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Archive for the ‘Ethics’ Category

End the “Code of Silence”

Friday, September 12th, 2014

I was asked to contribute to a survey recently, and one question made me think.  It was a question about why don’t more people consult investment professionals, and What keeps them from doing so.  I gave a fairly standard answer for me:

There are two reasons: first, most people don’t have enough income or assets for investment professionals to have value to them. Second, people don’t understand what investment professionals can do for them, which is:

  • They can keep you from panicking or getting greedy

  • They can find ways to reduce your tax burdens

  • They can diversify your assets so that you are less subject to large drawdowns in the value of your assets

After I wrote it, I submitted it for publication, but I wasn’t really happy with my answer.  The thing that left me less than happy are the various tales that I hear where investment advice is subpar, communicated poorly, etc.  Personally, I expect the real reason many people don’t consult investment professionals is fear of a bad experience, which may often stem from a a bad experience that they have had or a friend my have had.

I sympathize with the goals of the CFA Institute’s Future of Finance Initiative.  That said, I think it is a nice-sounding idea that won’t get far.  I have four main reasons why:

  • We don’t have a financial system where all financial professionals have to be under a common ethics code, with additional ethics code sections for areas of specialization.
  • We don’t have a culture among investment professionals that really wants to clean up the system, and talk about abusive practices, such that they become well-known and go away.
  • We don’t have enough of a culture among investment professionals that wants to genuinely educate the investors that want it, and in ways that don’t directly benefit us.
  • Because we don’t have one unified theory of investing, there will be enough gray areas where people will still get hurt by professionals.

On the first point, I would note a recent article of mine on self-regulation financial markets, where I said:

The guy from the National Futures Association emphasized the idea that mandatory membership in the association as a requirement to do business was paramount for an SRO and I can see that.  The SRO then has the “death penalty” hanging over the heads of those they regulate.  That said, consider this: the CFA Institute may dream of the day when all involved in investing *must* hold a CFA Charter.

I have no doubt that this would be a good thing.  Ethics codes are good for the industry, and to kick out bad apples would be a good thing.

On the second point, it would be worthwhile for financial writers and some larger firms to take on common practices that are abusive.  This will be controversial, because not everyone will agree on every item, but even getting a stoplight list where red is bad practices, green is good practices, and yellow means be careful would be a good start.

On the third point, we need to advocate for the best practices even where it doesn’t exactly fit where our businesses make profits.  Think of it this way: it often helps in home repair when someone who comes to fix one thing gives me some free advice on another matter that he doesn’t do, but sees it and tells me.  That builds goodwill for a later date, because I know that person cares about me, and not just what I pay him.

On the last point, my earlier article went over many of the disagreements:

Ethics aren’t neutral; people disagree about what is right and wrong to a high degree.  Even in finance, there are considerable disagreements in what is the correct behavior:

  • Active vs Passive mangement
  • Value vs Growth
  • Does Technical Analysis work?  (Is there truly a single discipline there?  I don’t think so.)

That’s a considerable reason why it would be difficult to enforce the views of the CFA Institute over the markets.  There is no commonly agreed-upon view of how the markets work.  The views of the academics are ridiculous, and do not reflect market realities. But many asset allocators trust them, even though their results are poor.

But even if this results in some squabbles, at least people can be aware that there are differences of opinion, and maybe that can inform the way we talk to clients.  Long only managers should tell their clients to buckle in, because they do not time the markets.  Traders should tell clients that they won’t do well in choppy markets, and that methods to limit losses and let gains run have their limitations.  Time horizons for investment decisions should be clearly identified, so that investors can set their expectations reasonably.

And that could be the best part of this: if investors have a good idea up front of how an investment will likely perform in a variety of scenarios, there will be fewer negative surprises, and hopefully, happy clients.

Anyway, that’s what I think the goals should be.  Now, who else wants to make them practical, and be willing to speak up about this?

Book Review: The Education of a Value Investor

Friday, September 5th, 2014


Before I start, I would like to remind readers of a Q&A that I did with the author, which is available here. [For readers at Amazon: Google "Aleph Education of a Value Investor". There are other useful links in the version at my blog.  Wish Amazon allowed for links...]

This is a good book if you know what you are getting and want that.  If you want a book to compare it to, I would class it with Benjamin Graham: The Memoirs of the Dean of Wall Street.  The reason for this comparison is that the book focuses on character development, and spends relatively little time on detailed value investing methods.  It spends a lot of time on the good parts of the lifestyle of a value investor, and this is where the book has its highest value.

Is it possible to “get rich quick?”  I don’t think so, but it is possible to become rich if you focus, make few decisions, but they are the right actions to take.

