An irreverent Wall Street Blog
by Bill Singer
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Written: September 19, 2014

Action -- it's an interesting concept when it comes to both gambling and investing. Some folks love it. Crave it. Need it. Others are looking for a way to get better odds and make a quicker, bigger buck. If you find the action you're looking for, as with many things involving risk, sometimes you win, sometimes you lose. In a recent regulatory case, it seems that some public customers wanted the action offered by investing in real estate. Unfortunately, they got in around July 2007. Some historians posit the beginning of the real estate market crash around August 2007, after which that market would crater. 

Case In Point

For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority (“FINRA”), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Michael L. Gorman submitted a Letter of Acceptance, Waiver and Consent (“AWC”), which FINRA accepted. In the Matter of Michael L. Gorman, Respondent (2013036727501, September 10, 2014). 

In 1996, Gorman first entered the securities industry and from 2002 through May 2009, he was associated with Citigroup Global Markets, Inc. ("CGMI").

Strip Mall Action

The AWC alleges that in late 2006/early 2007, Gorman introduced two of his CGMI customers to a local property developer, who was also a customer of Gorman’s. The twio customers purportedly were interested in real estate investments and the developer was soliciting investments in a strip mall project. 

In July 2007, the two customers signed a limited partnership agreement setting forth the terms of their $250,000 investment in the developer’s strip mall project. Pursuant to those terms, the customers were to receive a 7% preferred dividend and a 40% equity stake. The agreement also stated that upon completion of the project, the partnership would seek an immediate buyer for the mall, after which 40% of the proceeds would be paid. If, however, no buyer was found, the two customers wold receive 40% of the cash flow. 

A Little Sumthin'

The developer allegedly paid to Gorman a $15,000 referral fee. Seems that Gorman not only failed to disclose his role in referring his two CGMI customers to the developer but, in addition, he also failed to disclose his acceptance of the fee. 

A Thud And A Crash

As these things tend to go (otherwise they generally don’t wind up in the BrokeAndBroker Blog), the mall did not get completed. On top of that, all hell broke lose as the financial markets cratered into the Great Recession. According to the AWC, the two customers complained in April 2013 to a successor firm to CGMI. I'm wondering, what took them so long. 

The AWC doesn't specify the date on which the project fell through, so we don't know if the developer was trying to get the deal done from 2007 until, perhaps,finally throwing in the towel sometime around April 2013; or, maybe the project had collapsed much earlier and the two customers were hoping for some settlement that eventually fell through. I think it would have been helpful for FINRA to offer a bit more explanation in that regard. The self-regulatory organization apparently didn't agree.


FINRA deemed that Gorman’s referrals of the two customers to the developer and his acceptance of a $15,000 referral fee constituted his participation in a private securities transaction; and, accordingly, he failed to provide written notice of his participation in the transaction to CGMI, in violation of NASD Rules 2110 and 3040. In accordance with the terms of the AWC, FINRA imposed upon  Gorman a  three month suspension in all capacities and a fine of $20,000 (which include a disgorgement of the $15,000 referral fee).

Bill Singer's Comment

You wouldn’t think that such a simple prerequisite as providing prior written notice to your employer FINRA member firm would trip us so many folks, but it does. Industry outsiders may wrongly perceive that the motivation behind such non-disclosure is nefarious with the intent to conceal all sorts of shenanigans from both the employer member firm and the regulators. Often — okay, yeah, quite often — that’s likely the reason for not telling the firm about the PST or outside business activities ("OBAs"). On the other hand, very often the non-disclosure arises out of a lack of awareness. Sometimes, the registered person just doesn’t view the cited conduct as a "securities" or a “business” activity. Sometimes the registered person was engaged in the PST or OBA before joining the firm and the need to disclose just never got recognized. Sometimes the broker-dealer was aware of the PST or OBA through numerous conversations and communications but the required “written” notice just never got sent in the proper form.

