WASHINGTON — Wall Street’s self-regulatory body that self-admittedly failed to detect 2008’s major financial scandals has a plan to not miss the next one. The Financial Industry Regulatory Authority is touting its new fraud team as the key to spotting another Bernard Madoff.
“Before now, there wasn’t as organized a program,” says Cameron Funkhouser, the long-time FINRA sleuth now chosen to head the additional department, dubbed the Office of Fraud Detection and Market Intelligence. FINRA CEO Robert Ketchum had announced the program in October, but until now few details were known about its structure and deputies.
The 114-person department is separate from the enforcement and market regulation offices of FINRA, which bring cases and perform examinations. But the new department has been given near carte blanche to pursue fraud after FINRA missed the multibillion dollar Ponzi schemes of Madoff and Allen Stanford, whose broker-dealers were registered FINRA members and under its supervision.
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According to an internal document and details from Funkhouser, he has four deputies to lead the team:
- Tony Cavallaro, based in New York, a former Manhattan district attorney,
- Sam Draddy, a former Baltimore county criminal prosecutor and former Securities and Exchange Commission branch chief,
- Paul Lane, a former Manhattan district attorney and SEC staffer,
- Joe Ozag, a former Capitol Hill detective who has worked with FINRA for 10 years.
“I’ve been encouraged to pursue anybody who’s engaged in fraud, with unfettered access to sources with industry connections,” Funkhouser said.
The new fraud detection team pulls together the insider trading, fraud referral group and office of whistleblower, the last of which was created in March of last year to handle “high-risk” tips from investors. Together, those groups referred 400 to 500 cases for enforcement action last year, and 150 through the first quarter of this year, according to FINRA.
The new department may prove effective in recognizing some frauds that are more difficult to spot, like Ponzi schemes, according to Brian Rubin, a partner at Sutherland Asbill & Brennan.
“To the extent that FINRA can focus resources on fraudulent activity, I think it will help them uncover more incidents of fraud than they have in the past,” said Rubin, who was former deputy chief counsel of enforcement at the National Association of Securities Dealers, FINRA’s predecessor.
Critics remain
But at a time when the whole of the financial services industry is being questioned, from practitioners to regulators, FINRA has not been immune to the ire.
The Project on Government Oversight – a private non-profit group whose mission is to expose corruption in private business and federal government — harshly criticized FINRA in a seething February letter to Congress and subsequent blog posts for its failure to prevent and detect fraudulent activity and has urged action to fix or overhaul FINRA.
FINRA said POGO’s letter had “numerous inaccuracies and misperceptions” and said that the two organizations had never spoken.
The Securities and Exchange Commission is charged with overseeing FINRA, which is a private organization not required to fulfill Freedom of Information Act requests. Part of POGO’s argument is that taxpayers pay for SEC’s oversight of FINRA and other self-regulators, but do not have the ability to look into regulatory shortcomings.
FINRA has also been criticized for being too close to the industry it is supposed to be keeping an eye on, and the exit of two its senior enforcement officials has raised some eyebrows.
One of the recently departed, FINRA’s head of enforcement Susan Merrill, has left for the corporate law firm Bingham McCutchen, according an announcement from the firm on Monday. Merrill was widely criticized for lax enforcement during her tenure.
Robert Errico, the head of member regulation, also left full-time employment at FINRA last month, but he remains in a consulting arrangement until his replacement is found. Errico was responsible for ongoing surveillance and annual examinations of broker-dealer firms.
FINRA has not yet replaced Merrill and Errico, said FINRA spokesman Herb Perone.
The announcement that Merrill was going to Bingham, also the professional home of former SEC Chairman Chris Cox, spurred more fury.
“This just confirms for us the overly cozy relationship between FINRA and the securities industry,” said Michael Smallberg, an investigator for POGO. “The longer they’re serving at FINRA, the more lax they become in enforcement of the people they’re going to eventually work for.”
Self regulation under scrutiny
Sweeping financial regulatory reform legislation currently working its way through Capitol Hill addresses the issue of self-regulatory bodies like FINRA.
The House’s plan for financial reform passed in December and requires the SEC to evaluate the effectiveness of self-regulatory bodies.
“We are, in general, skeptical of self regulation and self-regulation organizations, having been through the financial crisis, and we do not favor this approach going forward,” House Banking Committee communications director Steven Adamske said in an e-mail.
The Senate bill, which is still pending, proposes that the SEC conduct a study in part to evaluate FINRA’s methods.
POGO also wants Congress to address perceived connections and conflicts of interests between the regulators and the regulated.
For his part Funkhouser, previously in the market regulation department, says he’s never had his investigative pursuits influenced by any other part of FINRA or by any subject of investigation.
Perone says that a common misconception is that FINRA is run by and paid for by the industry and in some sense works for them. He points out, however, that FINRA’s “members” are not voluntary. Any person who wants to engage in the securities industry has to register with FINRA, “otherwise you’re not in business,” Perone said.
SEC does a regular inspection of all self-regulated organizations. The last time there was formal action was in 1996, which was against NASD, FINRA’s predecessor.
Funkhouser says that when the SEC makes a recommendation, FINRA adopts it almost without fail.