This book describes the transformation of the author, who went from someone trying to get rich quick in the short-run, and failing, to being an investor who could wait until he had a good idea to invest in, and then concentrate his capital in the best ideas that he had, and succeed.

But getting there was not a linear matter.  First, he had to figure out he was miserable.  Then, he had to find a new way to support himself, handicapped because the last firm he worked for had a bad reputation.

He picked up an interest in value investing, particularly the style that Buffett follows, which led him to a clutch of contacts in the value investing world who would help to shape his view of the world.

Without spoiling the book, some events happened that enabled him to set up his own investment shop where he does value investing for clients and himself.  And as such, he lived happily ever after?

Well, not yet.  He meets one key person, Mohnish Pabrai, who helps him think through the key aspects of his business.  He makes a number of additional friends who are value investors, and he figures out what he is good at analyzing and acting on, and where he is less capable.  Armed with that data, he acts to make his entire life more effective for himself, his family, and his clients.

He moved so that he could be out of the “New York Vortex,” where groupthink can carry you along.  He moved to a quiet area, and set up an office where he could think, and the odds of being disturbed would be low.  He set up an action area and a contemplation area.  He limited electronics to the action area and made it uncomfortable to stay in the action area.  This enabled him to think longer-term, and avoid taking actions because others were doing so.  He also had to learn how to get advice from other intelligent investors, without letting their views short-circuit his thinking processes.

He enjoyed life a lot more.  He also realized he had enough assets to manage, and so he didn’t need to market much, which allowed for a focus on serving current clients well.  About the only thing he needs to do is develop a sell discipline, and that is not an uncommon problem with most asset managers.  [Two of my articles on the topic: one, two.]

Near the end of the book, he shares eight pointers that will improve the investing of most people, if they are willing to think long-term.  I endorse the principles there, though there may be other ways to achieve the same disciplined attitude.  He also gives four case studies that affects the checklist that he uses for making investments.

Now, I have purposely left out the most colorful part of the book, the lunch with Warren Buffett, to the end of this review.  He and Mohnish bid together for the lunch and win.  The main thing he takes away from the affair was how much Buffett focused on his guests, and not on himself.  Indeed, at the end of the book, he credits his relationship with Mohnish in helping him to become more selfless in many of his attitudes.  To him, that is the real prize, much as he has done well as an investor and a businessman.


Can all of ethics be summed up as being farsighted and unselfish?  No.  Those are good things, but the Bible has many more things to teach than that.


This book will help you understand the internal attitudes of some value investors.  It may help you invest to some degree, but that is not the main point of the book.  After all, what is it worth to be a great investor if you aren’t happy?  Being happy as an investment manager is the main point of the book.  If you still want to buy it, you can buy it here: The Education of a Value Investor: My Transformative Quest for Wealth, Wisdom, and Enlightenment.

Full disclosure: I received two copies from the author’s PR flack.  Good thing too, because someone swiped one of them before I finished reading it.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.

Not Apt, Not Teed Up, Not Going

Saturday, August 2nd, 2014

Okay, let’s run the promoted stocks scoreboard:

TickerDate of ArticlePrice @ ArticlePrice @ 6/27/14DeclineAnnualizedSplits
 8/1/2014 Median-97.2%-89.6%


Now for tonight’s loser-in-waiting: Apptigo [APPG].  This is a company that  until four months ago was a development stage company for selling Irish horses in the US.  This is a company that has never earned any money, and only has positive net worth at present because of raising capital when the prior company acquired Apptigo in a reverse marger, and renamed itself Apptigo.

This is a company that says it will make money off of selling apps.  Well, they have one app at present, and it is called SCORE – Match Maker.  It has a grand total of seven likes at the iTunes Store.  Now let me hazard a guess here, and say that it is difficult to create a broad network for matchmaking.  The value of a network goes up proportional to the square of its nodes.  How will they attract enough attention in the iTunes ecosystem to make  a significant network?  Even if this is a legitimate company, I don’t see how it will be easy to make it work, as the promoter said it would be easy.