What a registered person sees as a business venture with absolutely no connection to his securities industry job, can easily result in all sorts of lawsuits alleging apparent or actual authority to act on behalf of the brokerage firm — replete with astronomical demands for damages accompanied by outlandish allegations. And even if the case is so much garbage, the brokerage firm may still need to peel off a lot of large denomination bills to pay a defense lawyer and to also deal with the ensuing regulatory demands for explanations.

NASD Conduct Rule 3040: Private Securities Transactions of an Associated Person

(a) Applicability

No person associated with a member shall participate in any manner in a private securities transaction except in accordance with the requirements of this Rule.

(b) Written Notice

Prior to participating in any private securities transaction, an associated person shall provide written notice to the member with which he is associated describing in detail the proposed transaction and the person's proposed role therein and stating whether he has received or may receive selling compensation in connection with the transaction; provided however that, in the case of a series of related transactions in which no selling compensation has been or will be received, an associated person may provide a single written notice.

(c) Transactions for Compensation

(1) In the case of a transaction in which an associated person has received or may receive selling compensation, a member which has received notice pursuant to paragraph (b) shall advise the associated person in writing stating whether the member:

(A) approves the person's participation in the proposed transaction; or

(B) disapproves the person's participation in the proposed transaction.

(2) If the member approves a person's participation in a transaction pursuant to paragraph (c)(1), the transaction shall be recorded on the books and records of the member and the member shall supervise the person's participation in the transaction as if the transaction were executed on behalf of the member.

(3) If the member disapproves a person's participation pursuant to paragraph (c)(1), the person shall not participate in the transaction in any manner, directly or indirectly.

(d) Transactions Not for Compensation
In the case of a transaction or a series of related transactions in which an associated person has not and will not receive any selling compensation, a member which has received notice pursuant to paragraph (b) shall provide the associated person prompt written acknowledgment of said notice and may, at its discretion, require the person to adhere to specified conditions in connection with his participation in the transaction.

(e) Definitions
For purposes of this Rule, the following terms shall have the stated meanings:
(1) "Private securities transaction" shall mean any securities transaction outside the regular course or scope of an associated person's employment with a member, including, though not limited to, new offerings of securities which are not registered with the Commission, provided however that transactions subject to the notification requirements of Rule 3050, transactions among immediate family members (as defined in Rule 2790), for which no associated person receives any selling compensation, and personal transactions in investment company and variable annuity securities, shall be excluded.
(2) "Selling compensation" shall mean any compensation paid directly or indirectly from whatever source in connection with or as a result of the purchase or sale of a security, including, though not limited to, commissions; finder's fees; securities or rights to acquire securities; rights of participation in profits, tax benefits, or dissolution proceeds, as a general partner or otherwise; or expense reimbursements.


Written: September 19, 2014

This is an update of "USA To Gibralter To Cayman Islands Software Scam" ( Blog, March 17, 2014).

It's the stuff of Hollywood meets Silicon Valley meets Ponzi. We got music and movies. We got Internet and software. We got a Bernie Madoff/Jordan Belfort scamster. Then we got a hot trail of cash that flows from the USA to a number of small islands with ever-so friendly banking regulations. It's rip-off and intrigue.

A Little Diversion

From 2004 through November 2008, Robert Kelly, the Chief Executive Officer of software developer Wwebnet Inc. falsely solicited investors about his company's development of software for transmitting music, videos, and movies over the Internet. Instead of legitimately using at least $2.11 Million in investor proceeds, Kelly diverted a substantial portion of the money that he raised for his own financial benefit. 

Land Of Make-Believe

Not merely content to mislead his investors, Kelly falsely told Wwebnet’s Chief Technology Officer that the start-up had some money shorts preventing him from allocating funds for the necessary software development. In time, when the buck came in, Kelly told the CTO that the project would be funded but, for now, the team was told to work only on software program demos --  prototypes to show off the look and feel of what investors thought was ready to roll out. Of course, you know, we don't exactly have to highlight the fact for our financial benefactors that the demos can't actually deliver any entertainment content at this time. In the future. When we get the hard cash. Let's just do what we can with what we got. For now.

