Risky trading practices that caused huge losses for J.P. Morgan went undetected by U.S. regulators, sparking Congressional hearings at which SEC officials have been taken to task and one top official admitted some red flags went unheeded.
That reality didn’t stop FINRA chairman Richard Ketchum from standing up at the U.S. self-regulator’s annual compliance conference and lauding new surveillance and other information-gathering tools FINRA is putting in place. He further promised these tools will help his team do a better job of catching traders who game the system.
“We will use the data we collect through this survey—in combination with data we are collecting through other means—to help us tailor our exams to your firm’s unique risks,” he told the group. “This is another important step toward our goal of better understanding what’s happening at your firm and focusing on the areas that pose the greatest risk to investors.”
And, starting September 30, improvements to a specific quarterly report (called FOCUS) that’s filed by broker-dealer firms will let FINRA look more closely at a firm’s revenue and expenses, including breakdowns of principal trading gains and losses categorized by security type.
“This information will allow us to better align our examinations with your revenue stream,” Ketchum said. “In addition, firms that derive more than 10% of their total revenues, during a reporting period, from participation in unregistered offerings will be required to complete an operational page that requires information about each unregistered offering.”
But these efforts, and mea culpas by the SEC and other regulators, are trying to mask the elephant in the room: Regulators don’t have enough intellectual capital at hand to catch bad actors while the wrong doing is taking place. Smoking guns, sometimes. Red hands, never. It’s not easy for the cop to admit the crooks are always two steps ahead.
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It’s not entirely their fault.
The SEC scored huge early successes in the 1930s because so many top Wall Streeters were out of work and eager to turn the tables on their former colleagues. As insiders, they knew every trick and who was behind each. Led by Joseph Kennedy, they tacked some notable hides to the wall and gave the Commission a reputation for toughness.
But two things happened in the 1970s. Stock trading became largely computerized, allowing firms to profit from ever smaller pricing increments and creating huge incentives to develop highly complex trading strategies; and governments started cutting funding for regulatory staff.
What we’re left with are hard-working teams of lawyers and enforcement staff engaged in a perpetual game of catch up with ever-more-intricate activities at the firms they’re trying to regulate. The pay’s not great, and so the SEC, its counterparts worldwide, and self-regulatory staff, are unable to attract people capable of spotting large-scale, and ultra-complicated, financial crime.
As one regulatory staffer once put it to me, “If you could make high seven figures, would you go to work for a regulator? Neither would I.”
That reality forces those overseeing markets to rely on technology. And, while those tools will certainly help them pickup on outliers and lay charges against more firms engaging in trading irregularities, it won’t catch the big fish.
That quarry needs to be outwitted on its own turf.