The investigation into the alleged Madoff Ponzi scheme is revealing more well-known names have potential losses with the former NASDAQ chief’s company.RBS, SocGen, a gaggle of Swiss banks and AXA are amongst those who have lost millions in client funds. You can be sure that these companies are hiring some flesh eating lawyers to extract whatever they can from counter parties and directly from the wreckage of the firm but one group who will not be paying the price is the regulators, as usual, they are immune.
The thing is, and yes, this is another regulator rant, what were they doing? Over the years I have come to believe that the regulatory system (and in the UK is where most of this experience comes from) is broken in a very, very bad way.
The regulatory exposure for small firms such as stockbrokers is crushing. Rules on how you market, who you market to and what you can and can't sell are an obsession with regulators. I believe that all of this 'over-regulation' has lead to much of the problems we are facing now. Sounds ridiculous? Let me explain.
Take hedge funds for example. The regulators decided that if you had a net worth of over $1mn you could invest in hedge funds as you are 'sophisticated' enough to know what you are doing, if you don't have a net worth of $1mn you are not able to be 'accredited'.
We wrote in this article back in August that this approach was just plain stupid. We said;
"When the hedge fund Armageddon comes (and we all know it will) there will be a law suit from Mr X in XVille USA who made millions from a trucking business and invested $5mn in the latest fund to explode. He will sue on the basis that, although he was wealthy, he was not sophisticated enough in financial markets to understand what he was investing in. He will name the SEC as co-conspirators in his downfall because they effectively 'certificated' him as sophisticated on the basis of his wealth."
This may not be the exact scenario we are dealing with in the case of Madoff but its close. In fact it’s even worse.
The SEC, in 2006 granted a license to Madoff as an investment advisor. When you submit your application to the FSA in the UK, for example, you have to complete a huge amount of forms, even for the most vanilla of businesses. You then sit with the regulators who question you on your investment strategies and your business and make a decision based on these interviews.
Now if you are selling shares to retail customers, for example, clearing through another regulated company and your 'know your client procedures' are OK you will pretty much get through, but after a thorough grilling.
Imagine, therefore, that you are Bernie Madoff trying to explain trading strategies around end of month expiry of options and other complex trading strategies. Long conversation right?
You would assume therefore that the regulators did their home work and, by approving the firm, approved its strategies and internal systems.
If I was an investor that had just lost his shirt investing with this guy I would be after the regulators big-time, because if they could not figure out what the score is, with all their access and power, how the hell would I be able to?
In my opinion, regulatory oversight needs to get away from who can market to whom, what clients can and can't invest in and concentrate on the procedural issues of where the money goes.
If you are a broker, you have to have a segregated account. Meaning that your money is separate to the company’s money, so that if they go bang, you don't lose you cash, not so with the banks. They have been gambling with your money and giving you a pittance of the upside while all the time charging you for the privilege of you getting your money.
A simplistic view of the banking system I know, but at its core that is what it is.
Of course, all this works if the regulatory system works, but it doesn't.
Before anyone starts going on about how great the regulatory system is I will tell you now that I don't buy the bull. It is too complicated, to unwieldy, too restrictive and not focused. The regulatory regime does not work where it is needed most, in the big fat institutions and if you disagree, take a look at Madoff, Northern Rock, UBS, Bear Stearns, Lehman Brothers... shall I go on?
There can only be two reasons for the regulatory failures and the latest Madoff situation, either the regulators didn't know or they didn't care... either is unacceptable
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