The promoter also said this in tiny type:

Important Notice and Disclaimer: Flying Under the Radar Stocks is an independent paid circulation newsletter. This report is a solicitation for subscriptions and a paid promotional advertisement of Apptigo, Inc. (APPG). Flying Under the Radar Stocks received an editorial fee of twenty five thousand dollars from Micro Cap Media Ltd. APPG was chosen to be profiled after Flying Under the Radar Stocks completed due diligence on APPG. Flying Under the Radar Stocks expects to generate new subscriber revenue the amount of which is unknown at this time resulting from the distribution of this report. Micro Cap Media Ltd. paid nine hundred forty-eight thousand, three hundred sixty-three dollars to advertising agencies for the cost of creating and distributing this report, including printing and postage, in an effort to build investor awareness. This report does not provide an analysis of a company’s financial position, operations or prospects and this is not to be construed as a recommendation by Micro Cap Media Ltd. or an offer to buy or sell any security or investment advice. An offer to buy or sell can only be made with accompanying disclosure documents and only in states and provinces for which they are approved. Do not base any investment decision based solely on information in this report. Although the information contained in this advertisement is believed to be reliable, Micro Cap Media Ltd. makes no warranties as to the accuracy of any of the contents herein and accepts no liability for how readers may choose to utilize the content. Readers should perform their own due diligence, including consulting with a licensed, qualified investment professional. Further, readers are strongly urged to independently verify all statements made in this report APPG’s financial position and all other information regarding APPG should be verified directly with APPG Audited financial statements and other relevant information about APPG can be found at the Security and Exchange Commission’s website at It is recommended that any investment in any security should be made only after consulting with your investment advisor and only after reviewing all publicly available information, including the financial statements of the company. The information contained herein contains forward-looking information within the meaning of section 27a of the Securities Act of 1933 as amended and section 21e of the Securities Act of 1934 as amended including statements regarding growth of APPG. In accordance with the safe harbor provisions of the Private Securities Litigation Reform Act, statements contained herein that look forward in time, which include everything other than historical information, involve risks and uncertainties.  All forward-looking statements are based upon current assumptions that are believed to be reasonable. In the event any such assumptions turn out to be incorrect, forward-looking statements based upon those assumptions will not be accurate. Flying Under the Radar Stocks presents information in this report believed to be reliable, but its accuracy cannot be guaranteed. More information can be found at APPG’s website (underline emphasis mine)

I actually like this disclaimer, except for the fact that it is in tiny type, while the proclamation of the investment’s fake virtues are in big type.  So, I have a simple proposal for the SEC regarding newsletters like this: the type size of any disclaimer must be as large as the the largest type in the document.

This is fair, and consistent with other laws that regulate “the fine print.”

I emailed the CEO of Apptigo to ask him whether he knew about the stock promotions (there are three going on), and whether the company, its major shareholders, or its management was benefiting from the promotion.  There was no answer, though I wrote to him on Thursday.

Regardless, avoid promoted stocks, dear friends.  No company of any good reputation pays anyone to promote their stock.  Avoid promoted stocks.

Of Faith and Markets

Monday, July 28th, 2014

Here’s another letter from a reader.  If reading about my faith turns you off, stop reading now, because this will be thicker than usual.

Hi David,

 I’ve just started reading your blog, and greatly enjoy it. I noticed you integrated your faith with your perception of the world and economics/policy. I am a Christian who is attracted to the wonder of the financial markets. So many individuals making so many decisions being affected in so many ways; it can be overwhelming. My question regards how you view financial markets within your faith.

 I was originally going to work at an internship at a hedge fund in 2008. I thought it’d be the dream: making big money! But that summer, when all hell broke lose, the hedge fund closed down before I could even start. Fast forward six years, and I’m working in corporate finance at a non-financial company – nothing to do with the markets. I want to jump back in, but not as a trader. I feel there was some Divine Providence in how I’ve perceived my “close call” with the trading world. I’m currently trying to understand how I can approach careers involving the financial markets that don’t force me to leave my faith at home. How do you approach the world of finance with your faith?

 Thank you so much for taking the time to read this, and God Bless.


Dear Friend,

I went through a similar experience early in my Christian walk, because sadly, I ran into some Evangelicals who denigrated earning money – Evangelical Leftists were more common in the late ‘70s.  Thus, I turned against Finance though I was good at it.  My Master’s thesis anticipated price and earnings momentum, and most quantitative long-short equity hedge funds.  Too bad for me; I aimed at doing development work in the Third World.  As it was, when I figured out that development economics tended to inhibit growth, and its opposite encouraged it, I gave up.  I started a career in finance as an actuary.

When I did that, I realized that I must do many things:

Be a good example to those around me.

  • Be friendly and pleasant to my co-workers.
  • Oppose fraudulent practices.
  • Be honest with those with whom I dealt.
  • Apologize when I sin or make mistakes.
  • Avoid bad language.  That not only means foul language, but also cruel language, even if it is technically clean.
  • Work hard.
  • Learn, learn, and learn.  A dirty secret about Evangelical Christians is that we read more than non-Christians, and have more Ph.Ds per capita.  Okay, the Jews have us beat there, and badly.
  • Avoid working on the Lord’s Day [Sunday].
  • Don’t be afraid about using the Bible as an analogy or as an example.  After all, people cite all manner of garbage as authorities, and the Bible is not permitted?  Is it because the Bible claims universal authority that people want to ban it?  Yes, that is why.  No one wants the Owner of the Earth to remind us of His claims.
  • I was always honest with coworkers about my faith in moments where it was natural, but I never beat them over the head with it.
  • Love your coworkers, and those with whom you interact.
  • Avoid investments in companies that have sinful goals — gambling, illicit sex, etc.  Also avoid companies that try to cheat people.

