorts of courtesies and considerations. The "small fry"--well, as the name suggests, they get tossed into the fire and eaten. Double standards aren't fair. And they certainly should not serve as the basis for effective regulation.