The investment portfolio of the Financial Industry Regulatory Authority (FINRA) benefited from insider trading, according to Larry Doyle, author of In Bed with Wall Street: The Conspiracy Crippling Our Global Economy.
FINRA is “Wall Street’s private police force”
“The documentation I put forth (in the book) going back to 2003 provides significant support to that accusation of insider trading,” Doyle said in an e-mail statement to ValueWalk. Doyle says FINRA is really “Wall Street’s private police force,” a private corporation documented to be owned by the major banks that regulates markets to the benefit of their ownership while engaging in enhanced prosecution of smaller firms, he says.
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Doyle makes these charges, all documented in the book, as a man coming from inside an industry. As a former JPMorgan Chase & Co. (NYSE:JPM), UBS AG (NYSE:UBS), First Boston and Bear Stearns mortgage backed-securities trader – you know, the instruments of mass destruction that blew up the economy in 2008 – Doyle has a unique insight into Wall Street. But Doyle isn’t blowing the whistle out of spite. In the book he says he “loves Wall Street” and wants to help clean up what is considered an environment of Wall Street “lawlessness,” as major hedge fund manager Paul Singer recently described it. Ignoring the problems and providing cover to criminal activity is part of the problem that will only encourage further criminal activity.
Doyle makes many salacious charges, pointing to specific independent proof to support his charge of a Wall Street conspiracy. The author tackles issues typically discussed in whispers behind the scenes, including how certain people are “blacklisted” for speaking up and how FINRA targets people it regulates with an eye towards big bank objectives. This includes the charge a whistleblower testifying about big bank knowledge of fraud was told by committee investigators not to reveal damning information against top management; how top FINRA regulators have personally enriched themselves by allowing the big banks to operate with a separate standard of justice; but most ominous is the charge of insider trading to benefit FINRA’s investment portfolio, estimated at $2 billion.
How is it that a regulator has a $2 billion portfolio invested with companies they regulate?
What’s a stock market regulator doing with an investment portfolio it manages itself? It is more than odd that a stock market regulator, charged with policing the largest hedge funds, banks and brokerage firms, manages an investment portfolio and makes trading decisions on its own – investing with the same banks, hedge funds and in the same markets it regulates. Doyle charges that FINRA is given special consideration and information before the general public.
But you won’t get much information from FINRA on the matter, Doyle writes, as they aren’t talking. As a private organization, they are not subject to Freedom of Information Act requests, Doyle notes, they don’t respond to requests for information and Congress doesn’t appear interested in asking tough questions.
ARS market risk disclosure insufficient
At issue are interest rate products called Auction Rate Securities (ARS) that were marketed to individual investors as a liquid, cash-equivalent investment with a slightly higher yield suitable for retirement accounts. The truth was very different. They were highly risky and non-liquid investments – a wolf in sheep’s clothing.
Jefferson County bonds underneath “low risk, highly liquid” securities sold into retirement accounts
One somewhat humorous example of a “safe” ARS investment were the highly controversial structural bonds of Jefferson County, Alabama – bonds that had a maturity of 2042. Jefferson County imploded under the weight of the credit default swaps packaged by JPMorgan Chase & Co. (NYSE:JPM), as somewhat famously profiled in Rolling Stone Magazine, now held up as a classic example of criminal fraud in the SWAPs market. JPMorgan agreed to pay fines in the case, but charges of bribery of a pubic official didn’t make the cut. This is an example of what was underneath the “ARS” securities, considered risky by Doyle based on an objective formula to measure risk he proposes in the book. How ironic that the securities initially outed as a fraud were repackaged as part of what Doyle characterizes as a “Ponzi scheme?”
“FINRA knew that the securities themselves were not cash equivalents, even though they were marketed as such by Wall Street,” Doyle writes.
ARS market freezes but the market timers inside FINRA didn’t get hurt
Just like the mortgage derivatives were to implode in less than 10 months, on February 14, 2008, Valentine’s Day, a surprise to some: the ARS market froze and money could no longer come out of the now worthless investments. Investors who didn’t get out just before the crash were irate. They had been sold a bill of goods, but according to Doyle should not have been surprised.
