Tuesday, June 30, 2009

After Madoff, Fix the SEC and FINRA

While Bernard Madoff is sentenced to 150 years in prison for his Ponzi scheme fraud, let us not forget that an outrageous lack of oversight by FINRA and the SEC allowed a crime of this magnitude to occur and continue for many years.

Let us hope that Madoff's punishment does not end the oversight agency soul searching and revamping that must occur to prevent the recurrence of a fraud of a Madoff magnitude from happening again.

Madoff's crime is a simple form of affinity fraud. A gullible group with some cohesion, similarities and member trust is targeted, such as church groups, religious groups, ethnic groups, immigrant groups, etc. The fraudster relies on members of the group to introduce other members to the fraud. The referral among members of the group makes the job of the fraudster easier than if he targeted strangers.

The SEC has lots of experience with affinity fraud. Over the years, the SEC regularly targeted affinity group fraudsters, but usually those with a much smaller total dollar amount. As one example, see an SEC 1998 affinity fraud action here.

The oversight lapses at both FINRA and the SEC are responsible for the many year longevity of the Madoff fraud. As a simple example and certainly not the only issue with the regulatory agencies weaknesses, was that the agencies did not follow any simple audit procedures and verify any of the information supplied by Madoff or his firms, such as confirming the existence of any of the asset holdings or purported customer transactions.

It is not a question of an insufficient budget, inadequate staffing or a lack of leads. It is a structural and philosophical failure at the oversight agencies that allowed Madoff to defraud his investors over an extended period.

Unfortunately, there is nothing in the SEC chairperson (and former FINRA CEO) Mary Schapiro's background to indicate she has the knowledge or experience to change the culture of a large dysfunctional institution. As an example, see my previous post, "Time To Replace The US SEC."

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