Practically, the most important thing is to be honest, keep your word, aim for competence, and be faithful in your dealings with others.

Any vocation can be pursued in a worldly or Christian way – most of it is the attitude that you bring to it.  “Whatever you do, do it heartily, as unto the Lord.”

One final note: one time, I was given a very hard time by a boss who was under a lot of pressure.  Nominally, I was his assistant, and so the rest of the team was amazed with what he put me through, while I largely kept a good attitude (it was not perfect).  One of my co-workers, a Christian, came to me privately and asked how I was doing.  I said that I was fine.  She knew me well, and said that she was praying for me, and that the entire staff was astounded that I would put up with what the boss was doing.  I told her that he was the boss, under a lot of pressure, and that if I pushed back, it could do a lot of harm to all of us.  I was not doing it for me.

It made an impression on the staff, and though they liked me, when the boss left six weeks later, they chose me to run the unit.  Truth, management above chose me, but without their support and love, I would not have been half the leader that I was.

So, serve for the good of others, and you will succeed.  “Love your neighbor as yourself.” [Lev 19:18]




Book Review: The Big Con

Sunday, June 29th, 2014

9780385495387This is an unusual book for me to review.  This is a book about Confidence Men, first published in 1940, and recently republished in 1999.  It was written by David W. Maurer, who was a professor of linguistics, and used his skills to analyze the slang of the underworld.

This book deals with Con Men — men who try to gain the confidence of another man in order to get him to hand over money to them.

I have often said, and many grifters would agree, that it is very hard to cheat an honest man.  Honest men know that there are no easy pickings in life, and if there are some holes in the system, no one will share them with you for free.  Grifters trick those who think that the world is unfair, and want to be cut in on the inside action.

Sam Israel was tricked in that way in the book “Octopus.”  Clever actors convinced him that there was easy money to be made, and they milked him and his hedge fund clients, while he lost it all.

This book takes you through the human systems that con men create in order to convince their targets that they can make easy money, until the con men fleece them.  The two key characters are ropers, who attract victims, and the insiderman, who is the boss and is the one who directs the whole scam.

They design a system that delivers a few small wins to the victim, who gets greedy and puts up a lot of money, and then the rigged system delivers a loss, cheating him of his money.  Mot often, since the victim was an willing participant in an illegal scheme, even though he was cheated, he will not be willing to press charges, even though was cheated, because he wants to protect his reputation.

The book describes the many players involved as actors, to make the enterprise look legitimate.   It also describes the games that they played, and how they would entice a victim into an unfair scheme in which they would profit off others, but end up cheating the victim.  The book talks about how the justice system was often bought by the insiderman, thus protecting the activities of those he employed.

It also describes how the ropers would figure out whether a victim would go along with a scam or not.  It gives the history of confidence games — how they developed, and how some faded, and others grew, at least for a time.

Along with all of that, it describes the lives of the grifters, and how few of them truly prospered.  Most wasted the money that they earned in riotous living. As Proverbs 13:11 says, “Wealth obtained by fraud dwindles, But the one who gathers by labor increases it.” [NASB]

To the Modern Era

Breaking from the book review, is our era so much different, or do we have the same problems in different ways?

I’ve been down enough roads in the investing world to know that there are a lot of parties who try to get people to take bad deals.  It can be as simple as guys who use the “straight-line” pitch to get people to invest with them.  It can be institutional investors who try to trick naive institutions.

It can be seminars with shills and other accomplices like Rich Dad and their ilk.  We still have Nigerian Scams and other Scams on the Internet, many of which involve identity theft.  We have promoted penny stocks, structured notes, and Ponzi schemes.  I have written about all of these.  Is the current era less prone to con men than the era from 1890-1940?

I would argue no, though it was more colorful and personal in the past.  Today’s scams are more virtual and anonymous, leaving aside Madoff’s Ponzi Scheme which was highly personal, and psychologically design to harvest money from those that wanted a high yield with safety.

Why you should consider this book

By reading about all of the ways that people get cheated, you will be deterred from greed, and distrust those who incite greed.  These problems are alive and well today.  Can you learn that there are no free lunches, and no free money?  If you can learn that, you are well on the way to not being cheated.


