FINRA: Looking 'Where the Sun Don't Shine'

April 3rd, 2014
in econ_news, syndication

Econintersect:  There are continuing stories about the abysmal record of FINRA (Financial Industry Regulatory Authority) in the area of protection for individual investors.  An article yesterday (01 April 2014) in On Wall Street ('Should Dozens of FINRA Arbitration Cases be Reopened?') is just one of the most recent disclosures of a regulation process that seems focused on protecting the interests of investment firms and ignoring abuse of retail investors and individual employees and representatives of the firms.


Follow up:

Protection for Individuals a Masquerade

Last weekend (29 March 2014) Barron's carried an article which focused on whether FINRA was justified in "collecting details on 70 million brokerage accounts daily".  This was not a complaint about abusing the privacy of individuals, however, but was made by the Securities Industry and Financial Markets Association (SIFMA), "Wall Street's most muscular trade and lobbying association".  Ira Hammerton, executive vice president and general counsel for SIFMA is quoted:

"Why should the government -- I will put Finra under the government's umbrella -- conduct a mass-surveillance program monitoring all of your financial transactions, your personal information related to those transactions, the movement of funds in and out of your brokerage accounts? Why is this an essential government service?"

Econintersect would suggest that this is a disingenuous statement of concern for individuals and is merely covering a self-serving objection to an encumbrance on the operations of Wall Street firms.  As such it is simply a further manifestation of the armor-plating of investment firms masquerading as a concern for individuals.  As the Barron's article stated:

FINRA has a well-deserved reputation for catching small-fry scoundrels and letting big dogs run wild.

When Mark Mensack, whose arbitration case has been covered by GEI News and is discussed further later in this article, was asked about the Barron's article today, he told Econintersect that statement from SIFMA was missing a great deal of relevant information:

While it is reasonable for Mr. Hammerton to classify FINRA as "government," there is a huge caveat. Unlike a government agency, FINRA is not subject to the Administrative Procedures Act; therefore, unlike a government agency, Americans have no protection from FINRA's abuse. In FINRA's Motion to Dismiss my federal lawsuit, despite the proven acts of fraud, FINRA argued that it was not possible for FINRA to have violated my civil right to due process because it was not a government agency.  Perhaps worst of all, the US Supreme Court, in Standard Chartered v. FINRA,  ruled that FINRA is immune from prosecution.

After FINRA failed to take notice of multi-billion dollar Ponzi schemes run by Bernie Madoff and R. Allen Stanford they instituted a Comprehensive Automated Risk Data System (Cards).  This system conducts brokerage firm data sweeps to look for suspicious account activities such as "churning, excessive charges, pump-and-dump schemes, and investments not suited to a customer's risk profile".  This activity, presumably one of the objects of concern by SIFMA, has been endorsed by the Consumer Federation of America.

Arbitration as Fraud

Arbitration is a process accepted by investors and employees with brokerage firms for the settlement of disputes as a requirement for opening an account or accepting employment.. The On Wall Street article enumerates several arbitration cases that showed instances of blatant and gross misconduct by arbitrators.  GEI has covered one particular case where a whistleblower, Mark Mensack, was forced to take his revelations to an arbitration panel which, not surprisingly, did not uphold his complaints, but also ruled that he must return compensation he had received from from his employer, forcing him into personal bankruptcy.  See Whistleblower Taken to the Woodshed by FINRA (GEI News) and an Op Ed review of the case by Mark Mensack himself (GEI Opinion).

As documented by Larry Doyle in his book, In Bed With Wall Street: The Conspiracy Crippling Our Global Economy, financial regulation in general is rife with corruption and he offers FINRA as one of the most blatant examples.  Among the examples of malfeasance involving FINRA, Doyle includes the Mensack case.  It turns out that the outcome in Mensack's case (found in favor of Morgan Stanley) was not the only case of this type.  Mensack told Econintersect today about the case of Leyla Wydler (also mentioned in Doyle's book):

FINRA arbitrators ignoring evidence and ruling against whistleblowers is not unique.  Leyla Wydler is the woman who blew the whistle on the Stanford Ponzi Scheme. Because she refused to sell investments she believed to be fraudulent, Stanford fired her and then filed against her at NASD arbitration. (FINRA's predecessor.)  What's worse is that Leyla's arbitration took place in 2004 - 5 years before Stanford was arrested!   Perhaps it's FINRA's arrogance, Leyla's 2004 decision is still publically available at FINRA Arbitration Awards Online   (Search Case #03-02025 or Leyla Basagoitia) (Leyla's senate banking committee testimony).

