30 for 30 Interviews: Harry Markopolos

I can’t comment on that because I’ve been out of the industry for five years. Some things I can tell you about the Dodd bill, I’m certainly in favor of a single overarching regulator with one computer system. The reason is, if you have six or seven regulators, depending on whether the Consumer Financial Protection Agency (CFPA) has its standalone agency…but we had 16 different intelligence agencies with 16 different computer systems that didn’t share information prior to 9/11.And you can see what that resulted in– disaster. So to have six or seven regulators on six or seven computer systems, it’s going to lead to not being able to connect the dots and lead to disaster in the future. So you need to find a way that they are on the same computer system–that there’s information sharing and that’s a massive IT undertaking but they really need to do it. You have these conglomerate financial services giants that transcend national boundaries and they may have a broker/dealer arm, an insurance arm, an asset management arm, and they may have a proprietary trading arm, some of them probably have a banking arm–so they have five major functions and no one’s going to be able to connect the dots unless you get all the information on one single computer system so that people can connect the dots and see red flags and warning signs …and you need to be able to look at that like our intelligence agencies do now in regards to counter terrorism.

You had mentioned the SEC getting more oversight over derivatives and hedge funds. Do you think this is a good idea considering the size of the SEC’s staff? The SEC lacks adequate staff to examine the firms they already examine.

The problem with the SEC is the budget is so low–they are talking about $1.3 billion budget this year. Well, we’ll have individual hedge fund managers earn more than $1.3 billion for themselves personally on their individual tax returns this year. So you can see it’s an underfunded agency that doesn’t have the skilled people that they need. They really need to refocus how they run the entire agency and the best way they can do that is they need an entrance exam. They don’t test people coming in now. They get skill pay for people who I consider don’t have much skill. They need to make the compensation scheme commensurate with the industry’s, and the way to do that is to increase the base pay and make the rest dependent upon bonuses for successful case settlements. You can do that…you have to fine the bad guys triple damages for every time they get caught and a percentage of that revenue has to be devoted to the bonus pool for the agency employees that brought the big cases that are meaningful to deterrents of future wrongdoing. They need to compensate like Wall Street does because you need to be able to recruit foxes to chase foxes. Right now that’s not where the agency is. They don’t test on the way in and they under compensate.

What kind of testing would you have?

Certainly one thing I would do is have my examiner staff, if they were on the accounting side, I would want them to be CPAs and would want them to have the equivalent of Fortune 1000 public accounting or auditing experience. You want them to have X number years of experience and you want to give them an accounting exam that’s higher level than the CPA exam to make sure they are qualified. For the asset management division, I would certainly want them to be chartered financial analysts with again, I’d want to test them above the CFA level body of knowledge because I’d expect them to have industry experience. I’d want them to have derivatives experience; I’d want those people to know how to take apart and put together structured products and fixed-income instruments. So you’d want to have people like that…same for the lawyers, they need testing above the bar association. You want it to be an elite agency once again, instead of an also-ran, which is what it’s become.

Have you heard from anyone at the SEC asking for recommendations from you?

Yes, I certainly have. Mainly by Congress, though. I’d say I’ve been asked by both Houses of Congress; there have been people within the agency that have asked me for recommendations. Not many, and certainly not from Washington. People have called me to pick my brain from the [regional offices].

I wrote an epilogue in my book [No One Would Listen] where I make recommendations, and I’m happy to say the SEC is going out and adapting some of those recommendations. It’s a mixed bag; [the SEC is] changing faster than any government agency is changing. No one has gotten religion quicker than the SEC. They know that the collapse on Wall Street, with Lehman failing, Bear Stearns going down, the industry that they were supposed to be overseeing with it going down for the full count and almost disappearing but for a rescue by taxpayers, they’ve gotten religion. Cap that off with Madoff. They knew they were within a hair’s breath of going out of business, so they really are changing faster than the other financial regulators and I give them credit for that. But they are making evolutionary steps where revolutionary steps are needed.

The SEC has been uncovering a lot of Ponzi schemes.

I’ll tell you why. It’s a two-fold answer. The SEC now knows how to solve Ponzi schemes rather quickly; they know to get third-party data sources to find out if any trading has occurred, because in a Ponzi scheme there is no investments or products being provided–it’s all fake an illusory. …It was a tragic training vehicle for them but a perfect training vehicle and they’ve actually gotten religion. Ponzi schemes used to be low priority but now they attack them vigorously.

Do you think the way FINRA operates, that is, people saying that it needs to reorganize and restructure itself, is a threat to the financial system?

I would disband FINRA. If you have a hunting dog that doesn’t hunt–it’s a show dog and I wouldn’t bother keeping it around, I’d sell it to somebody who likes show dogs. I’ve never seen them attack industry; and if you have a self regulator that doesn’t regulate, it doesn’t serve a purpose. It seems to do low-level, clerical checking and you need someone to monitor those exchanges but unless you totally revamp that agency, I don’t see its purpose on the broker/dealer checks. And I’ve gone through them as a broker/dealer, and they seem more like a paper drill and a nuisance than anything else. It seems like a lot of the crimes are taking place in unregistered dealers and they don’t get to those and those are actually far more serious than those that go on within the ranks of the registered broker/dealers. They have some vital roles to play, but something needs to be done there.

Do you see anything as the next big blow up?

I’d say corporate debt. Is it going to get paid back? And fiscal debt. There’s a lot of it [debt] out there that needs to be refinanced on the corporate side. Mortgage-backed securities that are going to need to get refinanced and the question becomes can they? What is the value of those properties? Are they financable going forward at any interest rate, much less at a high yield interest rate? That’s going to be the question that we struggle with going forward; [And financial services reform must] eliminate all use of off-balance sheet accounting–for any use whatsoever. There are so many thing that are hidden off balance sheet…Everything must be on balance sheet and the best way they can do that is to make it a 40 year prison term for any CEO, CFO, general counsel from the companies that have off-balance sheet accounting…. We don’t know what’s hiding offshore at the major firms because they may not be telling us. You need to mandate that reporting so you know where the surprises are… If you’re only regulating three miles offshore of the U.S., it’s the stuff that’s four or more miles offshore that bothers me and that’s where the risks are going to come from; all of a sudden they are going to come on balance sheet and that’s what’s going to surprise regulators and the markets. …. I came from the derivatives world, so I saw the off balance sheet, offshore dealings first hand, and they are ugly, with hair and warts. Nothing good can come from off balance sheet transactions.