The book is repetitive.  It does not condemn the grifters for the sins they commit against others.  The book is almost amoral.  At least, it posits a human morality, where there is a code of honor among thieves, but thievery is not in itself wrong if the victim is a greedy person.


This is a classic book that if you read it should make you more skeptical about “sure things,” and “get-rich-quick schemes.”  Away from that, it is a commentary on the human condition, showing how many men are willing to compromise their ethics in order to make a lot of money.  Anyway, if you want to, you can buy it here: The Big Con: The Story of the Confidence Man.  It’s not expensive for what you get, and it is a colorful book.

Full disclosure: I bought a copy with my own money.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.


But They are not Actuaries, nor CFAs

Friday, June 27th, 2014

I am grateful that risk managers inside banks have more clout these days.  That said, I want it to persist, and the best way to do it is to have risk managers beholden to an ethics code, like actuaries or CFAs.

This is valuable, because the risk manager can point to a body of ethics that says to his manager, “I am sorry, but those of my discipline say that this action is unethical,” when line managers complain that the risk manager is killing business by insisting that certain risk standards should be maintained.

Actuarial risk models cover the life of the business, unlike Wall Street models that measured risk in terms of days.  Cash flows mater, and the ability to meet the demand for cash matters.  Long-term risk models tend to surface risks better than short-term models because an intelligent businessman can ask what are the odds that we will have a crisis over the duration of our existing business?

Once on a task force of the Society of Actuaries, when discussing non-traditional actuaries going to Wall Street, I said, “Great idea, but the line managers will eventually kill anyone that gets in their way.  They don’t want people who have an ethics code.  It inhibits business.”  After that, there were some nervous chuckles on the phone, and the conversation moved on.

Ethics codes are needed when the disparity of knowledge between the designers and ultimate consumers/investors/regulators is so great that there are many ways that the consumers/investors/regulators could be cheated.

My view is controversial but simple.  Every professional in investing and finance needs to have an ethics code, making them more sensitive to their clients.  The easy solution is that every investment/finance professional needs to hold a CFA charter.  The three exams are pretty minimal, and can be passed by most people with some study.  Give the actuaries a pass, their exams are far harder — far, far, far harder.

But set some boundary for ethics and examinations of competence, to clean up finance and send the flim-flam men to the edges of the market, where they belong.



Self-Regulation in the Financial Markets: My Thoughts

Friday, June 13th, 2014

Self-regulation: let’s think about a person.  Can he regulate his own life on his own?  Of course he can.  But will he?

The same is true of markets. SROs can be effective if the culture is good, and people are willing to take actions against friends.  But an SRO can also develop a culture that has a blind eye toward offenses, until the media embarrasses them.  The same can be true of regulators, though.  They can be “in bed” with the industry if the wrong culture exists in the regulatory body.

2) The trouble with financial companies and products is that they make promises, whether sharp or vague, about the future.  That leads some people to commit money today to those products, which may be bad or good.  When done across a whole economy, that can lead to booms and busts.  That is a great reason to regulate the promises made by financial firms.

3) But how do you regulate?  Do you have a sharp separation between the regulators and the regulated, which can make regulation adversarial, or do you introduce a third party, the SRO?  The SRO is a kind of middleman, who executes the will of the regulator, but takes into account the special conditions in each market, and talks with the regulator about where they might be wrong in what they would ordinarily do.

4) SROs have specialized knowledge, drawing from the firms they regulate.  Well, regulators could have the also, if they hired the best, and paid them what they could earn in the private sector.  My but the regulated would be baffled if they faced the “stone wall” of their equals in dealing with regulators.

But our government is chintzy where it should be bold.  Aside from idealistic investors like me, (and I have applied to various government positions without the decency of a reply) it is difficult to attract top talent without paying top dollar.  And as such, they have not gotten top talent.  Academics are not top talent.  They don’t really know how the markets work.  They know how their models of the markets work.

Ideally, you need investors who understand the academic research, like me.  If you have regulators with that strength of knowledge, you could regulate well.

5) Many of the speakers today talked about mining big data to get results.  I will tell you that the only way to get those results is to hire talented programmers, then train them in the markets.  Waste time teaching them; they’re bright, they will learn.  Then after the initial training, propose the first project.  You will create a cadre of clever programmers that can sniff out problems.  Pamper them, and you will have a fantastic corps for sniffing out financial irregularities.

The guy from the National Futures Association emphasized the idea that mandatory membership in the association as a requirement to do business was paramount for an SRO and I can see that.  The SRO then has the “death penalty” hanging over the heads of those they regulate.  That said, consider this: the CFA Institute may dream of the day when all involved in investing *must* hold a CFA Charter.

