Month: March 2009

For much of last week, going into the current one,
Gary Odom of Nashville, the leader of the Democratic Party in the state House of
Representatives, was experiencing a dramatic reversal of fortune. Suddenly
endangered were not only the laurels he seemed to have won by engineering the
election of Democrat-friendly East Tennessee Republican Kent Williams as House
Speaker but, indeed, Odom’s own position of party leadership.

A rebellion swelled up in House Democratic ranks,
ostensibly over remarks made by Odom during a visit to Memphis weekend before
last. Led mainly by close allies of former House speaker Jimmy Naifeh but
including also Democrats close to Odom himself, like fellow Nashvillian Mike
Turner, the party’s caucus chairman in the House, the challenge was based on two
matters: What Odom said about the origins and timeline of Williams’ ascent to
the Speakership, and what he said about Naifeh’s legacy as Speaker.

The two issues conflate in the sense that both
concern Naifeh’s role. On the question of how Williams came to be Speaker, not
only Odom but several specific others – including, importantly, Williams himself
– concurred from the beginning that Naifeh knew nothing of the Williams ploy
until 5 p.m. the evening before the vote. Until then Naifeh was by all accounts,
including his own, still preoccupied with trying to round up votes for himself.

At the height of last week’s furor, Turner and state
Representative John Litz of Morristown, a Democrat and Williams confidante, held
a press conference in which they outlined a counter-theory, one in which Naifeh
had been an active collaborator in the maneuver which would see Williams cast
his own vote, along with those of 49 Democrats, to overcome Republican House
leader Jason Mumpower, who had expected to gain the Speakership in a chamber
which had a 50-49 Republican edge after last fall’s election.

On the surface, it would seem that the two extant
chronologies are inconsistent with each other , though there are some who argue
– a la left hands not knowing what right hands are doing – that the rival
versions are compatible. The meta-issue would seem to be whether Naifeh comes
off better as somebody who helped mastermind the Williams coup or as somebody
who stayed free and clear of a plot which still riles partisan anger.

The other point of contention regarding Odom
concerned the wisdom of his having offered opinions in Memphis regarding what he
saw as the negative effect of Naifeh’s erstwhile support of income tax proposals
on party fortunes and the need for Democrats to chart a different course
regarding that still tender subject.

Perhaps Leader Odom was indiscreet in having so
spoken (to a handful of political adepts at an after-hours gathering following a
formal reception for Williams and himself with local Democrats), and perhaps he
regarded his remarks – though not accompanied by “off the record” or “between
you and me” or any of the usual disclaimers – as meant privately rather than
publicly.

In any case, there was nothing inherently either
treasonous or disrespectful about what he said, and, as somebody who strongly
opposed income-tax legislation back during the legislative wars of the late ’90s
and early 2000’s, and as somebody who now has a position of influence within his
party, Odom may have both a right and duty to espouse a different view on the
issue than once prevailed in Democratic ranks.

Reality and protocol both dictate that Gary Odom
now make amends and pay some kind of public homage to the distinguished Jimmy
Naifeh, whom – it is well known – he considered challenging for the speakership
had the Democrats maintained their House majority. But that is not the same
thing as needing to backtrack on his political philosophy or his views
concerning his party’s proper political tactics.

Odom’s fellow Democrats elected him to a
leadership role two legislative sessions ago in search of an aggressive,
alternative mode. It would be ironic indeed if he should now be penalized for
supplying it

UPDATE Leader Odom apparently met with the Democratic caucus Monday night and apologized directly to Naifeh. He also apparently attempted to maintain that the Flyer‘s account of his remarks in Memphis were inaccurate in some way. This is untrue and unacceptable, and proofs are likely to be forthcoming.

Back when the Madoff scandal was “hot off the presses,” my faithful readers may recall I did a piece in The Flyer online entitled “As You Reap’ — The Meaning of the Madoff Case.” In it, I examined the role and responsibility of securities regulators in failing to catch that scam before it exploded. And, while I acknowledged the SEC’s responsibility for ignoring the “red flags” (whistle blower Harry Markopolos tried to give them for several years), I also highlighted what I thought was the culpability of another, lesser-known, regulator in the mess, namely FINRA, the Financial Industry Regulatory Authority, the so-called “self-regulatory organization,” or SRO, which has the responsibility for overseeing the nation’s brokerage firms and their employees.

I mentioned, among other things, that FINRA ignored warning signs at the Madoff entity that was registered with FINRA, and pointed out the cozy relationship Madoff and his family members had with the regulator. Markopolos himself told the House committee he testified before that, while he considered the SEC to be incompetent (NOTE: politicized, neutered, maybe; but incompetent, unh-unh), the reason he never tried to sic FINRA on the Madoff apparatus was that he considered FINRA to be corrupt and beholden to the industry it regulates. So, which would you rather be if you were in the regulation business, incompetent or corrupt?

But, of course, very few focused on FINRA’s responsibility for the Madoff disaster, preferring to focus on the SEC’s. Maybe that’s because it’s more than just FINRA who are beholden to the securities industry. Or maybe it’s because no one wanted to rain on the parade of Mary Schapiro, FINRA’s CEO, who was in the process of being appointed as the next chairman of the SEC, in spite of a poor track record during her tenure there. FINRA even tried, incredibly, to suggest it had no jurisdiction over the Madoff entities, but, as anyone who knows that Madoff ran his scam out of his registered broker-dealer will tell you, that claim won’t pass the “yuh, right” test.

