Thursday, November 21, 2019
The broker-dealer community enjoys unusual influence over its regulation because Congress made an industry trade-association the primary regulator for broker-dealers. FINRA's member firms elect much of its governing board and influence how FINRA will allocate its resources and set priorities. This includes decisions about how many resources to devote to enforcement and supervision activities which might prevent significant investor losses. Giving the industry collective responsibility for making harmed investors whole might cause the organization to devote more resources to enforcement and investor protection.
Unpaid arbitration awards may escalate if changing market conditions reveal that brokerage firms have sold investors interests in frauds and ponzi schemes. Consider the recent case of Taylor Capital Management. Taylor's representatives reportedly sold interests in "an alleged $283 million loan fraud" run though a company known as 1 Global Capital. The allegations remind me of the Woodbridge Ponzi scheme that collapsed last year. Now that Taylor Capital Management has closed its doors, the investors harmed by its conduct may not be able to recover. We may never know the true scope of the harm because investors won't file arbitration claims against an entity that cannot pay them.
It's difficult to know whether these early collapses will be isolated events or the beginning of a growing trend. A strong stock market can hide misconduct and allow Ponzi schemes to continue longer than they would otherwise. If the market reverses, it would not surprise me if we discovered that many more Ponzi schemes have developed and been fed by commission-chasing brokerage firms.