Coalition Accuses Brokers and Insurance Agents of Spreading Misinformation

January 13, 2010

The other day I read a sharp-edged and tartly worded document from, of all places, an apparent coalition of

  • the North American Securities Administrators Association (NASAA),
  • the Consumer Federation of America,
  • the Certified Financial Planner Board of Standards, Inc.,
  • the Financial Planning Association, 
  • Fund Democracy,
  • the Investment Adviser Association, and
  • the National Association of Financial Planners Association. 

Not exactly the rabble of Wall Street.  The title of their position paper says it all: 

There They Go Again:
Brokers and Insurance Agents Are Spreading Misinformation About
the Senate Regulatory Reform  Bill's Fiduciary Requirement for Investment Advice

Wow --- and they say that I don't pull my punches? 

In case you haven't heard, there is a nasty fight brewing between

  • the broker-dealer community and the financial planning/investment advisers community; 
  • those espousing the historic Fiduciary Standard and those clinging to the Suitability Standard; and
  • FINRA (and its allies, most notably SIFMA) and the Financial Planning Coalition (the CFP Board, FPA, and NAPFA). 

This is not just a minor tiff between competing industry interests but a fight for the future of Wall Street.  Much is at stake. It may well be a fight to the death.

While a number of salvos have already been lobbed back and forth in this war, the signatories to the There They Go Again memorandum have raised the pyrotechnics up a notch. Consider this excerpt, an in-your-face haymaker at FINRA:

Myth: FINRA should be recognized as the SRO for investment advisers in order to eliminate the regulatory gap that led to its failure to detect the Madoff Ponzi scheme.

Fact: FINRA cannot credibly claim to have missed the Madoff Ponzi scheme because it lacked jurisdiction over Madoff's investment adviser operations. On the contrary, there was no Madoff investment adviser operation until 2006, when the SEC changed the rules governing commission-based discretionary accounts. Prior to that time, accounts of the type that Madoff purported to offer were deemed to be brokerage accounts exempt from regulation under the Advisers Act and thus squarely within FINRA's jurisdiction. Even after the rules changed, such accounts would have been subject to Exchange Act regulation and FINRA jurisdiction as brokerage accounts in addition to regulation as advisory accounts.

FINRA failed to uncover the Madoff Ponzi scheme because of its own internal failures. Specifically, Madoff lied on registration documents about the nature of his professional activities - claiming to engage exclusively in market-making and proprietary trading and to have no customers - and FINRA's inspection and oversight regimen was not sufficiently rigorous to detect the lie, even after articles in the personal finance media should have sent up red flags. While serious reforms of regulatory practices are needed at all the regulatory bodies with jurisdiction in this case, designating FINRA as the SRO for investment advisers is not the solution to this problem.

It's hard to believe, but it's over a year now since the Madoff scandal hit the press.  Way back on December 12, 2008, I published a blog titled: Madoff: Right Under FINRA's Nose and caught quite a bit of flack for being among the first to point the finger at the Financial Industry Regulatory Authority (FINRA).  For those of you familiar with this blog, you know that I have a penchant for calling it as I see it.  Here's what I said way back when:

[I]f a major player such as Bernie Madoff and his FINRA-member firm can pull off a multi-billion dollar scam right under the nose of FINRA, then of what value is that regulator?  And let me at least be blunt.  Madoff and his firm were no strangers to FINRA.  To the contrary, they were welcomed if not esteemed.  They sat on Boards, on committees--even on the National Adjudicatory Council that reviews enforcement matters.  Those folks had the ears of the powerful and likely helped formulate policy.

Everything I have read today and everything that I suspect that I will read in the weeks to come apparently went on right under the nose of FINRA.  When its staff did its yearly examinations, either things were disregarded, missed, or overlooked (and quite probably there was a fair deal of obfuscation by the firm as well). It will be interesting to follow the criminal case and see how much of FINRA's dealings with the firm was at arm's length and whether the judgments of many supervisors and executives was clouded by the knowledge that this was Bernie's firm.

I have said it far too many times, but now it bears repeating: Self-regulation is a failure.  What more proof can I offer than to point to this current cause celebre?  If FINRA couldn't detect this--when it went on right under its nose--then just how effective is this regulator?

I believe that the events of the past year have proven my December 2008 surmises and suspicions as being well founded.  While FINRA was not solely to blame for Madoff's ongoing fraud, and while FINRA may not have even been the most culpable of the regulators charged with policing Wall Street, certainly FINRA was not the blameless "victim" that its early spin efforts suggested.

For some two decades I have been a fairly lonely voice in the regulatory wilderness -- some have called me a gadfly.  I suspect that in some corners, the descriptions are far less kind.  Nonetheless, lately, I notice that the wilderness is getting a tad crowded and there is almost a hum of naysaying.