Well, now we have yet another investment scam of similarly biblical proportions to Madoff’s, namely Stanford Financial, and guess what? FINRA is, once again, up to its eyeballs in responsibility for failing to ferret out the fraud that was going on at that member firm, even though it knew about some of it as early as six years ago.

Let me, briefly, detail FINRA’s role in the regulation of the securities markets, because, unlike the SEC, FINRA flies, for the most part, under the public’s radar as a watchdog of those markets, and yet is equally (and sometimes more) pivotal to the SEC in that role. FINRA is the successor to the National Association of Securities Dealers (NASD). The NASD was formed, in 1934, as part of the regulatory reform that resulted in the federal securities laws and the formation of the SEC following the excesses in the securities markets that contributed to the “crash” of 1929 (is this a deja vu moment, or what?). The NASD also used to run the securities market known as the NASDAQ, which is now an independent entity. NASDAQ is the little brother to the other stock exchanges, like the “Big Board” (the NYSE), and lists the stocks of over 3,000 companies who, for one reason or another (typically the number of shareholders and level of capitalization) aren’t qualified to be listed on the Big Board.

In 2007, FINRA was formed from the merger of the NASD and the regulation and enforcement functions of the NYSE. It is the entity responsible for licensing and overseeing the country’s 5,000 “broker dealers,” and the nearly 700,000 licensed brokers who work at those “BDs.” It has 3,000 employees and a budget of nearly $700 million (by comparison, the SEC employs 3,500 and has a budget of $900 million). FINRA conducts regular examinations of its member firms, and promulgates (subject to SEC approval) and enforces the rules and regulations those firms and individuals are required to comply with. It has virtually plenary authority over the firms and individuals it licenses, including the ability to fine them, and to suspend or revoke their registrations.

FINRA is a strange hybrid. It is a nongovernmental entity, but it has a regulatory, policing function. It regulates and polices itself, hence its characterization as a “SRO.” You will have to look far and wide for another industry that is allowed to police itself, and for good reason. We’ve seen how ineffectual the financial and securities industries have been at policing themselves lately.

FINRA has another important function, which most investors are also unaware of (though more will become aware of in the fallout of Wall Street’s latest excesses). It manages a system of “alternative dispute resolution,” under which customers who have grievances against their brokers are required to bring those disputes to FINRA for resolution by means of arbitration. So, when you, as a customer, open an account with a securities firm, you sign a document that relinquishes your right to have your day in court if he defrauds you. I’m guessing you didn’t know that. Instead, you must file your claim with FINRA, which is then heard by a panel of (typically, three) arbitrators, at least one of whom is a member of the very industry your broker comes from. I have served (but do not, any longer) as a so-called public (i.e., unaffiliated with the securities industry) arbitrator, and have represented clients in such arbitrations.

Not surprisingly, the results of these securities-industry-run arbitrations are predictably bad for the customer, with fewer than 40 percent of the arbitrations resulting in a finding in favor of the customer, and a process of choosing arbitrators that is skewed in favor of the broker. Yet another example of how FINRA is an apologist for the industry it supposedly regulates.

Now, getting back to Stanford: FINRA, it turns out, had Stanford on its radar screen for years. It also turns out that, as early as 2003, a former Stanford employee
warned FINRA that Stanford was running a Ponzi scheme, as the SEC has now alleged in its amended complaint against the firm and others. The infraction by Stanford that should have gotten the most attention from FINRA, and that bears most directly on the cause of the current scandal, the apocryphal CDs, occurred in 2007. FINRA found, back then, that the unit of Stanford that was registered with it as a broker dealer (Stanford Group), and through which the CD’s that are at the heart of the current scandal were issued:

…failed to present fair and balanced treatment of the risks and potential benefits of a CD investment … and [provided] misleading, unfair and unbalanced information [concerning CD investments

Talk about a smoking gun! So, what did FINRA do about this discovery? Why, it fined Stanford a grand total of $10,000, without even requiring it to admit it had done anything wrong, and sent it on its way to, as it turned out, continue “misleading” investors.

A year earlier, Stanford committed an infraction of FINRA’s rules that could (and should) have resulted in the suspension of its license to do business. FINRA found that Stanford;

… failed to establish and maintain a supervisory system reasonably designed to achieve compliance with applicable securities laws, regulations and NASD rules …

and that, most seriously of all, it:

“conducted a securities business while failing to maintain its required minimum net capital.”

Violation of the net capital rule (i.e., having enough capital to assure a firm’s financial responsibility) is one of the most serious infractions a securities firm can commit, and can result in shutting down its operation. In this case? Once again, a fine (this time a whole $20,000), and again, with no requirement that it admit it had done anything wrong. “You were bad boys, Stanford; now run along and rob people of their life’s savings.”

And to cap off all this “Keystone Koppery” by FINRA, it turns out that, just as Mr. Madoff and his family were FINRA insiders, so, too, were some of Stanford’s executives.

All of which is to say that there is more than enough blame to go around for the Madoff and Stanford scandals, and that the system of regulation of the securities markets, to the extent it relies on the “honor system” of self regulation, for which FINRA is the poster child, needs to be seriously re-examined and substantially overhauled. As a regulator, FINRA has shown itself to be an abysmal failure. Its reign must end.