I have no doubt that this would be a good thing.  Ethics codes are good for the industry, and to kick out bad apples would be a good thing.

6) When there are more than two parties in any economic arrangement, regulation gets tough.  It becomes difficult to separate the various interests, and come up with the right division of duties toward the ultimate consumer.

7) On Rules-based vs Principles-based regulation, in the American context, I lean toward rules-based.  Rules-based has the advantage of comparability.  Let the analysts make their adjustments, and let the companies provide the data to do so.  But provide a consistent set of rules that all need to comply with first.

8 ) Finally, on derivatives.  Regulate them as insurance, and let the states deal with it.  Require insurable interest such that only bona fide hedgers can initiate trades.  Speculators should not be allowed to trade with each other; that is gambling.  If we did this, the derivatives market would shrink dramatically, and no one would be hurt.

That is what I would do, and Wall Street would fight it, tooth and nail.

Self-Regulation in the Financial Markets: Exchange Issues, Market Structure, and Investor Protections (Part 3)

Thursday, June 12th, 2014

US System of Self-Regulation through SROs: Strengths and Areas for Reform 



  • What are the most substantial/significant contributions of the current SRO system in the United States?
  • What areas present the greatest need for reform?
  • How can the private versus “state actor” functions of non-exchange SROs be reconciled?


David Blass
Chief Counsel, Division of Trading and Markets
US Securities and Exchange Commission

Trading markets division oversees oversees rules, rule changes, etc.  Promulgate rules, exposes to the public.  Dodd-Frank gives strict deadlines now, which if exceeded leads to proceedings, which now means further time to evaluate, decide, and additional public exposure.

Lynnette Kelly
Executive Director
Municipal Securities Rulemaking Board (MSRB)

Created in 1975 to deal with egregious conduct.  Regulates the muni market.  Writes rules and others enforce.  SEC regulates on anti-fraud.  Protect muni issuers since Dodd-Frank.  Provides data to other regulators.


Daniel J. Roth
President and CEO
National Futures Association

SRO deals with Futures & Swaps — interacts with the CFTC.  NFA is to CFTC as FINRA is to the SEC regarding crafting of regulations.

Moderated by: Cheryl L. Evans, CFA Institute

DM Note: attendance down to about 50 at this point.
Q to LK:  How does MSRB “protect issuers?”
LK: Qualified professionals are held to a higher standard.  [DM: note Poway School District...]
Q: What do you look for in an SRO?
DJR: Mandatory membership is needed, which makes expulsion end the business of the one thrown out.
LK: Collection of data is important.  Led the way on “pay to play” issues.  Argues that the muni market is the most transparent bond market after Treasuries.  [DM: I doubt that.]
DB: Authority, Deep Knowledge, Sanctions help make for a good SRO.
Q: How can SROs aid regulators with data issues?
DB: we are data hungry in order to classify market participants.  MIDAS — more timely analysis of market trading data.
LK: Aids in collecting analyzing data.  Analyzes trade data daily.  Responds to requests from law enforcement and regulators.  They have allocated a lot more time and money getting analyses together.
DJR: Drawing together all of the data is tough, but when you do it, you uncover anomalies.  Constantly developing new systems.  Have to have human intervention, computers aren’t enough.
Q to DB: How are you increasing your analyses of data at the SEC?
DB: lots of ways, one example is churning.
Q: Conflict challenges, how do you deal with them?
DJR: Create a system of checks and balances.  34 people on his board, public director are the largest bloc.  Diverse interest also sometimes checks matters.
LK: We are audited.  Staff is independent of the board.  Directors must be competent & ethical.
Q to LK: How do you provide interpretative guidance?
LK: they try to interact quietly with the regulators to resolve differences of opinion.
DB: FINRA is in the same place regarding the SEC.  FINRA has to enforce SEC securities rules.
Q: What the data sharing rules regarding agencies and SROs?
DJR: CFTC has full access to our data.  We notify other affiliated regulators/SROs.
LK: Formal rules w/FINRA, IRS, banking regulators, etc., law enforcement via subpoenas.
Q to LK: Additional financial information on new issues?
LK: No authority over financial issuers, more frequent disclosure would be better.  We make our systems easy for issuers to upload data.  FOIA requests can be made as well on issuers.  Munis are not high quality liquid securities.
Q: Thoughts on principles-based rules and regulations?
DB: perennial issue, we will never be fully one way or another.  Market participants request rules to guide them when principles are issued.
LK concurs.
DJR says that principles-based rules allow them to be tougher.  Market participants have a rule: they complain.  (laughter from audience)

Self-Regulation in the Financial Markets: Exchange Issues, Market Structure, and Investor Protections (Part 2)

