The brokerage industry’s self-policing body must make reforms to protect investors after its inspections failed to uncover the massive Ponzi scheme run by Bernard Madoff and the purported fraud by R. Allen Stanford, according to a special review.
The special committee’s review recommends that the Financial Industry Regulatory Authority’s brokerage examination program be revamped to ensure that detecting and preventing fraud are central elements.
FINRA lacks a central database for its examiners with investors’ complaints about firms, so staff members missed numerous “red flags” on Mr. Stanford’s firm, according to the review released Friday.
The Securities and Exchange Commission’s stunning failure to detect Madoff’s fraud for nearly two decades, despite numerous warning signs raised by outsiders, has brought the federal agency widespread criticism and pressure to revamp itself. The SEC inspector general found that the agency bungled five investigations of Madoff’s business between June 1992 and last December, when the prominent financier confessed.
Earlier this week, the inspector general issued recommendations for the SEC to avoid another breakdown, including a new system for handling the thousands of tips and complaints the agency receives.
FINRA’s internal review, begun in April, was conducted by outside attorneys led by Charles Bowsher, a former U.S. comptroller general.
The organization is developing a reform plan based on the recommendations to be presented to its board in December, FINRA Chairman and CEO Richard Ketchum said in a letter Thursday to the SEC, which oversees FINRA.
FINRA already has taken steps to strengthen its regulatory program, including improving its routine examination programs, Mr. Ketchum said.
The special committee also recommended creating a fraud detection unit within FINRA to ensure that exams involving significant allegations get high priority — something the organization’s management plans to establish.
In addition, FINRA is hampered by limits on its authority, the review said. FINRA can’t expand its oversight beyond brokerage firms to other investment operations. The organization made periodic exams of Madoff’s brokerage operation, but the fraud was carried out through Madoff’s investment business.
FINRA has suggested that Congress expand its jurisdiction.
FINRA’s failure in the Madoff case also shows the need to improve exchanges of information between FINRA and the SEC, the review found. The SEC didn’t share with FINRA the tips it received from outsiders on Madoff’s operation.
Madoff, who pleaded guilty in March, is serving a 150-year sentence in federal prison in North Carolina for what could be the biggest Ponzi scheme in history.
In the Stanford case, FINRA received credible information from at least five different sources between 2003 and 2005 alleging that the certificates of deposit sold by Mr. Stanford’s Caribbean-based bank were potentially fraudulent, the review found. They included a five-page letter from the SEC’s Fort Worth, Texas, office in July 2005 explaining in detail why the high returns being paid on the CDs couldn’t be made with the investment strategy the bank said it used.
Mr. Stanford is in jail awaiting trial on charges he ran a $7 billion Ponzi scheme by promising huge returns on CDs from Stanford International Bank on the island of Antigua. Investors were promised the CDs were safe.
Mr. Stanford has pleaded not guilty. His next court hearing is Oct. 14.