The Human Factor On Wall Street

June 14, 2018

A Personal Note from Bill Singer, Esq
Publisher of the Blog
in response to
"A Suicide on Wall Street"
( Guest Blog / June 13, 2018)

Before I became a lawyer, I was the third generation of my family in the wine business. Sometime in the early '70s, I came across a wonderful quote by the late oenophile Andre Simon that I believe was from his book "The Noble Grapes and Great Wines of France":

There is a great deal in common between us and our wines. Wines enjoy, just as we do, the gift of life, a loan rather than a gift since it is ours and theirs for a short time only; and all wines are, as we are, liable to sickness and doomed to death. Most wines are quite ordinary wines, as most of us are quite ordinary people. There are, unfortunately bad wines, as there are bad people, but not nearly so many as the publicity given to crimes leads one to believe.

Whether I was mopping floors and carrying cases of booze in a liquor store, or pursuing my profession as a second-career lawyer, I rarely came across an individual who got up each and every morning with the desire to do wrong and cause harm. Not saying they don't exist. They do. I've defended them. I've sued them. Having been on Wall Street since 1982, it has been my experience that the overwhelming majority of the men and women in our industry are honest, decent, dedicated, and professional. That goes for regulators, back-office and compliance staff, lawyers, stockbrokers, traders, and everyone else that makes the Street work. Some of those folks are exceptional, like a rare, great vintage wine. Some are crooks and scoundrels like Maderized wine. Somewhere in the middle are those of us who do our jobs and earn a living -- the table wines of our daily life. 

As a vocal critic of many aspects of Wall Street regulation, I complain when industry regulators unfairly charge compliance staff for an alleged failure to supervise without taking into account the so-called "human factor." What is the human factor? It is that lapse of time during which men and women on the front-lines of compliance are trying to understand what the hell is going on -- what does it mean, what do I need to do? Compliance isn't a video game that you can replay or restart if you lose. You don't get to press CTRL-ALT-DEL and the crisis is frozen in time and you can re-boot back to a clean start. 

Sometimes the best we can do is the best we can do, and often that may prove too little, too late. 

Not every problem has a solution.  

If you come up with a solution, it is often via trial and error. The trial part no one cares about. The error part is what invites your bosses and the regulators to criticize your actions.

In discharging their mandate to protect the investing public and police the industry, regulators need to ensure that reasonable supervisory policies and procedures are in place so that compliance staff isn't forced to make it up on the fly as problems emerge. Effective in-house compliance depends upon having IFTTT (If This Then That) protocols in place before problems arise. Untimely and untested compliance responses often exacerbate problems to an extent that can destroy the brokerage firm and devastate its customers. All of which is why industry compliance departments are the first line of defense and why industry regulation is not about giving second chances. The business of compliance and regulation is not a game. It is a deadly serious profession. Sadly, in the story related by "A Former NASD Employee," death won.

What gets under the skin of many compliance staff is when, months later, a regulatory examiner or investigator waltzes into a broker-dealer and wags a finger about what should have (or should not have) been done. It's not that the regulator's conclusion is wrong: often it is spot-on. The problem is that the conclusion was made after staff sat in a quiet conference room, surrounded by the boxes of documents that you assembled, and they munched on a donut and sipped a cup of coffee. Not exactly how events unrolled when the compliance department was trying to put out a fire as all hell broke loose. On top of that, when the shit hit the fan, you still had to deal with all the daily crap that came across your desk. You had to deal with the dirty looks from management, who told you to simply "make it go away." You had to counter-punch with some jackass top producer or trading-desk honcho, who took every opportunity to remind you to see the bigger picture, to be a team player -- and, for good measure, told you that they made ten times what you did and would destroy your career if you threw them under the bus. No . . . you weren't dipping donuts into a hot cup of Joe when everything was melting down. 

Sure, a regulator's hindsight usually comes with 20/20 vision, but that leisurely look-back never takes into account the dirty little secret of Wall Street that most compliance departments are understaffed, underpaid, and over-worked. 

When the nit-picking pressures from the regulators and the paycheck threatening pressures from the employer become too much, many dedicated Wall Street compliance professionals quit. Which opens the door for folks who are less dedicated, less professional, and more willing to look the other way. As "A Former NASD Employee" related in his email to me, both he and his friend cared deeply about what they were doing. That either one of them could have acted quicker or should have done something different is not an excuse to grind them up for the sport of it. Supervisory mistakes should not automatically command fines and suspensions. Such a counter-productive response socially engineers the good folks out of compliance. 

"A Former NASD Employee" shoves our faces in the toilet bowl and makes us hold our breath as we struggle. It's not a pretty picture. We have an industry where good people often find themselves at bad firms. Some say that's part of the problem. Good folks shouldn't work at bad firms. Good folks shouldn't rationalize how they are furthering fraud. Good folks shouldn't prop up dishonest firms and low-life stockbrokers. 

Then again, how many conservatives worked at the Securities and Exchange Commission during the Obama Administration? 

How many progressives are working at the SEC during the Trump Administration? 

One's values and one's paycheck have an odd way of balancing the scales. You can get through a lot in life if you hold your nose and close your eyes. It happens among regulators. It happens among compliance staff. It happens everywhere.

