Regulators Retreat and Our Financial Protection Depletes

Back when I worked for FINRA, when people asked what I did for a living, I would say I was a financial regulator. Few people asked too many follow-up questions (and some people literally walked away!), but some quizzically asked, “What exactly does a regulator do?”

 

Simply, we enforce rules to maintain law and order within an industry. By “enforce,” I mean holding those accountable (via fines, suspensions, or expulsion) who break the rules. There are tons of rules within each industry, so it’s impossible to enforce every rule. The key is to maintain effective enforcement of rules that can lead to serious wrongdoing like fraud.

 

But what happens when the enforcement of the rules becomes ineffective or nonexistent?

 

Imagine if speeding in your car was no longer being enforced by the police. While it still is technically against the law to speed, if the population knew police were no longer on the highways with speed traps, do you think that might bring an uptick in accidents and deaths?

 

Imagine that underwriting standards on mortgages are not being enforced. Companies then sell billions of dollars in mortgages to unqualified people who should never have received a mortgage, but the companies do it because they can sell the mortgages to a bank (thereby taking the mortgage company off the hook if that person defaults on their mortgage) which aggregates a ton of these mortgages and gets a high credit rating by the credit agencies because the credit agencies are paid by the banks, and then the bank sells it to every wealthy person and entity around the world (since they think what they’re buying can’t fail due having the highest credit rating). The mortgage companies, the banks, and the credit rating agencies  know the regulations dictating their actions are not being enforced, so why not do this? They’ll all get rich! This happens a million times over and the world economy eventually collapses. (Cue The Big Short by Michael Lewis).

 

Imagine the Federal Aviation Administration makes a dramatic shift to stop focusing on the enforcement their rules. Guess what an airline might do? This.

Regulation without Enforcement Is Meaningless

Without a mechanism in place to punish and deter people from breaking the rules, all manner of people will rationalize their actions to profit off of you. Good companies and good people will do the right thing even if regulations aren’t being enforced, that’s the benefit of good and morale companies and people! People and companies in the middle who are typically law abiding will sway whichever way the herd goes. The immoral, unscrupulous, and profit-at-all-costs companies and people will lead the herd. They will take advantage of every single angle they can, to hell with regulations if they’re not being enforced. Many will follow their lead.

 

As a regulator at FINRA, I saw this over and over and over again. We started the Anti-Money Laundering Investigative Unit because it became very apparent that some of the biggest Wall Street firms had woefully ineffective Anti-Money Laundering Programs to monitor, detect, and report suspicious activity occurring at their firm to the U.S. government.

 

Why did these firms have terrible programs to monitor some really bad activity (which included accounts and/or money movements to/from drug cartels, terrorist financiers, entities linked to sanctioned companies, and so on)? Many firms view compliance as profit-taking instead of profit-making, and if regulators aren’t looking at something then why spend the money to comply with the rule?

 

During this time, barely any regulator - outside of the Florida district office (where I worked) - was enforcing the anti-money laundering rules. In turn, these firms dedicated minimal resources to ignore or window dress their anti-money laundering responsibilities.

Present Day

We are in the midst of an amazing market run, one that has lasted for over nine years and returned approximately 218% since the low in February 2009:

S&P500 Returns 218% from Feb 2009 to April 2018
Source: Yahoo! Finance

With the recent tax cuts, U.S. corporations bringing money back from overseas, and unemployment at historic lows, many expect the good times to continue. No one can say for sure how long the market and economy will continue cruising, but good economic times coupled with a pro-business (read: deregulatory) president leads to lax enforcement of current regulations and the gutting of many others. This inevitably leads to abuse as we saw in the last financial collapse.

 

I’m all for getting rid of onerous and costly rules that provide little protection to taxpayers and stifle innovation, but you can’t tell me that delaying the fiduciary standard (which just says that financial advisors have to act in the best interest of their client) makes sense for anyone other than the financial firms and their brokers who are in the business to sell product.

 

As for the regulatory regime that Trump has put in place, he’s has made it clear that enforcement of regulatory rules will be on the backburner. Although I’m focused on the financial regulatory agencies which I’ll detail below, consider The New York Times article, “The Business Links of Those Leading Trump’s Rollbacks,” which showed that Trump appointed four individuals to agencies that they previously lobbied, two individuals to agencies where they may personally profit from changing regulations, and thirty-five members appointed to agencies or departments are connected to private sector groups that interacted with or were regulated by their current agencies. Then think of Scott Pruitt at the Environmental Protection Agency and Ben Carson of Housing Urban and Development Deregulation. The list goes on and on.

 

Foxes watching the henhouse.

Consumer Financial Protection Bureau (CFPB)

We’ll start with the most egregious of Trump’s appointees, the Consumer Financial Protection Bureau’s (CFPB) Director, Mick Mulvaney. Prior to being selected, the former member of Congress said that the CFPB was “a sick, sad joke,” and “some of us would like to get rid of it.”