Thursday, June 12th, 2014

Exchange SROs: Meeting the Needs of Investors and the Financial Marketplace


  • How do exchange SROs contribute to the effective functioning of the securities markets?
  • How has the role of exchanges changed since they were first designated as SROs, and have these changes affected their ability to function effectively in that role?
  • Do recent breakdowns in exchange oversight functions indicate a need for an overhaul of structure/functions or point to “fatal flaws” in the current system?
  • Are conflicts in the current system of demutualized exchanges resolvable or inherent in the system?
  • What needs to be done to reinforce the integrity of the system and increase investor protections?
  • How does increased competition from broker/dealer internalization networks and foreign trading markets affect exchanges under the constraints of the current self-regulatory system?


Roberta Karmel
Centennial Professor of Law, Brooklyn Law School
Former Commissioner of the US Securities and Exchange Commission

The change from fixed commissions was significant.  NASD traders had preferential rates trading with one another.  Existing SROs continued on.  Expulsion was a threat.  Exchange listing standards were a significant protection.

Many markets, and profit seeking exchanges have changed matters.  Sarbox and Dodd-Frank have affected matters  with listing requirements.  JOBS act has opened up listing standards, and perhaps not in a good way.  SEC was happy to see the monopoly of the NYSE broken, but there have been unanticipated secondary effects.  We need to ask what kind of regulation we need now in the present environment.


Richard G. Ketchum
Chairman and CEO, Financial Industry Regulatory Authority

Mentions MS was the first Chair of FINRA.  Merger of NASD and NYSE Reg.  FINRA has an enhanced majority of public governors.  No way for industry to capture FINRA.  Oversees all bond and equity trading.  Exchange SROs can delegate to FINRA, but they must oversee what FINRA does for them.


Mary Schapiro
Vice Chairman of the Advisory Board, Promontory Financial Group
Former Chairman of the US Securities and Exchange Commission
Former CEO of the Financial Industry Regulatory Authority (FINRA)
Former Chairman of the Commodity Futures Trading Commission

SROs are cost-effective and flexible, with deep expertise.  Examine participants, Surveill markets, etc.  New tech, markets, exchanges as profit-seeking entities are new challenges.  Conflicts of interest have grown along with HFT.


Moderated by: Andrew N. Vollmer, University of Virginia School of Law

Q: Does the current system work well? What areas do we need to change?

MS: It’s working well.  Vigilence is needed.  Well-functioning SROs are an aid to regulators.  Easier for an SRO to address an issue with stakeholders.

RK: Wants the SEC to have a bigger budget, merge the CFTC into the SEC.  SROs are necessary now because the system won’t work without them.  Fragmentation of trading makes self-regulation less effective.

ANV asks RGK to reply.

RGK says FINRA aids regulators.  FINRA brings knowledge, focus and access.  Government regulators are more confrontational, FINRA can get more done.  Exchanges are the only ones enforcing listing standards.

MS concurs that listing standards are needed.


Q: Have we lost some of the benefits of SROs with the delegation of authority to FINRA?

RGK: has worked with SROs his whole life.  Comments how things were often worse in the past, not all things are worse today.

MS: Concurs with RGK.

RK: There has been loss, much of it through the destruction of exchange-based trading.  2008 meltdown — few firms did anything to stop the crisis.  Everyone acted in their own interest.


Q: Aside from listing standards, what other things should the exchange SROs do?

MS: Exchanges will always be responsible for aspects of investor protection.

RK: Exchanges will always have an interest in the integrity of their markets.

RGK: Comments that exchanges should watch over the quality of products traded [DM: think of leveraged and inverse ETFs, ETNs, penny stocks, promoted stocks, etc.]


Q: What about efficiency at the SRO level?

MS: Competition and efficiency don’t always work well together.  SEC and CFTC should be merged.

RK: SEC and CFTC should be merged.  Need more than one regulator, though.  Did not work in the UK.  FSOC a disaster, a non-solution.

RGK: We interact with everyone.  No opinion on whether the SEC and CFTC should be merged.

Self-Regulation in the Financial Markets: Exchange Issues, Market Structure, and Investor Protections (Part 1)

Thursday, June 12th, 2014

I’m at the Self-Regulation in the Financial Markets: Exchange Issues, Market Structure, and Investor Protections Conference hosted by the CFA Institute and the DC Society.  I will be making occasional posts on this today, in the form of summary notes.

Jim Allen, CFA
Head, Capital Markets Policy – Americas

CFA Institute – already self-regulated.  Aids in flexibility of regulation.  De facto standards of investment performance measurement – GIPS [Global Investment Performance Standards].