Another well known whistleblower, Henry Markopolos, avoided FINRA altogether when filing his complaints about Bernie Madoff, dealing only with the SEC (which ignored him, but that is another story).  As quoted later in this article, Markopolos has labeled FINRA as corrupt.

For investor complaints referred to arbitration, less than 25% of losses are recovered and more than half of the cases are resolved in favor Wall Street.  Doyle says the cases resolved in favor of the investor are largely small cases against smaller broker-dealers.  Most large cases are resolved in favor of the firm.  It s a clear pattern of might makes right.

Arbitrators Committing Fraud

Not only is the arbitration system a fraud, the arbitration panelists themselves have been found to commit fraud.  Mensack details the fraudulent billing by arbitrators in his case.  The Welsch article (On Wall Street) tells of an arbitrator who falsified his credentials on the application to become an arbitrator.  Also, Welsh describes a case in which key evidence for the investor complaint were disallowed by the arbitration panel.

One of the more astounding events in this history occurred in the Mark Mensack case when key sections of the recorded transcript of his hearing were missing from the files that were available after the hearing closed.  A scene right out of the Watergate script.

Official Corruption

FINRA is an industry self-regulating organization, although many refer to it as an agency, inferring some government connection.  As a representative for the securities brokerage business, it would not be unreasonable for them to consider their mission to keep member firms hands clean.  If such were their objective then the record established makes sense.  The fact that employees and investors have fared so poorly in the FINRA arbitration system is consistent with FINRA as an industry "reputation enforcer".

Thus FINRA could be described as a wolf in sheep's clothing.  But that is perhaps far too kind.  Former investment banker William D. Cohen wrote in Bloomberg (12 January 2012):

But it just isn't right that the only way the millions of people who work at banks or do business with them can resolve their disputes is through a kangaroo arbitration system overseen by Wall Street itself.

He wrote further:

This requirement [agreeing to arbitration in lieu of tort], which affects millions of people, may be the largest ongoing abdication of legal rights in America today.

Congressional testimony by Massachusetts Secretary of State William Francis Galvin in 2005 said that the arbitration system should be reformed to put investors' interests on the same level as those of Wall Street.  He mentioned that a few small fines had been levied against brokerage firms for withholding documents from arbitration proceedings.

But no fine or other regulatory tinkering will address the more fundamental flaw of the so-called arbitration process - namely, that it's run by the industry and for the industry.  The system is unfair.

Galvin characterized the system as it exists as

... an industry-sponsored damage containment and control program, masquerading as a juridical proceeding.”

But famous Madoff whistleblower Henry Markopolos may have summarized it best:

"I'd give the SEC an A+ for incompetence and FINRA an A+ for corruption."

When asked today about all these notable characterizations of FINRA, Mark Mensack told Econintersect:

Dozens of other advisors have contacted me with stories of arbitrators ignoring concrete evidence against brokerage firms, and  ignoring the fact that the brokerage firm did not own the promissory note on which suit was based. How is this any different than banks foreclosing on homes when they did not own the mortgage?  One of the most egregious is where FINRA arbitrators ruled against a former Morgan Stanley advisor despite the testimony of the former Morgan Stanley Complex Manager who he had recruited testifying on his behalf.  There is no question that William Galvin was accurate when he said that FINRA arbitration is "an industry-sponsored damage containment and control program, masquerading as a juridical proceeding."

Statute of Limitations

So why aren't all the apparent mistakes by arbitration panels corrected?  It's all part of the arbitration agreement.  Findings are final and cannot be appealed after 90 days from a ruling.

All these cases are filed where the sun don't shine, along with other similar material.

John Lounsbury


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