SEC Chairman Mary Schapiro could credibly claim that during her tenure as head of Finra, the group was not responsible for failing to detect the Madoff Ponzi scheme. That failure was largely the fault of the Securities and Exchange Commission, which had the clear responsibility and authority to examine Bernard L. Madoff's operations but failed to detect the disastrous fraud he perpetrated despite several warnings from outsiders.
Given her previous experience as a member and acting chairman of the SEC, and her role in merging the regulatory roles of NASD and the
New York Stock Exchange into the
Financial Industry Regulatory Authority Inc., she therefore seemed like an outstanding choice to head the SEC and to shake it up after its Madoff failure.
But now, it's not so clear.
A special committee appointed by Finra's board of governors to examine the organization's processes for the detection of fraud and Ponzi schemes has found that it missed many early warning signals of the alleged Ponzi scheme involving R. Allen Stanford. Finra did have authority over the Stanford organization.
So it appears that Finra was as incompetent as the SEC.
How credible is Ms. Schapiro's vow to reform the SEC when similar failings were occurring at Finra while she was in charge? The special committee noted that both the Madoff scheme and the alleged Stanford fraud were “striking because of their size and duration.”
Regarding the Stanford case, the committee noted that NASD, Finra's predecessor, “received credible information from at least five different sources between 2003 and 2005 claiming that Stanford certificates of deposit were a potential fraud.”
But Finra did not launch an investigation until January 2008, by which time investor assets at risk had climbed to approximately $7.2 billion, from $1.5 billion.
The committee also found that while Finra received no whistle-blower complaints about Madoff, it did miss several matters that might have revealed the Madoff fraud that, “with the benefit of hindsight, should have been pursued.”
Ms. Schapiro was part of top management at NASD/Finra during this whole period, having joined NASD in 1996 as president of NASD Regulation. She was named vice chairwoman of NASD in 2002 and in 2006 was named chairwoman and CEO. She had plenty of opportunity to learn where the organization's weaknesses were and attempt to fix them.
Having helped steer the ship while it suffered serious damage, she must take responsibility.
If the details about Finra's shortcomings in the Stanford case had been fully known before the Senate hearings on her confirmation as head of the SEC, it's very possible she would not have been confirmed.
Clearly, Ms. Schapiro will have to improve her game if she is to repair her reputation and lead the SEC into a new era. Her task has been made even more difficult by Judge Jed S. Rakoff's embarrassing rejection last month of the proposed SEC settlement with
Bank of America Corp. over disclosures to investors regarding its takeover of Merrill Lynch & Co. Inc.
She will have only a short time to improve the SEC's performance by bringing in people who can compete with Wall Street's financial wizards, reorganizing departments and replacing department heads who failed, improving communication between departments and offices, and rebuilding staff morale.
Without evidence of significant improvement, it will be difficult to justify giving the SEC additional responsibilities as part of the post-crisis financial reforms.
And if such evidence doesn't surface, President Obama should start looking for a new head of the SEC.
