SEC funding, SRO debates rekindle Madoff blame game

When the House of Representatives takes up an appropriations bill this summer that includes funding for the SEC, at least one lawmaker almost certainly will bring up the $65 billion Bernard Madoff fraud case to justify denying the agency the funding that it seeks.

That would rekindle a heated debate over which regulator — the Securities and Exchange Commission or the Financial Industry Regulatory Authority Inc. — is to blame for letting him perpetrate his Ponzi scheme for years.

Key Republicans place culpability with the SEC, an argument that rankles investment advisers, who contend that there is plenty of blame to go around and note that Mr. Madoff didn't register as an investment adviser until 2006.

“EVERYBODY BLEW IT’

“He had a broker-dealer. Everybody blew it with him,” said David O'Brien, president of O'Brien Financial Planning Inc.

“Finra didn't find him,” Mr. O'Brien said. “The SEC did.”

In House Appropriations Committee deliberations last month, Rep. Jo Ann Emerson, R-Mo., defended a $50 million increase to the SEC's $1.32 billion budget for fiscal 2013 — $195 million less than the commission requested — by saying that it doesn't deserve more money.

She criticized “stovepipes” at the agency that prevented the sharing of information in databases that might have allowed the SEC to catch Mr. Madoff's scheme earlier.

“I don't believe we should be throwing money at the SEC at this time,” Ms. Emerson said in a June 20 meeting of the committee, just before it approved the SEC funding proposal and sent it to the House floor.

This parsing of Madoff blame comes up over SEC funding and the related debate over a self-regulatory organization for investment advisers.

In promoting his bill, which would establish one or more SROs, House Financial Services Committee Chairman Spencer Bachus, R-Ala., explicitly stated that the SEC fumbled regarding Mr. Madoff. Mr. Bachus argued that an SRO would strengthen investor protection by significantly increasing the number of adviser exams performed annually over what the SEC can do.

“Finra regulated the broker-dealer sides of Madoff. It was the investment adviser side where the fraud went on,” Mr. Bachus said at a June 6 hearing.

“So [Finra] could not regulate that,” he said. “That was up to the states and the SEC where that fraud took place.”

Peter Chepucavage, general counsel at Plexus Consulting Group LLC, disputes that characterization.

Mr. Madoff's fraud “happened in the broker-dealer,” Mr. Chepucavage said.

Finra is the SRO for brokers.

Mr. Chepucavage also noted that the SEC should have looked more carefully at Mr. Madoff's registration as an investment adviser.

JURISDICTION QUESTION

“No question — the SEC missed it,” Mr. Chepucavage said. “But Finra missed it also.”

In January 2009 testimony before the Senate Banking Committee, Columbia University law professor John Coffee said that Mr. Madoff's brokerage firm fell within the jurisdiction of Finra and NASD, Finra's predecessor.

Finra should have reviewed internal controls at Madoff's firm, which shouldn't have been able to stiff-arm Finra inspection or information requests, according to Mr. Coffee.

“I express no view on whether the NASD or Finra necessarily should have uncovered the Madoff fraud, but I reject as overbroad the claim that they had no jurisdiction or reason to inquire,” Mr. Coffee said in prepared testimony.

Finra didn't have jurisdiction over Mr. Madoff's investment adviser business, said Michelle Ong, a spokeswoman for the SRO.

A 2009 report by a Finra special-review committee concluded that the agency's reach should be extended to allow it to enforce the Investment Adviser Act of 1940 for firms dually registered as broker-dealers and investment advisers.

“Mr. Madoff's fraud highlights how our current fragmented regulatory system can allow bad actors to engage in misconduct outside the view and reach of some regulators,” Ms. Ong wrote in an e-mail.

The continuing blame game helps create the atmosphere for the SRO legislation, which hasn't yet been scheduled for a vote in the House Financial Services Committee.

“His name is the symbol of people feeling vulnerable to fraud,” Erin Baehr, owner of Baehr Family Financial LLC, said of Mr. Madoff.

Allocating blame for his actions brings up another sore point for investment adviser advocates. They say that Finra has avoided congressional scrutiny.

WEAK OVERSIGHT

While Finra chief executive Richard G. Ketchum testifies in front of congressional committees regarding the agency's views on policy issues, Finra itself has never been the subject of regular oversight hearings, according to David Tittsworth, executive director of the Investment Adviser Association.

“No one has looked at NASD/Finra in the same way that they've looked at the SEC,” he said.

Finra spokeswoman Nancy Condon suggested that Mr. Tittsworth was critical of Finra because he opposes the SRO bill.

“Mr. Tittsworth is a lobbyist trying to keep his industry from having appropriate regulation,” she said.

Even the SEC has come under criticism for its oversight of Finra. In a recent report, the Government Accountability Office called on the SEC to more carefully track the effectiveness of Finra rules and analyze the agency's compensation practices.

Finra is the chief proponent of Mr. Bachus' bill and is promoting itself as the logical choice for the adviser SRO, which is strongly resisted by most investment advisers, who want the SEC to remain their regulator.

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Related Topics: Financial Industry Regulatory Authority, Securities and Exchange Commission