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The Inside Story of How Our Financial Regulators Let Us All Down

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.

[Editor's Note: Money Morning Capital Waves Strategist and retired hedge-fund manager Shah Gilani became a national icon in 2008, as he dissected the shady workings of Wall Street, uncovering how the greed of a few brought down the economy of our entire country. He's since launched a new publication called Wall Street Insights & Indictments. His goal simply is to show you what's really going on in the markets, so you can "know the story" and make some money. And the best part is, it's absolutely free. Just sign up by clicking here. You'll also receive Gilani's latest report: "5 Ways to Trade the Coming EU Collapse – And Make a Killing".]

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About the Author

Shah Gilani is the Event Trading Specialist for Money Map Press. He provides specific trading recommendations in Capital Wave Forecast, where he predicts gigantic "waves" of money forming and shows you how to play them for the biggest gains. In Zenith Trading Circle Shah reveals the worst companies in the markets - right from his coveted Bankruptcy Almanac - and how readers can trade them over and over again for huge gains. He also writes our most talked-about publication, Wall Street Insights & Indictments, where he reveals how Wall Street's high-stakes game is really played.

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  1. john ashton | November 4, 2011

    Shah, Keep pushing. These alleged criminal acts need to be prosecuted for the future health of the capitalist system.

  2. Gordan Finch | November 4, 2011

    Thank, you for bringing this information out, it was noticed that AIG files 2009 appeared missing.

  3. Eric | November 4, 2011

    Please stay on them to get to the bottom of it…………and not be so quiet.

  4. Lawrence Ashfield | November 4, 2011

    Do you know of any stock manipulation investigations by/of the SEC? Example SIRI

  5. MikeB | November 4, 2011

    Mr. Shah! You have done it again!

    At one point, a couple of decades ago, I had worked in my brokerage firm's Accounting Dept. When auditors, internal or external, came for an audit. We were always attentive to any request for information that they asked for. They sampled the data we provided for accuracy and looked very closely at a majority of the significant and even insignificant numbers. If there was a difference of opinion as to the validity or accuracy of any data, we needed to bend over backwards to prove we were correct or would have to adjust that data to what the auditors felt they should be.
    With many of the blowups that have been reported, internal auditors and those from regulators need to shoulder much of the blame. The CPAs needed to separate out their Advisory Businesses because of conflicts, there were many points where Madoff's scheme could have been stopped early (see Shah's comments), etc, etc, etc!
    Regulators have to have their investigators/auditors increase their curiosity and they themselves need to take responsibility when reviewing the business community. Unfortunately we will probably get more regulations, but they will be as meaningless as the regulations already in existence. When regulators ignore or break the rules, or put forth a limited effort, we all suffer.

  6. Jonathan Widell | November 4, 2011

    Great investigative journalism in its own right! It is good to know there are knowledgeable persons like Shah Gilani who know how the "system" works and are still not happy with it.

  7. jim | November 4, 2011

    Let us all down?…
    Give me a break, full on treasonous scandal at the highest levels, and the best headline you can come up with includes the words "let us down"?

    I say, "let them down"…from the gallows. This corruption has ruined this country, and is pervasive throughout the financial system and regulatory agencies almost anywhere you point the finger.

    Fraud on a massive scale has been purposely released since the 1999 repeal of Glass/Steagall so that profits can be privatized, and losses sociallised. Highly leveraged gambling with no risk of loss…I cry treason.

    Military generals need to invade Wall Street hellholes, arrest and try known felons for treason, and or RICO racketeering and fire-up the firing squad.

    Thank You, and have a nice day!

    • Gambit | November 4, 2011

      RICO act? Why not use the new Patriot Act? These acts of vandalism against our financial well being are more terrifying than the shoe bomber. Certainly many people have lost their lives already due to the need brought on by these acts of Terrorism.

      I say start with the extraordinary rendition of the scoundrels and water board them until they tell all.

  8. Gill O'Teen | November 4, 2011

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

    And don't worry. The AG at DOJ is checking the financial contributors' list to the White House Cartel as I type. As soon as he's completed a rather superficial scan, he will know the proper steps to take.

    Bottom line – all companies with the foresight to have bought sufficient amounts of protection are exempt form following the law. Other companies will be made an offer they can not refuse.

  9. Indira K Betina | November 4, 2011

    Good job, Mr.Gilani. Keep it up.

  10. Augustine Moscatatello | November 4, 2011

    Do you know that since yesterday customers of MF Global have not been able to exit any of their existing positions (not even with market orders) thus leaving them swinging in the breeze watching their accounts dwindle with no abilitiy to stem losses? Our regulators are really looking out for us aren't they?

  11. Werner | November 4, 2011

    Thank you for this scaring reminder. I am not directly concerned, being without any meaningful position on any US asset. However I can hardly imagine that this kind of law-breaking is a US exclusivity. It must be going on worldwide in one form or another. It is not sure though that wistlebower's outside the US are allowed (or willing) to express their opinion in the same way you are doing it!
    Meanwhile you are making me think twice, before investing in the US!

  12. Steven Bens | November 4, 2011

    I agree with your comment – no need to change the regulations, just enforce them; and prosecute the
    offenders ! Government employees are the same whether they are SEC, Justice Department, Immigration Department or TSA – they harass the small guy and allow the big culprits to get away.
    It's time we had a real "Sheriff" in Government.

  13. MichaelB | November 4, 2011

    This kind of thing has been hinted at in the news for some time. I'm convinced that it is not just the SEC. Pick ANY regulatory agency. The scandal is that we have a cycle of increasing regulations, NON-inforcement, scandal, and then NEW regulations. It seems that each administration won't make sure that the regulatory agencies enforce their respective regulations. In fact, documentary after documentary points out how agencies like the SEC, FDA, etc, etc, are in bed with the organizations they are to oversee. Cronyism is the rule of the day that needs to be stopped!

  14. fallingman | November 4, 2011

    You really are the man Mr. G.

    Good thing we have all that government to protect us from Wall Street criminality and insider shenanigans, huh.?

    "Let them down from the gallows" … "The AG is checking the financial contributor's list" … good ones guys. Right on.

  15. Benton H Marder | November 4, 2011

    Why am I not surprised? Some folks think that it was the 'Occupation' that was turning Wall Street into a modern-day Seven Dials. Now, it looks like it's been Seven Dials for a long time. Seven Dials was a section of London proverbial for crime, squalor, immorality, and worse way back in the bad old days.

  16. Paul | November 4, 2011

    Shah, This is what good Journalism is all about. Your timing is perfect.

  17. Fr. Tom Loucks | November 4, 2011

    Good job!
    I've been reading "Toward Reforming the International Financial and Monetary Systems in the Context of Global Public Authority," the document produced by the Pontifical Council for Justice and Peace. Most people will miss the part about changing human behaviors that harm the common good. I think that most people can understand that our mountains of laws are not working because of the human elements that fail to act for the common good. Thus, suggesting a supra-government uber alles isn't exactly going to solve the economic problems. However, one could read the document and reflex upon the human conditions we once called sins. Somehow, regulations don't change that.

  18. ted plottner | November 5, 2011

    I knew the SEC was a sham in progress way back when they were investigating then citizen and stockholder george w…..and lately when I had 9,000 qz. of silver I had been buying since 2002 and nobody will prosecute the man that carried out the sham……….It is all rigged,,,,,,,,,,,,,,,,,there is no law and order… is all an illusion……………..

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