 

Mulvany was installed by Trump solely to gut the CFPB and leave its dying carcass in the wake of wronged consumers. Mulvaney is reportedly minimizing his own agency’s powers by reducing its independence and increasing its reliance on Congress to pass rules and receive funding. Per a New York Times article, Mulvaney “has frozen all new investigations and slowed down existing inquiries by requiring employees to produce detailed justifications. He also sharply restricted the bureau’s access to bank data, arguing that its investigations created online security risks. And he has scaled back efforts to go after payday lenders, auto lenders and other financial services companies accused of preying on the vulnerable.”

 

Mulvaney also requested zero funding from the Federal Reserve (the CFPB had requested $217 million a quarter ago under former Director, Robert Cordary) because the CFPB already had $174 million in the bank, which would cover its $145 million quarterly budget. I’m sure that sent a great message to his employees who now have no idea what he might request the following quarter when their jobs are at risk because they can’t cover payroll.

 

Recently, Mulvaney gave the keynote speech to 1,300 bankers at the American Banker Association. Mulvaney was reported to appeal to the bankers to diminish the CFPB’s powers by describing the two types of people he was most responsive to as a congressman — constituents and lobbyists who contributed to his campaign.

 

This is the same agency that was formed and championed by Elizabeth Warren (and Director Richard Cordary) in the aftermath of the financial crisis to make substantive changes to protect consumers who were screwed out of their money due to lax regulations over predatory lenders, debt collectors, and others. Prior to Mulvaney, the CFPB paid out approximately $12 billion in restitution to 29 million customers. $12 billion!

Office of the Comptroller of the Currency (OCC)

Another Trump appointee and former banking executive, the Chief of the OCC, James Otting, recently said he wants his agency to be more responsive to “our customers, which are the banks” by decreasing regulatory burdens and costs, which includes a priority in modifying how banks are examined on their compliance with anti-money laundering laws. Based my experience with lax anti-money laundering rules leading to the facilitation of criminal activity by others, this is a terrible idea.

 

Another regulatory change in the works is a joint agency effort to ease restrictions tied to the Volcker rule, a provision of the 2010 Dodd-Frank Act that prevents banks from making speculative trades and risking their customer’s capital.

Securities Exchange Commission (SEC)

The man Trump put in charge of regulating Wall Street, Jay Clayton, was a Wall Street defense lawyer representing Goldman Sachs, Deutsche Bank, Pershing Square Capital, and a host of others. While all reports paint Clayton as a smart and talented lawyer, one not besieged in any scandal or frivolity, I can’t believe that a man who made millions and millions of dollars to defend Wall Street will be a champion for consumers.

 

An article in The Washington Post stated, “The nomination of Mr. Clayton to head the SEC underscores the shift away from enforcement.” Further proof in the pudding is that SEC enforcement actions and fines have dropped precipitously under Clayton.

 

To his credit, Clayton has stated that fraud prevention is a significant issue for the SEC, and he has been shocked at the level of fraud in the cryptocurrency world.

Financial Industry Regulatory Authority (FINRA)

While not a Trump appointee, FINRA’s new CEO, Robert Cook, has mainly worked as a partner at couple law firms for the past couple decades (focused on the regulation of the securities markets as well as broker-dealers, exchanges, alternative trading systems and clearing firms.) while also working for three years at the SEC as their Director of the Division of Trading and Markets.

 

Cook is the only one of these four regulators with former regulatory experience, and he only has three years sandwiched between partnerships at law firms. My interactions with Cook were good, and he seemed intelligent and thoughtful, but I think he’s focused on improving FINRA’s reputation with the financial industry, which only matters to the financial industry and not to the consumers being scammed by awful brokers and firms. 

 

From my own inside knowledge while I was at FINRA, it was not only clear that FINRA was shifting away from enforcement, but I was told by a high level employee that enforcement was being pared down. Of all the open cases that I had developed or worked on, which included egregious market manipulation by two penny stock firms with littered regulatory histories as well as some bigger Wall Street firms with awful AML compliance programs, none have seen the light of day via settlement or a complaint (which could lead to a hearing).

 

These insights are also buoyed by Cook’s results in the first-half of 2017 which saw FINRA fines and enforcement actions plummet. In late 2017, FINRA did have a $13 million fine against Merrill Lynch (and the SEC fined Merrill $13 million as well), but that was a really old case that took forever to close and, if my memory serves me correctly, we were already in negotiations with Merrill way before Cook was hired as CEO. (A similar thing is assumed by me to have happened - with no knowledge or information on the case but knowledge of how long these cases take to bring to settlement - with the recent CFPB and OCC $1 billion settlement with Wells Fargo. I assume these cases were made by the prior regulatory regimes, and the new ones could not squash them.)

Overall

So we’re 0-4 when it comes to the biggest financial regulators making enforcement of their rules a priority. This focus by the Trump administration to deregulate will eventually lead to terrible conduct against consumers and any other entity or person with money which will precipitate or exacerbate a financial collapse. We always forget what got us here, and history repeats itself.

 

What all this means to athletes, and to consumers in general, is the very little individual protection you had before the Trump presidency has now been gutted to something miniscule.  You are on your own to protect your financial interests. Good luck out there.