By Bill Singer
In recent days, we've seen all sorts of allegations launched against Wall Street's regulators by defrauded public investors and by more than a few industry firms and registered persons. At the heart of many of these grievances is a nuanced complaint: It's not that you regulators aren't working--no, to the contrary, you always seem involved in make-work. We're furious because you seem to relish going after minor miscues at the expense of focusing on major fiascos; and, even when you seem to have lined up the target in your sights, your shot goes way off the mark.
In essence, the SEC and FINRA seem to have gotten down the art of baiting the hook-- if not quite catching the fish and bringing it on board.
Consider this recent case that seems to underscore so much that frustrates regulatory pundits.
In the Matter of the Application of CMG Institutional Trading, LLC and Shawn D. Baldwin (Securities Exchange Act Rel. No. 59325, Admin. Proc. File No. 3-12994/January 30, 2009) http://sec.gov/litigation/opinions/2009/34-59325.pdf , the Securities and Exchange Commission considered an appeal of an NASD case in which CMG, an NASD member firm, and its president Baldwin were found to have violated NASD Procedural Rule 8210 by failing to completely and timely respond to the self-regulator's demands for information. The SEC confirmed the findings and sustained the sanctions of a two-year suspension and a $25,000 joint and several fine.
CMG was a $5,000 introducing broker-dealer that was informed in September 2005 by SEC staff that it had insufficient net capital under Rule 15c3-1. In response, Baldwin promised to contribute $75,000 in good capital. As early as October 13th, the SEC Staff informed Baldwin that proof of the promised capital contribution had not been received. In response, CMG represented to the Staff that it had received a $3 million capital contribution, which it listed on its balance sheet as due from FX Trading LLC (a foreign exchange dealer registered with the National Futures Association (NFA) and the Commodity Futures Trading Commission (CFTC). Moreover, CMG produced a corporate resolution designating the $3 million as permanent capital; and also noted that a Proprietary Account of Introducing Broker Agreement (PAIB Agreement) with FX Trading provided that the assets in that account would be used to meet its net capital requirements.
Things appeared to begin to unravel during an October 20, 2005, meeting during which Baldwin gave the SEC Staff a purported printout from FX Trading's website that showed the $3 million in CMG's account--however, the Staff thought that the produced document was doctored with an extra digit. What then followed were attempts by the Respondents and SEC Staff to contact FX Trading. That didn't go well for either the member firm or the regulator. In response to that frustration, it seems that NASD complained to NFA, which eventually suspended FX Trading on November 21, 2005. It didn't stop there. December 8, 2005, by order of the U.S. District Court for New Jersey in response to a CFTC request, the assets of FX Trading were frozen.
Now, back to CMG.
Starting on November 29, 2006, NASD sent a Rule 8210 request for documentation of the source of the $3 million net capital contribution referenced above. Frankly, Net Capital is a critical cog in the regulatory machinery and among the most pressing concerns for NASD (now FINRA) Staff. Given that fundamental role of Net Capital, one can only wonder what went through Baldwin's mind when he fired off this very testy response to NASD:
[T]he $3 million came from an account from me. That's at FX. Prior to . . . that is, quite frankly, none of your business. It came from another account from me, but I'm not going to share that with you because I don't think you've been the most scrupulous of people. So I'll send you the account information that I have at FX, and I will send you the account information for [CMG] and you'll see that it comes from the Shawn Baldwin account to CMG.
As a frequent defense lawyer for NASD/FINRA respondents, I share the annoyance and at times outrage of many independent/regional firms and their employees when they are forced to deal with document/information requests that seem compounded for no other legitimate purpose than to harass -- and which are frequently accompanied by such unfairly short production timeframes as to infuriate those who were satisfied to merely gnash their teeth at the substantive requests. Still, if only Baldwin had bit his tongue or deleted the message prior to sending.
On April 18, 2006, the Department of Enforcement filed a Complaint charging that Baldwin and CMG failed to respond to written requests for information, in violation of Rules 8210 and 2110. The Hearing Panel found that Enforcement failed to prove that Respondents failed to respond to an 8210 request concerning an Exit Conference Report; however, the panel did find that Respondents failed to fully respond to another 8210 net capital request. The hearing panel expelled CMG from membership and barred Baldwin. On appeal, the NASD National Adjudicatory Council (NAC) reduced the expulsion/bar to two-year suspensions in consideration that Baldwin had provided some information.
In confirming the dismissal of the Exit Interview allegations, the NAC clearly rebuked the Staff 's preparation and presentation of its case (See, at Page 9 of NAC Decision) :
Moreover, we find troubling the contradictory statements given by Enforcement's witnesses with respect to respondents' failure to respond to the final disposition letter. The differing responses from Enforcement's witnesses, coupled with the confused nature of the FINRA examiner's testimony, raise considerable questions concerning the accuracy of Enforcement's general assessment that respondents did not respond completely to the requests...
There seems to have been an appreciation at both the NAC and SEC appellate levels that NASD Staff may have been a tad hasty in loading for bear with the presentation of its initial case against CMG and Baldwin. Cooler heads may well have prevailed and while the facts don't necessarily scream out for "Not Guilty," one wonders whether this case could have and should have been settled for something less than the originally demanded expulsion and bar (which were overturned at the NAC and the reduced sanction sustained by the SEC).
All of which leads us back to the growing chorus of criticism against Wall Street's regulators. This case took three to four years to reach its final adjudication. Add up the allocation of NASD and SEC staff and time. Keep in mind that Bernard Madoff was cruising along untouched during this time. Which leads you to wonder how much of this case was payback for Baldwin's perceived slights, and was this a worthwhile utilization of time and resources? Ultimately, we'll just never know. I'll leave that for more academic debates.