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The Inside Story Of How Our Financial Regulators Let Us All Down (XLF, FAS, FAZ, GS, BAC)

November 4th, 2011

Shah Gilani: Did you hear the story about MF Global? No, not the headlines about its bankruptcy – the real story. If you haven’t heard it yet, it goes something like this. MF Global became a primary dealer only eight months ago.

“Primary dealer” is an elite status. It means the firm is one of only 22 government bond dealers that trades directly with the Federal Reserve’s New York trading desk.

Only, the Federal Reserve doesn’t regulate or oversee MF Global, the Commodities Futures Trading Commission (CFTC) does – or rather is supposed to.


But, even more incongruously, the CFTC isn’t the first overseer of MF Global . It ceded that responsibility to the CME Group Inc. (Nasdaq: CME), which owns and operates the largest futures exchanges in the United States. The designated self-regulatory organization for more than 50 futures brokers, CME was supposed to be the cop on the beat.

However, t he not-so-funny thing about the relationship between MF Global and the CME Group is that MF Global recently boasted on its Website that it “was the top broker by volume at CME’s metals and energy exchanges in New York and in the top three at its Chicago exchanges.”

So, is it any wonder that the CME just last week audited MF Global’s segregated customer funds and found them to be in compliance?

These are the same supposedly segregated funds which the CME is now saying may have been tampered with. According to the CME:

“It now appears that [MF Global] made subsequent transfers of customer segregated funds in a manner that may have been designed to avoid detection insofar as MF Global did not disclose or report such transfers to the CFTC or CME until early morning on Monday October 31, 2011.”

How much money are we talking about? About $633 million – or 11.6% out of a segregated fund requirement of about $5.4 billion.

Do you see what I’m driving at?

So the real story is, t he Federal Reserve, which doesn’t regulate MF Global but regulates all banks in the United States, lets a futures commission merchant with investment bank wannabe desires become an insider in its dealings. Meanwhile, a private for-profit enterprise that runs the self-regulatory apparatus that oversees its own customers steps in for a federal agency that’s supposed to be in charge of commodities, futures and derivatives markets.

And that’s only the tip of the iceberg.

Let me jump on the Securities and Exchange Commission (SEC) next, because you aren’t going to believe this, either.

Subterfuge at the SEC

It’s come to light recently that the SEC has been blatantly violating federal law for decades.

Since at least 1992 through 2010, the SEC has destroyed more than 9,000 documents that by law were supposed to be saved and turned over to the National Archives and Records Administration and kept for 25 years.

The documents were records of enforcement cases where, after preliminary inquires, it was decided not to pursue full-blown investigations.

When the SEC has information – an anonymous tip or insights from a whistleblower, for instance – that could lead to an investigation, the subjects are pursued as “matters under inquiry,” or MUIs.

A couple of examples of MUIs that went nowhere include: The several tips the agency received that Bernie Madoff was running a Ponzi scheme; the anonymous tip on Ernst and Young letterhead that said Lehman Bros. Holdings Inc. (PINK: LEHMQ) was cooking its books; or the MUIs on insider trading, fraud, and market manipulation at Goldman Sachs Group Inc. (NYSE:GS), Bank of America Corp. (NYSE:BAC), American International Group Inc. (NYSE:AIG), and SAC Capital Advisors, to name a few others.

But since none of these MUIs morphed into full-blown investigations, the SEC decided to destroy all records pertaining to these inquiries rather than hand them over to the National Archives, as federal law requires.

When confronted with the unauthorized disposal of federal records, thanks to a couple of steadfast and honest lawyers in the enforcement branch of the SEC, the agency said it was “not aware of any specific instances of the destruction of records.”

What’s shocking and sickening is that even while addressing the Archives’ inquiry into the missing documents, the SEC somehow forgot to disclose to the keeper of federal records its policy to “destroy all such documents” when no further action is warranted.

