The Financial Industry Regulatory Authority referred a record 692 cases involving potential fraud to law-enforcement agencies last year, according to Richard Ketchum, chief executive officer and chairman of Wall Street’s self-funded regulator.
Referrals to the Securities and Exchange Commission and other organizations outpaced 2011, when more than 650 were made, Finra said in an e-mailed statement. A record 347 involved insider trading last year, compared with 286 through mid-December 2011. The increases came as Finra and the SEC focused on risk-based examinations to pursue fraud and manipulative activity, Ketchum said in a telephone interview.
“We need to spend less time on technical violations,” Ketchum said. “We need to take the resources we have and focus them on the firms that are most worrisome and on the areas of the firm which are most likely to have an adverse impact on investors.”
Finra and the SEC revamped the way they conduct inspections in the wake of Bernard Madoff’s Ponzi scheme, discovered in 2008, and the credit crisis that started the prior year, Ketchum said. Problems are now addressed more rapidly, he said.
Firms were ordered to repay more money to investors harmed by brokers’ improper practices last year, though fines fell, the statement said. Restitution climbed to $34 million from $19 million in 2011 and fines declined 5 percent to $68 million.
Many of the fines involved real-estate investment trusts, leveraged exchange-traded funds and other complex products, Ketchum said. Finra will continue to examine sales of those securities and will also look at bundled leveraged loans and non-traded business development companies, he said.
“In a world of very low yields, customers are very subject and at risk to being encouraged into products that are less liquid and riskier and often involve much more substantial commissions,” Ketchum said.
Another regulatory area of focus for 2013 involves conflicts of interest among brokers, such as when salesmen earn more for recommending certain securities, Ketchum said. Finra asked for comments last week on a rule that would require brokers to tell their clients when they get a bonus for switching firms.
“If you were a customer, why would you not want to know the variety of reasons that your rep moved?” Ketchum said. “I don’t see why additional disclosure hurts.”
The number of brokers Finra oversees has declined annually since it was formed in 2007 as smaller firms shut down and the securities industry contracted. The regulator was responsible in November for monitoring 4,319 brokers, 14 percent fewer than the 5,005 under its supervision five years earlier.
Finra boosted its cross-market surveillance at exchanges and alternative trading venues such as private broker-run dark pools last year to probe for fraudulent and manipulative trading, Ketchum said. It added oversight systems that examine more than 50 “threat scenarios,” Finra said in the statement. It also instituted new surveillance techniques to hunt for manipulative activity around the close of trading, and so-called front-running, which refers to buying or selling ahead of clients to whom a broker has a fiduciary duty, for non-exchange-listed equity securities, the release said.
Examinations focused last year on alternative trading systems, information barriers within securities firms and the market-access rule implemented in 2011, the statement said. That rule requires brokers to employ risk checks on orders before they’re sent to markets to make sure they aren’t erroneous and don’t exceed preset capital and credit levels. Inspections of brokers’ oversight of their clients’ access to markets have shown deficiencies, Ketchum said.
“While firms have generally improved the quality of their supervision from a standpoint of direct market access, it’s still very spotty and very inconsistent,” Ketchum said. “We see a lot of foreign activity that raises very significant concerns both with respect to manipulation, sometimes with regard to account intrusion, and often raises anti-money laundering concerns. That area with respect to foreign direct access is going to be continuing.”
Many of these involve so-called master-subaccount agreements for active traders in which activity is routed through a foreign entity, Ketchum said.
Finra’s budget is comparable to the SEC’s. It spent about $1 billion in 2011, funded mostly by fees levied on brokers, according to its annual report. The SEC’s budget was $1.2 billion last year, the agency said in a November report.
The private-sector regulator was formed in 2007 when the National Association of Securities Dealers combined with the member regulation unit of the New York Stock Exchange. Finra refers many cases to the SEC and state and federal law enforcement agencies. Ketchum, who had been chief executive of NYSE Regulation, became CEO of the industry group in 2009 after Mary Schapiro left that role to become SEC chairman.
Ketchum, named in a November report in the Wall Street Journal as a potential successor to current SEC Chairman Elisse Walter, said he wouldn’t be the next head of the agency. “I’m very happy in the job I have,” he said.