FINRA, the Financial Industry Regulatory Authority, also dropped the ball in investigating Bernie Madoff.
Sam Draddy is head of FINRA’s fifty-seven-person Insider Trading Surveillance Unit- Draddy said thirty-seven work in Rockville, Maryland investigating stocks and bonds and another twenty in Chicago investigating options- and he was the latest guest on FINRA’s podcast, Unscripted.
“Mr. Draddy joined FINRA in 2007 after more than seven years in the Division of Enforcement at the SEC. At the Commission, he was a staff attorney/senior counsel in the Division of Enforcement from 1999 through 2004, and then a branch chief in SEC Enforcement from 2005 through 2007. Prior to the SEC, Mr. Draddy was a criminal prosecutor in the State’s Attorney’s Office for Baltimore County, MD from 1994 through 1999.”According to his biography online.
Draddy said this of the Madoff investigation: “You’ll recall in the Madoff scandal there was a guy named Harry Markapoulos who was a whistleblower, who really tried to get attention of the SEC for some a long time and sent some information to FINRA, and that information was disbursed throughout the organizations but was never centralized, no one ever put all the pieces together to make the determination that the Madoff situation is something that be should looked at immediately by the SEC or FINRA.”
A New Way Forward
In analyzing what went wrong and developing reforms, Draddy said that FINRA decided to house all the fraud which came into the agency in one unit, called the Office of Fraud Detection and Market Intelligence.
All fraud tips which come into FIRNA now go to this office.
Draddy heads the insider surveillance unit inside this office.
He said all tips are looked at by a senior level staffer first; they determine whether that office, another (like enforcement) office, or some entity outside FINRA, like the SEC, the US Department of Justice, and others, should do the investigation.
By this, the process is “triaged” Draddy said.
He said his FINRA group investigates most securities transactions in the US. “Our group covers the entire US marketplace for equities, which are stocks, corporate debt, which is bonds, and options.”
SONAR the Super Computer
As Draddy noted in the podcast, his team is fifty-seven people, but the real star appears to be SONAR, Securities Observation News Analysis and Regulation.
“The job sounds simple enough. But catching such crimes requires a lot of effort. The Office of Fraud Detection and Market Intelligence (OFDMI)monitors every transaction that takes place in both equities and options markets, using powerful software called Securities Observation News Analysis and Regulation, or SONAR, to look for everything from suspiciously well-timed trades ahead of a corporate announcement to huge jumps in trading activity on penny stocks. They also comb through regulatory filings, looking for brokers who have been fired suddenly and eyebrow-raising customer complaints.” FIRNA said in 2015, of the algorithm designed to spot suspicious trades.
Draddy expanded on the podcast. “Our investigations are mainly triggered by our electronic surveillance system called SONAR; basically, what SONAR mainly does is look for unusual price or volume moves in the marketplace surrounding publicly traded companies. It’s not telling us where insider traders are trading, but it’s telling us where to look for insider trading.”
Who is Sam Draddy?
Draddy’s biography is interesting because it shows just how interconnected the trading world is to the rest of the world.
Draddy tried to be a stock broker very early in his professional career before moving to the County Prosecutor’s Office in Baltimore, Maryland.
Draddy said that most of the criminals he prosecuted then he considered crimes of necessity in that they were so desperate they had to steal, defraud, etc.
Draddy considers insider trading, an unadulterated manifestation of greed.
“They should have known better,” Draddy said of those who commit these crimes.
He said, he had developed a passion for prosecuting it as a result.
Draddy said he received an opportunity to work at the SEC, before moving onto FINRA, where he’s been since 2007.
Draddy’s Two Most Interesting Insider Trading Cases
Draddy said the two cases which stuck out in his mind were the Raj Rajaratnam.
That case stands out for the stiffest penalty, eleven years, for any insider trading case.
Draddy said what impressed him was how much the US Department of Justice embraced the case which introduced tools like bugs, like those used to convict mobster John Gotti, informants, and even undercover work.
Rajaratnam was a Sri Lankan hedge fund manager; he ran the Galleon Fund from New York, City.
The hedge fund peaked at $7 billion in assets under management, and Rajartnam was reported to have made $60 million in illicit profits.
The second case involved golfer Phil Mickelson; Draddy said this was interesting because of the cast of characters involved.
A man named Thomas Davis, the former Chief Executive Officer and then current board member of Dean Foods, got into serious gambling debts with a shady character named William “Billy” Walters, a sports gambler from Las Vegas.
Davis worked off his debt by providing Walters with insider tips, which Walters trade on.
Walters then shared tips with Mickelson, who also had gambling debts owed to Walters.
What is FINRA?
FINRA is referred to as self-regulatory organization (SRO), and it formed when the regulatory arms of the NYSE and NASDAQ merged.
Indeed, an exchange in the US is required before being approved to have an enforcement arm, or be self-regulatory, before it is approved.
For instance, The Industry Spread covered when trader Daniel Ostroff was sanctioned by the CME Group for spoofing.
That story ran because Ostroff worked for 3 Red Trading, a repeat offender; yet, the firm was inexplicably left out of their release.
More recently, the CME took an enforcement action against another firm for spoofing.
“Chicago Mercantile Exchange Business Conduct Committee (‘Panel’) found that on multiple dates between June 1, 2016, and February 15, 2017, a trader employed by JoErik entered and canceled multiple layered orders in CME Nikkei/Yen futures markets on the Globex electronic trading platform without the intent to trade, but rather, to encourage market participants to trade opposite the smaller orders he entered that were resting on the opposite side of the order book.”A more recent, from December 2018, CME action noted.
At a recent hearing, the CME’s head of Clearing, noted that the clearing division has an internal regulatory side for its clearing members.
Those are a couple of numerous ways in which the CME, self regulates, as it is required by the CFTC.
SRO’s are often controversial because they are private entities pursuing governmental, or at least quasi-governmental, duties.
For instance, it is illegal to practice law without a bar card, just like it is illegal to be an investment advisor without being licensed through FINRA.
Just how much of a good idea this depends on how much you think licenses, especially ones granted by quasi-public and quasi-private organization, help or hurt things.