Mary Schapiro
Vice Chairman of the Advisory Board, Promontory Financial Group
Former Chairman of the US Securities and Exchange Commission
Former CEO of the Financial Industry Regulatory Authority (FINRA)
Former Chairman of the Commodity Futures Trading Commission

Keynote talk

Has spent much of her life heading self-regulatory organizations [SROs].  She thinks SROs lever the effectiveness of government in regulating finance.  Congress does not appropriate the proper amount of money to regulate finance on its own.  Employee levels in the government regulators have not grown.

Regulating RIAs – only 9% examined in 2013 managing $55 Trillion of assets.  SROs are not a second choice solution.  There is more expertise, tech knowledge, etc.

The Future of Self-Regulatory Organizations

Cited this article: Top 10 Characteristics of Effective Self-Regulatory Organizations

DM note: There are about 60 people here in this room adequate to hold about 150.

First Panel

Global Overview: Role of Self-Regulation in Increasingly Interconnected and Complex Markets



  • What are the benefits of an effective self-regulatory system in the securities markets?
  • What challenges does the self-regulatory system face in light of the complexity of financial products and trading mechanisms (algorithmic trading, dark pools, etc.), and what resources are needed in response?
  • How does the use of “front-line” regulators in certain market sectors contribute to more effective regulation?
  • What is the future for self-regulation? How do the experiences differ between emerging markets and those that are more established?

Chris Brummer
Professor of Law — Georgetown University Law Center
No intro talk.
Amarilis Sardenberg
Chair of the Board — BM&FBOVESPA Market Supervision

Government Bond – Central Bank

OTC Bond, Securities, and Derivatives – all under one regulator.  Each has its own SRO.  Her securities SRO audits brokers and custodians.  All trades tracked by beneficial owner; makes tracking manipulation easier.
Susan Wolburgh Jenah
President and CEO –Investment Industry Regulatory Organization of Canada [IROC]

Heads a national SRO in Canada.  Provinces have financial regulatory authority.  This is somewhat similar to insurance regulation in the US.  SROs have greater authority in Canada.  Audited regularly, and the results are made public.  Thinks they hold to the Top 10 Characteristics of Effective Self-Regulatory Organizations pretty well.

Moderated by: Jim Allen, CFA, CFA Institute

Q: Challenges of SROs?

CB: 2 ½ points: 1) Globalization – financial trade can go on anywhere – affects regulation.  Coordination is helpful, the US cannot dictate international rules.  Soft principles have dominated over negotiating hard principles.

2) Disintermediation of financial services firms eliminates gatekeeping functions of financial firms.  Bitcoin, Crowdfunding, Dark pools, etc.  (DM: I would have said derivatives or money market funds…)

SWJ: Changes have been huge – explosion of exchanges in Canada and the US.  High frequency trading [HFT] is highly controversial – and it is a data-intensive task to investigate what is right or wrong.

AS: Coordination of policy is important.  A little surprised at arbitrage trades.


Q: What to do about attacks from hackers?

SWJ: Big issue, the investment banks are big targets.  Smaller firms lag on resources.  We try to educate on the issue, create best practices, policies, etc.  Their SRO hires hackers to test their systems.

AS: Similar answer to SWJ, adds that the exchanges have their own efforts.

CB: Capture the right data, analyze it.


Q: Regulatory arbitrage, how to reduce?


CB: Cites: The Danger of Divergence: Transatlantic Financial Reform & the G20 Agenda

Different regulators move at different speeds, and face local challenges.  Different cultures affect implementation.

SWJ: Businesses move faster than regulators.  Are provincial securities regulators able to adapt more rapidly than a national regulator? [DM: If they cooperate, I think it can work.]

AS: There are so many trades going across borders that it is very difficult to police.  Post-trade settlement is tough – harmonizing settlement standards has a long way to go.


Q: How do you avoid industry capture?

SWJ: IROC does not advocate, it only regulates.  Purity of purpose is important.  Board is 7 independent, 7 industry and the Chair.  Nominating Committee composed of the independent directors plus Chair.  Everything public and transparent.

AS: Her exchange SRO is established by statute, and has clear authority and goals as a result.  Board of 11, 8 must be independent.


Q: Not many SROs in banking, as finance goes more global, how will SROs fare?

CB: Harmonization of data collection would help.  Difficult to harmonize all regulation under one roof.  Federal Reserve doing some of this. [DM: not really]  Long history of SROs in finance and other areas, like accounting.  Independent majority on SRO boards need with an independent source of revenues.

SWJ: There is an academic paper to be written here.  [DM: Panic of 1907, Great Depression help explain it.]

AS: Not many exchange based SROs: US, Canada, Brazil, Columbia…


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.

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