Island Intrigue

Once Kelly got his victims' funds, the trail of those millions is the stuff of a Hollywood thriller. We start with the transfer from Wwebnet into a Gibralter bank account. From the island of Gibralter the dollars are sent to a Cayman Islands account. At this point, do the investors' funds get placed into the touted software development?  Not that it's a spoiler alert but waddya think? Surprise, surprise, surprise -- Kelly uses the funds in the Cayman Islands account for his own options and futures trading, which didn't go all that well because by May 2008, that account had a zero balance. 

IRS Gets Paid

Not merely content with ripping off his investors and converting their funds for his trading, Kelly also used his victims' money to pay his federal and state personal income taxes.  Hey, at least he feared the Internal Revenue Service. 

Crash And Burn

On October 02, 2012, pursuant to the unsealing of a criminal Complaint, Kelly was charged with one count of securities fraud and one count of wire fraud, each of which carries a maximum potential penalty of 20 years in prison. In addition, Kelly faces a maximum fine of $5 million or twice the gross gain or loss from the offense for the securities fraud count, and a maximum fine of $250,000 or twice the gross gain or loss from the offense for the wire fraud count. Kelly was subsequently indicted on November 28, 2012. USA v. Robert Kelly (SDNY, 12-CR-888 November 28, 2012).

On March 11, 2014, Kelly, 57, plead guilty in federal court in Manhattan to one count of securities fraud and one count of wire fraud. Also, Kelly agreed to forfeit $2,111,600 and pay $2,111,600 in restitution. Sentencing is scheduled for July 2014.

READ the full-text Indictment: USA v. Robert Kelly

Also READ:

On September 18, 2014, Kelly was sentenced to 27 months in prison and three years of supervised release; and ordered to pay $2,111,600 in forfeiture and $2,111,600 in restitution, as well as a $200 special assessment fee.


Written: September 18, 2014

The Securities and Exchange Commission's ("SEC's) human lightning rod, Commissioner Daniel M. Gallagher, is at it again -- and he's got my attention (as usual).This time, the commissioner is asking questions about the so-called self regulation of Wall Street and even though I suspect that we disagree on the ultimate conclusion, I give him credit for striking the flint and starting the fire.  

Self Regulatory Crossroads

According to content posted on the SEC's website: "Remarks at the 2014 SRO Outreach Conference" (September 16, 2014), Commissioner Gallagher reminded his audience that (footnote omitted):

At the January 2012 SRO Outreach Conference, I stated that we were at a crossroads with respect to the status of self-regulation. I posed fundamental questions to the audience, such as whether we should continue to have exchanges with statutory self-regulatory responsibilities when the vast majority of those responsibilities have been outsourced to another SRO and whether the Commission should impose limits on the ability of SROs to contract with others.

Well, we’re still at that crossroads, and the questions discussed at that conference are still pressing today. . .

As readers of the Blog know, I am an outspoken and long-time opponent of the current form of self regulation on Wall Street. As I noted a few months ago in "SEC Commissioner Gallagher Takes A Sledge-O-Matic To Wall Street Regulation" ( Blog, May 16, 2014):

Troubling for me is Gallagher's foray into the creation or perpetuation of the whole self-regulatory organization ("SRO") construct for the RIA community. My inference is that he appears to favor an SRO for RIAs, and I fear that he may be leaning towards some role for FINRA as the solution. 

BrokeAndBroker Blog readers know that I believe the current form of Wall Street self-regulation is a failure and should be abandoned. Similarly, I do not believe that FINRA has been an effective SRO, and I see no laudatory track record commending FINRA as a candidate to take on an even more expansive regulatory docket pertaining to an industry with which it has virtually no experience. If Commissioner Gallagher is leaning towards expanding FINRA's reach into the RIA community, he is terribly mistaken. Hopefully, he will keep an open mind on this issue. 

Still -- I have to compliment Gallagher for not shying away from controversy and having the guts to wield his sledge-o-matic down upon far too many sacred compliance procedures and sacrosanct regulatory policies.

Breathing Life Into Dinosaurs?