In the 1990s, the NASD self-regulatory-organization countenanced anti-consumer, anti-competitive conduct by market makers. Worse, NASD closed ranks with its largest market makers and engaged in unprincipled, retaliatory regulation. None of which could have gone on without the assistance of regulatory examiners, investigators, and lawyers who knew better and kept silent. The good folks at the NASD didn't quit. They didn't speak out. They didn't blow the whistle. It was no better a culture than the worst boiler-room. During those days. I represented confidential informants who were cooperating with the government's investigations of alleged price-fixing and market rigging. I participated in NASD disciplinary hearings where NASD staff lied about what they knew and what they were doing. As noted in 1996 by the SEC in its 21(a) Report

A primary focus of the investigation was whether the NASD had adequately carried out its obligation under the Exchange Act to oversee the Nasdaq market and the conduct of its members.  The investigation identified a number of serious deficiencies in the NASD's performance of its duties as a self-regulatory organization ("SRO"), especially as they relate to oversight of the Nasdaq market.  The NASD failed over a period of time to conduct an appropriate inquiry into an anti-competitive pricing convention among Nasdaq market makers, even though the NASD knew of facts and circumstances evidencing such matters by 1990. In addition, the NASD failed to enforce vigorously significant rules applicable to its market maker members.  These rules included the firm quote rule-[2] -- and the trade reporting rule,-[3] -- both of which are crucial to the fair operation of the Nasdaq market.
The investigation revealed that the Nasdaq market has not always operated in an open and freely competitive manner. Nasdaq market makers have engaged in a variety of abusive practices to suppress competition and mislead customers.-[4]- 

See Pages 3-4 of 21(a) Report

In the two decades since both the SEC and the Department of Justice took Nasdaq, NASD, and 24 market makers out to the woodshed, we should still remember the words of then SEC Chair Levitt, who stated in part in "Statement by Chairman Arthur Levitt, U.S. Securities and Exchange Commission, Press Conference Regarding the NASD (August 8, 1996)

So Congress arrived at a formula in which the industry polices itself, with SEC oversight.  This keeps us out of most day-to-day affairs, and allows us to keep our hands off, but our eyes open.  And on those rare occasions when self-regulation goes off track, the SEC must act in the public interest. 

This is one of those occasions.  

I will state it simply and up front.  We have found a widespread course of conduct among market makers to coordinate their quotes.  Investors paid too much, and received too little, when they bought and sold stock on Nasdaq.  New traders were, as a matter of course, trained in this fashion.  Over time, this practice became the expected standard.  In some instances, those who did not comply were harassed and penalized, even if they had acted in the best interest of investors. 

This culture of collaboration subverted the price mechanism and curtailed competition.  It raised the cost of capital and undermined market efficiency.  It hurt investors and damaged the reputation of Nasdaq. 

Where was the NASD, the cop on the Nasdaq beat?

The NASD was not blind to these practices in the marketplace.  It simply looked the other way. 

As the issue of the pricing convention was brought to the attention of the NASD, as the press and others raised it with increasing frequency, the NASD sounded no alarm; it conducted no investigation. 

Nor was the pricing convention the only unacceptable practice.  The NASD failed to ensure the accuracy and fairness of quotation and transaction information -- the backbone of  securities trading. It failed to apply certain rules to its members, and selectively enforced rules against others. The NASD allowed the interests of large market-making firms to have undue influence over the conduct of its affairs and the regulation of its market.

The evidence -- gathered from hundreds of witnesses, thousands of hours of tapes, and more than a million pages of documents -- shows that the NASD did not fulfill its most basic responsibilities -- and I quote from its charter: to promote just and equitable principles of trade for the protection of investors. On the contrary, American investors were hurt -- large and small, sophisticated and inexperienced, institutional and individual -- all were hurt by these practices.

Nor has the SEC emerged unscathed.  To the extent these practices took place on our watch, we should have acted sooner. We, as well as the NASD, need to be faster and more vigilant, to assure that the public interest is protected.

Here we are, some 22 years since the historic censure of NASD and Nasdaq. What has always fascinated me is that not a single NASD Board member, executive, lawyer, investigator, or examiner was personally charged or fined or suspended. Imagine that! Sure, the SEC imposed a Censure on NASD/Nasdaq and required the organizations to clean up their act but not one man or woman at the regulatory organization was charged with failing to supervise. That is in sharp contrast to the experience of the lowly compliance officer, who gets fined thousands and suspended for weeks for similar misconduct.  

You may dismiss my NASD/Nasdaq references as an old story about old misconduct involving a bygone Wall Street -- a tale told by an idiot, full of sound and fury signifying nothing. I would argue that past is prologue and the shameful legacy of the federal government's tepid 1996 responses to the grotesque failure of self-regulation still troubles our industry. The double-standard, the hypocrisy remains embedded in the relationship between the regulator and the regulated. Those who know better and should do better in regulation get away with failures to supervise that would upend the careers of their counter-parts in the very industry that they oversee. It may partially explain why those in regulation don't quite understand the pain and anger of those they regulate. 

No, I don't think that the folks at FINRA have blood on their hands as "A Former NASD Employee" said. I want to make that clear. On the other hand, I do understand why the guest blogger feels that way. My hope is that yesterday's "A Suicide on Wall Street" and my remarks today will raise the consciousness of the folks who work at FINRA. I know many at FINRA will scoff at that notion and may have already dismissed "A Former NASD Employee" as a malcontent, disgruntled, former colleague. FINRA staff should take note, careful note, however, that both the author of "A Suicide on Wall Street" and his friend were former NASD regulators. They were one of you. There but for the grace of God . . .

In conclusion, my hope is that yesterday's and today's blogs will prevent further tragedy. My desire is that, at long last, we begin a belated dialog between regulator and regulated; that we all understand the need to do our respective jobs with dignity and integrity; and that we take a moment to say a prayer for one soul on board who did not make it back home. 
For those of you who still don't quite understand the "human factor," please watch this video clip from the film "Sully":