Too bad for the SEC an internal investigation by SEC Inspector General H. David Kotz brought to light the agency’s directive to destroy certain MUIs, along with the discovery of MUIs on old hard drives that somebody accidentally forgot to erase and destroy.

Why wouldn’t the SEC keep records of enforcement activities? Why would they destroy critical data and information that could be used in the future to pursue cases that re-surfaced and could lead to bone-crushing conspiracy or racketeering charges, if not even the simple garden variety securities law violations?

With any luck, we just might find out.

The SEC could and should face criminal charges for breaking federal law.

There’s a powerful push by a quiet group of angry journalists to get to the bottom of this, and I’m one of them. So, expect to hear more about this as we press on for the truth.

In the meantime, it’s high time we take a good look at regulators and not just regulations to see where the cracks are in the prudential governance of markets, financial institutions, and most importantly, individuals who are responsible for decisions that break the law or grossly impact markets and our economy.

After all, it’s not just regulations we need to worry about – it’s the regulators too.

Related: Financial Sector SPDR ETF (NYSEARCA:XLF) Direxion Daily Financial Bull  3X Shares ETF (NYSEARCA:FAS), Direxion Daily Financial Bear 3X Shares ETF (NYSEARCA:FAZ),

Written By Shah Gilani From Money Morning

Shah Gilani is the editor of the highly successful trading research service, The Capital Wave Forecast, and a contributing editor to both Money Morning and The Money Map Report.  He is considered one of the world’s foremost experts on the credit  crisis. His published open letters to the White House, Congress and U.S.  Treasury secretaries have outlined detailed alternative policy options  that have been lauded by academics and legislators.

His experience and knowledge uniquely qualify him as an expert.  Gilani ran his first hedge fund in 1982 from his seat on the floor of  the Chicago Board of Options Exchange. When the OEX  (options on the Standard & Poor’s 100) began trading on March 11,  1983, Gilani was working in the pit as a market maker, and along with  other traders popularized what later became known as the VIX (volatility  index). He left Chicago to run the futures and options division of the  British banking giant Lloyds TSB. Gilani went on to  originate and run a packaged fixed-income trading desk for Roosevelt  & Cross Inc., an old line New York boutique bond firm, and  established that company’s listed and OTC trading desks. Gilani started  another hedge fund in 1999, which he ran until 2003, when he retired to  develop land holdings with partners.


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  1. Jackson
    November 4th, 2011 at 11:48 | #1

    Mr. Gilani hits the nail on the head. We have heard the government lambaste the banks since the current economic crisis began with very little being said of their own culpability. The government is the real culprit here. They have neglected to do proper due diligence for years in policing the financial industry. We do not need any more regulation, we just need the government to enforce the existing current regulations. To make matters worse the current government will not do that and will not accept responsibility since it means that they would need to repudiate the Clinton Presidency since they, not the banks, are responsible for the mess that we are currently in. Since Clinton is a democrat this administration will not do that. They will only continue to point fingers at the Bush Administration since it is a republican administration. While the Bush Administration holds some responsibility one needs to understand that after 8 years of ruinous policy by Clinton there was little choice but to continue down that path in the hopes that the day of reckoning can be forestalled as long as possible. The choice was recession in 2001 or in 2008. Now the current administration after 3 years continues to point fingers and provides no real policies that will help end the recession. There is little hope of creating jobs since they continue to be close-minded about job creation looking only to put construction workers back to work by building homes, the same thing that got us into this mess. We need to be creative and look at how we can provide reasonably paying jobs for the American worker. In the immediate future this means looking at our past. There are many ways to create jobs by looking backwards and seeing where were people put to work 20, 50, 100 years ago. I have mapped out a plan and forwarded that to the appropriate people, but guess what, I have not heard a single word back in response. I have 30+ years in the private sector and frankly the response is what I expected since no public sector worker ever wants to believe that they are wrong and the private sector is right. God Bless America because right now she needs it more than ever.

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