Given my above commentary, I read with great interest Commissioner Gallagher's observations that he shared with attendees at the September 16, 2014 conference:

In doing so, we must evaluate the SROs and markets as they are today and acknowledge that, in many cases, SROs today are fundamentally different from what Congress conceived of as self regulation decades ago. The circumstances under which the self-regulatory framework was put into place almost eighty years ago - private, mutualized, self-regulating exchanges and a simple association of dealers – no longer exist.

The fact that the majority of the equities exchanges outsource their SRO obligations and market surveillance to FINRA, for example, calls into question the very meaning of the SRO concept as it exists today. There are benefits that arise from the consolidation of oversight in a single entity with access to market data from transactions on multiple exchanges. With the majority of exchanges subject to FINRA’s rules, market participants know what to expect in the event of disciplinary action, and a single arbitration regime facilitates the dispute resolution process.

For all these advantages, however, we still need to ask whether this is the optimal solution. Indeed, we need to ask whether exchanges that outsource their regulatory responsibilities to FINRA are still SROs at all, or whether they’ve instead effectively become FROs – FINRA-regulated organizations. A related question is whether the benefits of rule standardization amongst exchanges are canceled out by the lack of a competition of ideas among exchange regulatory regimes contributing to the development of best practices.

And as for FINRA itself, we need to ask whether it has inappropriately exceeded its mandate, or is simply evolving with the markets. Regardless of the answer, we need to consider what that means for both the SEC and SROs. This is especially pressing as we continue to consider the possibility of subjecting investment advisers to self regulation. Although FINRA has ceased to actively pursue the possibility of expanding its mission to encompass IAs, were Congress to pursue new legislation to establish an investment adviser SRO, the conversation would inevitably turn to FINRA as a possibility again.

In addition, as I have noted in the past, leveraging the current resources and expertise of broker-dealer SROs to serve as third-party examiners for investment advisers examinations could greatly facilitate our ability to examine “dual-hatted” investment advisers without having to rely on Congressional action to create a new investment adviser SRO out of whole cloth.

Regardless of the path we ultimately end up taking to strengthen our examination program for investment advisers, one thing is clear: an “SEC-only” approach would not work for investment advisers any more than it did for broker-dealers. In other words, the answer is not to exponentially expand the SEC staff by adding a brigade of new investment adviser examiners when there are third parties that could perform that role.

. . .

The fact that the investment adviser industry has operated without SRO supervision offers an opportunity for what could be considered a control experiment: two regimes alongside one another, one with SROs, one without. Even as we continue to ponder whether that situation needs to be changed, we should compare and contrast the two industries to better examine some of the strengths and weaknesses of self-regulation. We certainly must do this before even considering a fiduciary duty rulemaking for brokers.

Bill Singer's Comment

Some of Commissioner Gallagher's points I like -- some, however . . . well, let's just say that I respect the evolving nature of his opinion and will wait and see where he ultimately comes down.

On the plus side, he certainly has it right when he warns that the self-regulatory organization construct, which was promulgated in the late 1930s, must now be held up to the light of the evolved modern day markets. As Gallagher properly cautions, many of the circumstances that existed when the SRO legislation and regulation were created, no longer exist. All of which calls into question whether the very premise of self regulation is valid in this age of high frequency trading, the rigging of the FOREX and LIBOR markets, and an explosion in market manipulation and insider trading.

Commissioner Gallagher and I clearly part company when it comes to the nearly monolithic (and paleolithic) nature of Wall Street self regulation, which, these days, has essentially been reduced to FINRA. Gallagher waxes somewhat fondly about the "benefits that arise from the consolidation of oversight in a single entity with access to market data from transactions on multiple exchanges. " In contrast, I worry about a regulatory monopoly that suffocates regulation through a lack of competition and dampens innovation. 

