Speakers examine broker-dealers in post-Madoff world
By CHRIS GAETANO
Trusted Professional Staff
Speakers at the Foundation for Accounting Education’s Broker/ Dealer Conference on May 9 illustrated how the fallout of Bernie Madoff’s multi-billion dollar Ponzi scheme has changed the rules for broker-dealers in the post-Madoff landscape, beginning with how such schemes are being recognized and identified as suspicious.
When Madoff’s scheme eventually came to light, resulting in 11 felony convictions and a 150-year prison sentence, the crime created a “backlash from a regulatory perspective and an industry,” said speaker Jeffrey Abramczyk, a member of the Stock Brokerage Committee. Madoff was only one factor in what Abramczyk called a “perfect storm of regulatory compliance and change,” which was also driven by an overhaul in risk management practices in reaction to the financial crisis.
Once such change subjects investment advisers with signing authority over client assets to surprise inspections, regardless of whether they exert direct control, said Abramczyk. The inspections are performed by a public accounting firm and confirm that the assets under their management actually exist, under a provision put into place by the Securities and Exchange Commission in 2009.
The SEC also implemented a program, through the Public Company Accounting Oversight Board, to inspect auditors of broker-dealers, in response to the workpapers of Madoff auditor David Friehling, which conference presenter Steven N. Garfinkel said were “negligible at best.”
“This was the first aspect of responding to the Ponzi: ‘Let’s ante up and get the game going when it comes to inspections on the adviser side,’” said Abramczyk.
Bob Lehman, a broker-dealer investment advisor with the firm Lehman and Eilen LLP and a conference speaker, said that in the years since Madoff was arrested, the SEC has brought more than 100 enforcement actions against about 200 individuals and 250 entities involving Ponzi schemes.
The SEC hasn’t been the only regulator to introduce reforms post-Madoff. The Financial Industry Regulatory Authority implemented a number of changes in its regulatory structure in the wake of the Ponzi scheme’s collapse, said Abramczyk. Because the Madoff fraud was perpetrated using computers, it demonstrated to FINRA that there were other types of professionals who work in broker-dealers who support operations and who were not formally registered, and, therefore, were under no direct oversight, from a fraud perspective, said Abramczyk.
FINRA’s Rule 4530 obligated broker-dealers to disclose material issues, which were previously optional, he said. FINRA also expanded its licensing requirements beyond the Series 7 license for sellers and traders, and created the Series 99 license required for senior managers, supervisors in operations and those with the authority to materially commit capital in back office functions.
Abramczyk said that there is also a different mindset among regulators that has affected the manner in which they approach their responsibilities, beyond the on-paper regulatory changes. As a result, there’s been a methodological change in how regulators approach financial institutions—the examination process is longer, involves more staff members and requires more work and disclosure on the part of the regulated entities, explained Abramczyk.
Regulatory processes that assumed more “in good faith” and inspections “based on a presumption of trust, a presumption that people are not crooked,” no longer have a place, he said.
“Now it’s ‘show me,’ which is what it should have been all along: Trust, but verify,” said Abramczyk.