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NASDAQ Sale: Why Would Schapiro and FINRA Execs Lie?

Posted by Larry Doyle on October 22, 2009 10:50 AM |

Writing about the integrity, or lack thereof, of a senior governmental official and other high ranking financial regulators is a serious topic. Given the seriousness of this topic, I do not treat it lightly. For newer readers here at Sense on Cents, I am referring to the commentary I wrote this past Monday entitled, Attorney Richard Greenfield Brands Mary Schapiro and FINRA Execs As “Liars.”

If in fact Ms. Schapiro and her FINRA colleagues lied, what was their motivation? We learn more about this amazing financial intrigue as on Tuesday a redacted version of a Second Amended Complaint brought on behalf of Standard Investment Chartered and all others similary situated  v FINRA, NYSE Group, Mary L. Schapiro, Richard F. Brueckner, T. Grant Callery, Todd Diganci, and Howard M. Schloss was made public.

Recall that the core of this complaint is a charge made by plaintiffs against defendants regarding the inappropriate allocation of proceeds generated from the sale of the Nasdaq Stock Exchange. That sale generated approximately $1.5 billion. FINRA paid out $35k per firm to approximately 5100 member firms for a total of approximately $175 million.

Why would the defendants be motivated to withhold the balance or a large percentage of the balance of those funds from the member firms?

The plaintiff’s attorneys represent that Ms. Schapiro and the other defendants orally and in writing repeatedly maintained that the IRS mandated that the $35k per firm was the absolute maximum that could be paid in order for FINRA to maintain its not-for-profit status.

The plaintiff’s attorneys represent that assertion is a blatant misrepresentation and that the IRS did not provide a full review of this matter until a few months after FINRA’s member firms had voted on the consolidation of the NASD with NYSE Regulation to form the entity now known as FINRA.

Against that backdrop, the question still begs as to why these defendants would have chosen to misrepresent this situation and not properly allocate these funds. Let’s navigate this Second Amended Complaint. We learn the following about the plaintiff’s allegations:

pg 3 Point 9: “The Individual Defendants abused their positions of trust and authority, misrepresented key facts repeatedly, orally and in writing, and sacrificed the interests of the Plaintiff and members of the Class (“Members”) so that the Officer Defendants could line their pockets.”

Wow. This claim alleges that the defendants individually benefited in monetary terms as a result of this merger and by abusing their position. Very strong charge. We learn on page 5 that certain defendants’ compensation in 2007 relative to 2006 increased by 17.8% to a not insignificant 57% for Ms. Schapiro ($1.999 million total compensation in 2006 to $3.140 million in 2007).

Additionally, in my opinion, the allegation of materially misrepresenting or omitting information in a Proxy Statement is the most serious charge in this complaint. Plaintiff’s attorneys highlight at least eight material misrepresentations or omissions (page 6, point 16). Anybody involved in the world of finance appreciates the sacrosanct nature of the integrity of proxy materials. This charge warrants a thorough investigation and total transparency as it strikes at the core of our capital markets and financial system.

If, in fact, these allegations and charges are true, why and how could the defendants have thought these egregious actions would not be exposed? Obviously, they have not been fully addressed and publicly exposed to this point, but if this case goes to trial the discovery process, questioning, and cross examination will be captivating. Clearly the defendants hope it will never get to that point, but what comfort level could they have to shield themselves? Plaintiff’s attorneys believe and assert the following:

pg 3 point 10: “all Defendants had every expectation of escaping all scrutiny for their misconduct and never expected to be caught or held accountable for the commercial consequences of the Transaction and its impact on the Members. Since SROs (LD’s edit: SRO = self-regulatory organizations) have successfully raised exhaustion and immunity (LD’s links) defenses in many cases, the Defendants believed themselves to be immune from accountability through the judicial discovery and trial processes.”

Wow, again. If, in fact, the defendants expect exhaustion and immunity defenses to work, and to this point those are their defenses, then they believe their actions in this case would never be brought to light. That belief and approach belies any notion of transparency.

There must be more, though. I do not believe a payoff for defendants in the mere single to low tens of millions hardly warrants defendant’s misappropriating what could potentially be north of $1 billion. Why else might defendants have been so aggressive in pursuing this transaction? Well, the payoff is not simply in the single to low tens of millions. A pool of capital of approximately $1.5 billion (proceeds from the sale of Nasdaq) properly managed (which we know FINRA did not do, given its 2008 investment returns of -26%) would generate $75 million annually (a 5% return). Who benefits from that? Plaintiff’s attorneys highlight the following:

pg 13 point 36: “The large Wall Street firms who are members of the NYSE are the principal beneficiaries of the Transaction. Through the Transaction, they:

a. eliminated a source of oversight that was the NYSE’s SRO arm; and

b. gained access to the assets of the NASD, which afford them large financial gain because they can be, and are diverted, to offset their own costs of the SRO system.

This charge is truly where the rubber meets the road. What does this charge address? The approximate 200 member firms which belong to the NYSE (and also belong to FINRA) benefit at the expense of the 4900 member firms, largely the small broker dealers, which merely belong to FINRA. In layman’s terms, this allegation is the equivalent of “Wall Street Screws Main Street!”

This complaint addresses key points at the core of the Wall Street and Washington incestuous relationship. For those with an interest in the structure of our financial markets, the full complaint is a must read. Please share it with your colleagues.

After having finished reviewing this amended complaint for a second time, I come away convinced that the defendants in general and Mary Schapiro specifically possess a wealth of information which they should be compelled to share with the American public. Some may think that Ms. Schapiro’s deposition might be too explosive for our markets and economy. I would respond that given what our markets and economy have absorbed, the explosion has already occurred. The recovery needs what I wrote about this past January upon witnessing what I deemed to be an excessively easy confirmation process for Ms. Schapiro as the new head of the Securities and Exchange Commission.

I knew nothing of this complaint at the time when I wrote on January 16th “Let’s Really Question Ms. Schapiro…”:

In light of the disaster that is Wall Street, I do not know if I am simply dumbfounded or merely dismayed by the softball questioning of prospective SEC chairwoman Mary Schapiro yesterday.

With the dissolution of the investment banking model, the massive injections of government capital, and potential indictments of major Wall Street icons in the offing, I looked forward to some very juicy testimony. The results were beyond disappointing. The public deserves so much better.

Mary Schapiro may end up being the best SEC commissioner ever, but let’s make her earn a few stripes before anointing her.

Did Ms. Schapiro receive the “E-Z Pass” to the SEC from FINRA with the support of the powers that be on Wall Street? Was the chair of the SEC the ultimate payoff to Ms. Schapiro for the successful completion of the merger between NASD and NYSE Regulation to form FINRA? While I appreciate that my questions are aggressive, the charges embedded in the above complaint warrant a full and thorough investigation. Full market confidence will only regenerate in the presence of total transparency and integrity in our financial regulatory system. To that end, I repeat my concluding statement from last January:

the public deserves to know the full extent of the relationship between the inmates and the warden.

Comments, questions, constructive criticisms always appreciated.


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