“Disguising risk is an art form on Wall Street,” the Wall Street insider Doyle writes, and then makes a logical recommendation for hedge fund risk disclosure that would end many of the typical shenanigans. Breaking down the complexity to simplicity is unlikely to be adopted because it would eliminate the competitive advantage owned by the large banks, and this leads to a critique of the book. What Doyle suggests will never make it as regulatory policy — the suggestions are too simple and transparent. Wall Street fraud thrives like a mold in the complex, opaque shadows. What Doyle proposes no longer gives the most sophisticated banks a market advantage; it would be too effective, that’s why it won’t be implemented.
ARS is “Ponzi scheme bigger than Madoff”
The ARS market is no exception. Here the Wall Street banks were primary buyers in a thin market and had artificially manipulated outcomes, Doyle charged. What they had done now was withdrawn their offers to buy and pulled the rug out of what he calls a “Ponzi scheme bigger than Madoff.” After investors lost their capital there was a regulatory response against the banks, who were required to pay a $13 million fine without admitting or denying guilt. Doyle says FINRA acts as a “meter maid,” handing out a nuisance fine that was only a small fraction of the revenue generated while bringing down the hammer on smaller firms.
FINRA pulls 1/3 of its investment portfolio before crash
With the new year, 2008 underway and approaching Valentines’ Day, the SWAPs derivative market was shaky — and warnings were delivered to regulators. For instance, Hank Paulson, then Treasury Secretary, provided the Bush Administration a warning that the SWAPs could implode the economy — and the US Federal Reserve had received similar warnings. It is unclear if warnings were passed to regulators, although whispers were known to abound.
The SWAPs being underneath the ARS market was really the first warning for the coming derivatives implosion that had been predicted by former CFTC Chairwoman Brooksley Born.
When the ARS market collapsed, not all investors were caught off guard. A select group of institutional insiders were able to exit the market before the rug was ripped from under general investors. But traditional hedge funds were not the only insiders to exit early. FINRA, which regulated the ARS market and invested $650 million, over 1/3 of its portfolio, in ARS was smart enough to take their own money off the table months before the collapse.
It’s hard to predict the exact date of a collapse, but structure deficiencies can be identified that lead to signs of a collapse. Born, for instance, didn’t know when the SWAPs market would collapse, she just knew with opacity and fraud at the center of an investment product, it would implode at some point.
In a statement to ValueWalk, FINRA denies the charges of insider trading, saying it exited the market six months before the collapse. “FINRA sold its ARS investments more than six months before the market started becoming unstable,” said FINRA spokesperson Michelle Ong in an email statement. “Any suggestion that anyone could have possibly known what would happen months later is simply unfounded.” Doyle attacks the six month timeline, citing public documentation to suggest otherwise and in part points to a Bloomberg report that says the market exit occurred “less than six” months before the crash. Nonetheless, Doyle thinks FINRA should exhibit transparency in the matter. “Open your books and records on ARS securities,” he demanded.
“If they had these securities, they had to know the market was in trouble,” Ed Dowling, the owner of a clothing manufacturer in New York City, said in the Bloomberg report referring to FINRA. Dowling is an individual investor who had $2.25 million of auction-rate securities he couldn’t sell after the market crashed. In the Bloomberg report FINRA claimed not to know the market was poised to weaken, and the regulator didn’t issue its first guidance for investors caught in the debt on March 31, 2008, more than a month after the failure rate rose to about 80 percent and nearly 7 months after they withdrew 1/3 of their investment portfolio.
While FINRA didn’t know the exact time the market imploded, they did exit the market and didn’t bother to warn ordinary investors. This leads Doyle to ask in the book if FINRA is nothing more than “crooked cops on the take?”
FINRA is “casino cop” with eye in the sky and chips on the table, says Doyle
But here’s where the questions get interesting: did FINRA receive special treatment or information when dealing with the banks on their own investments, as Doyle plainly states? “The cops in the financial casinos,” Doyle writes, “were not only manning the eye in the sky and walking the floor, but they also had a seat at many of the tables with their own chips in the game.”
Deterrence is badly needed, and avoiding the problem only makes it worse
As incredible as it sounds that a Wall Street regulator even has a $2 billion investment portfolio and is accused of utilizing inside information and connections to improve performance, that’s not all. Tomorrow ValueWalk will detail how an investigative committee asked a whistleblower not to implicate a major bank executive, how the private stock market regulator magically avoids questioning and how the system needs to be changed to generate real confidence in the markets. (Hint: the solution involves government sending the only message of deterrence that Wall Street will understand: handcuffs.)
Michael Lewis has accused Wall Street of being “rigged,” but he’s really just scratching the surface, as Doyle outlines in this excellent book.