I have had and continue to play multiple roles on Wall Street. I started out in-house in the legal department of Smith Barney, Harris Upham & Co. I then became a regulatory attorney for both the American Stock Exchange and NASD (FINRA's predecessor). My next job was as an in-house lawyer for a mutual fund complex and investment advisory firm. Finally, I became a Series 7 and 63 registered representative and also entered the private practice of law, where I have represented industry participants, defrauded public investors, and, more recently, whistleblowers.  Given the panoramic perspective of a three decade career that has taken me to all sides of the table, I objectively take issue with Gallagher's inference that the consolidation of the SRO landscape into FINRA and only FINRA fosters a healthy expectation by market participants when it comes to "disciplinary action, and a single arbitration regime . . ." To the contrary, there has been more than enough evidence that the unhealthy concentration of SRO power into one organization has resulted in the: 
  • uneven discipline between smaller and larger members;
  • disenfranchisement of registered men and women in the SRO process; and 
  • ability of FINRA member firms (who are the only enfranchised participants in FINRA's rulemaking and election processes) to compel mandatory arbitration upon public customers and industry personnel.
I would urge Commissioner Gallagher to very, very carefully consider the legacy we have inherited from an emasculated SRO landscape dominated by one, and only one, SRO in the form of FINRA. Perhaps he does not fully appreciate the ramifications in his musings:

Although FINRA has ceased to actively pursue the possibility of expanding its mission to encompass IAs, were Congress to pursue new legislation to establish an investment adviser SRO, the conversation would inevitably turn to FINRA as a possibility again.

Inevitably? What, may I ask, is FINRA's impressive track record that it should be the "inevitable" SRO for investment advisers?  Has the good commissioner reviewed FINRA's track record with Madoff or Stanford?  Has the commissioner reviewed FINRA's history of internecine warfare with its "small" member firm community?  And, please, remind me of all the effective pre-emptive regulation that this purportedly vaunted SRO implemented that helped hold back the devastation of the Great Recession

SIDE BAR: For a more detailed consideration of my antagonism towards FINRA's assumption of the role as the investment adviser SRO, see "Crony Politics Of Congress Wants Crony Regulation Of Investment Advisers" ( Blog, June 4, 2012).

The danger with Commissioner Gallagher's proposed regulatory experiment, however, is that it gets rigged.  You know, like LIBOR, like FOREX, like the municipal bond markets -- rigged. First you rig the qualifications to bid. Then you rig the request for proposals. Then you rig the selection system. When it comes time to bid, we are left with a carefully tailored pool of only one qualified candidate. That anointed bidder then runs up the costs and in the absence of competition, often screws up the program under consideration. Going forward, vested interests in Washington, D.C. will draft legislation eviscerating meaningful reform and embed crippling exemptions within thousands of pages of unread provisions. 

In the end, the investing public and industry inherit legislation based upon a wink and a knowing nod from folks who inevitably wind up with lucrative seats on the boards of regulatory organizations that they mandated or they wind up in the employ of corporations they protected -- and, to boot, those who play the game often find ways for their family and friends to wind up with high-paying consultancies and no-show jobs.Oh my, how the politicos and the lobbyists in our nation's capital love to experiment. See, for example: "Lap Dances, The World Series, And A Highway Bill" ( Blog, August 20, 2014). 

I always get nervous when folks in political and regulatory leadership advocate for monopolies or unhealthy concentrations of power rather than the robust competition that is the very basis for the capitalism upon which Wall Street was built. The clash of ideas in the marketplace is the bedrock principle of our economy.  When the private sector or the government wrongfully interferes with competition, when steps are taken to unfairly weight one side of the scales against the other, when we suck the air out of any industry by exalting one player among all others, that is a danger against which we must all rally.  That is my fear and that is why I will oppose any effort to make FINRA the self regulatory organization for the investment adviser community.

I urge Commissioner Gallagher to get out the needle and thread necessary to do the bespoke tailoring needed to create a new investment adviser SRO. I would suggest that a 21st Century solution for a 21st Century marketplace is a far better route than trying to cobble together the failures of 20th Century legislation and regulation into yet another half-assed nightmare of a bloated Washington, D.C.-based bureaucracy. Sometimes, we need to get out the whole cloth rather than attempt another round of alterations.

Notwithstanding our considerable disagreements about FINRA and the viability of self-regulation, I still give Commissioner Gallagher credit for raising the testy and unpopular issue about an investment adviser SRO, and for suggesting an experiment in regulation for the investment adviser industry.  His plays a very valuable role and one that has been absent from the SEC for too long.


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