Celebrating 100: FINRA Unscripted's Greatest Hits

We are celebrating 100 episodes of FINRA Unscripted! We’ve covered a lot of ground over the past four years and 100 episodes, but we wouldn’t have made it to this point without you, our listeners.

To celebrate our 100th episode, we would love to hear from you. Take the quick, anonymous FINRA Unscripted survey today. With your help, we can make the next 100 episodes better than the last.

For today’s episode, we are going to hop in our DeLorean and take a listen to excerpts from a few of our greatest hits, including:

Episode 33: Money Laundering in the Securities Industry

Episode 23: Finding the Needle in the Haystack

Episode 16: How FINRA Rules Get Made (And Reviewed)

 

Other resources mentioned in this episode:

Episode 86: FINRA’s Financial Intelligence Unit

Listen and subscribe to our podcast on Apple Podcasts, Google Podcasts, Spotify or wherever you listen to your podcasts. Below is a transcript of the episode. Transcripts are generated using a combination of speech recognition software and human editors and may contain errors. Please check the corresponding audio before quoting in print. 

FULL TRANSCRIPT 

00:00 - 00:19

Kaitlyn Kiernan: From New York, from Washington, D.C., from Rockville, from FINRA's Boca Raton district office, from FINRA's Chicago district office, from Hoboken, New Jersey, I'm your host, Kaitlyn Kiernan. And today we are celebrating 100 episodes of FINRA Unscripted.

00:19 – 00:28

Intro Music

00:28 - 01:38

Kaitlyn Kiernan: Welcome back to FINRA Unscripted. Thank you to all of our listeners for joining us on this journey. Today, we are celebrating quite the milestone with 100 episodes. Wow. We've covered a lot of ground over the past four plus years and 100 episodes, but we wouldn't have made it to this point without you, our listeners. For those of you who have been tuning into the show for a while, it will come as no surprise that we are big on continuous improvement here at FINRA. And to celebrate our 100th episode, we would love to hear from you. We currently have an anonymous, three-minute survey live on SurveyMonkey and linked in our show notes. It has questions about how we're doing and what we could be doing better. With your help, we can make the next 100 episodes better than the last.

Now for today's episode, we are going to hop in our DeLorean and take a listen to some excerpts from a few of our greatest hits. To start, we're going to set the clock back to April 2019, when we first talked about AML to hear a bit from our all-time, most-downloaded episode. Let's take a listen.

01:39 - 02:25

Kaitlyn Kiernan: When three hapless employees inadvertently embezzle a bunch of cash in the movie Office Space, they decide the best way to cover it up is to launder it. But the thing is, they don't really know what money laundering is, so they turn to the dictionary, which prove to be less than helpful. If you want to understand what money laundering is and more specifically, the efforts brokerage firms must take to prevent and detect it, we have something much better than the dictionary.

I'm pleased to be joined today by Blake Snyder, a senior director and Jason Foy, director with FINRA as AML Investigative Unit, a specialized team of examination staff that conducts complex anti-money laundering examinations. Before we dig in to FINRA as AML program, I wanted to start with the very basics. What is money laundering?

02:26 - 03:10

Blake Snyder: A simplified explanation of money laundering is the movement of funds intended for or derived from criminal activities. Money laundering generally occurs in three stages. There is the placement stage, which is the introduction of illicit funds into the financial system. The layering stage, which is a process whereby transactions are done to disguise either the origin of those funds or the destination of those funds. And then the integration phase is the phase where the funds are reintegrated into the legitimate economy. Sometimes you hear about this in the news and see it on TV, where the funds will be used to purchase luxury assets such as real estate and expensive cars and things like that.

03:10 - 03:26

Jason Foye: One unique aspect of money laundering in the securities industry is that you can actually generate illicit proceeds directly in your account through things like insider trading or market manipulation, other securities frauds. And that's something that you don't see in every industry that has money laundering risk.

03:27 - 03:39

Kaitlyn Kiernan: OK, so like bank criminal activity, they're trying to put the money into the legitimate system at the bank. But in the securities industry, the illicit money is actually being generated in the account?

03:39 - 04:05

Jason Foye: It can be, I think, is the answer. Certainly, a brokerage industry could be used as a conduit in the same way a bank account could to process suspicious money movements or payments that are used and maybe the layering phase, as Blake described, of a money laundering scheme. But I think it's important to point out that because of the unique aspect of the securities industry and brokerage accounts, you can actually generate illicit proceeds right in your account as well.

04:05 - 04:13

Kaitlyn Kiernan: That's interesting to know. So how does that make regulation different for the securities industry versus banking?

04:14 - 04:46

Blake Snyder: So, the brokerage industry only became subjected to anti-money laundering requirements with the implementation of the Patriot Act in 2001. The banking industry had been subject to anti-money laundering requirements for decades before that. So, they are very far ahead of us in terms of how long they're implementing it and in terms of what the expectations are. The brokerage industry is catching up quickly. As Jason alluded to, there are some different risks that banking institutions and brokers institutions are exposed to.

04:46 - 05:18

Blake Snyder: In the brokerage world, we don't see really hardly any physical cash being deposited as compared to what you see with banks, where that's a relatively frequent occurrence. So, when we talk about the placement stage in the brokerage industry, we don't see illicit cash being deposited. I think more of the concern is related to what Jason referred to earlier, are situations where illicit funds can be generated within a brokerage account itself through tactics such as market manipulation or insider trading or Ponzi schemes.

05:19 - 05:57

Jason Foye: And then specific to the layering phase, you may get some similarities between what you would see in the banking industry and what you would see in the securities industry through a brokerage account, because in a lot of instances, you can do everything you can do in a bank account in a brokerage account. You can send wire transfers to third parties. You can get a debit card or a credit card that's attached to your account. You can write checks depending on the services provided. So, there's a lot of different controls that firms have in place to try to handle the risk. But I think it's first and foremost important just to understand where the risk lies inside the industry. And then you can go about talking about the controls

05:57 - 06:22

Kaitlyn Kiernan: As a quick update, Blake now heads the Financial Intelligence Unit within the National Cause and Financial Crimes Detection Program team, which we talked about on episode 86. And Jason has been promoted into that senior director role for the AML program. Now, let's go a little further back in time and set the clock to December 2018, when I spoke with Sam Draddy, head of FINRA's Insider Trading Surveillance Team.

06:24 - 06:55

Kaitlyn Kiernan: More than 15,000 different stocks, options and bonds, millions of trades. When it comes to detecting insider trading. It really is like finding a needle in a haystack. But that's precisely what Sam Draddy and his team in the Insider Trading Group do every day. They find those unusual and suspicious trades. Whether they net the potential illegal trader a couple hundred dollars, millions of dollars or even net them a loss.

Now your group, Sam, how is it looking at illegal insider trading?

06:56 - 08:08

Sam Draddy: People probably wonder why FINRA is doing this work. People look at FINRA as an organization and know generally that they're charged with the responsibility of overseeing the broker dealer industry, examining broker dealers, writing the rules, enforcing the rules. And that is a vast majority of our regulatory structure. But in my surveillance responsibilities, as well as with Market Regulation within FINRA, we actually are representing the U.S. exchanges and performing the surveillance responsibilities. We have contractual arrangements with them to do their surveillance, and that surveillance includes looking for insider trading in the U.S. Markets. And our group covers the entire U.S. marketplace for equities or stock, corporate debt, which is bonds, and options.

And as you said, we are looking on the other side of the coin, which is the illegal insider trading. And so, we are looking across the U.S. markets for anything unusual going on surrounding what are the material news announcements, announcements that are going to move a company's stock or the bonds or options and looking for suspicious trading surrounding those material news announcements. Anyone trading timely, profitably, suspiciously and whether there are trading on information they got from someone else or they gained through themselves. That's sort of the name of the game for our investigations.

08:08 - 08:12

Kaitlyn Kiernan: So how do you work to uncover insider trading?

08:12 - 09:58

Sam Draddy: Well, it's a process. Our investigations are mainly triggered by our electronic surveillance system called Sonar. And basically, what Sonar does is look for unusual price or volume movements in the marketplace surrounding publicly traded companies. And it's not telling us where insider traders are trading, but it's telling us where to look for insider trading because we have about 15,000 stocks and securities that we're looking at every day.

So, Sonar is tracking the trading. It's looking for something unusual in the sense that if a stock is trading unusually compared to a 100-day average or trading usually compared to the index it trades on or to the sector it trades in, there's a whole slew of algorithms that go into it. But it spotlights those particular stocks and then it actually matches it up to news stories and Sonar, basically saying, "Hey, there's unusual trading going on with a particular security. And here's what the news is surrounding."

And so, for example, when Amazon acquired Whole Foods, Sonar flagged Whole Foods stock and said, there's something unusual going on here, and here's all the news surrounding it. And Sonar receives about 30,000 news stories a day and highlights all the news, not only current news with respect to what's going on with a particular stock, but what the past news is. So, we can see if, for example, there were any rumors out there about a particular merger. Did The Wall Street Journal report that Amazon and Whole Foods were in discussions a month before the public announcement? Because an insider trader can point to those types of things.

So that's how our investigations are triggered to start with. We're looking at any trading ahead of a material news announcement because there are very sophisticated traders in the marketplace who know how to trade in such a way as to not to move the market, quite frankly. And so, it's important not to discount even situations where there's very little movement in terms of volume or price ahead of a material news announcement.

09:59 - 10:01

Kaitlyn Kiernan: So how much data are you working with?

10:01 - 11:45

Sam Draddy: Millions and millions of trades in a particular day. And we actually store the data as well. So last count, we had stored trade data going back 20 plus years. And in our investigations, we go through a process. So, after the surveillance system, Sonar, flags the particular event that we want to look at, we start an investigation, and we go through a few steps in the investigation. The first thing we do is we send out a request chronology information from the parties involved in the material news announcement.

So, in the case of a merger, I'll stick with that because that's probably about 60 percent of the announcements that we look at. We're looking at mergers, we're looking at earnings announcements, FDA approvals or rejections of drugs, anything that's going to move a company stock. But mergers are really our bread and butter because that's where people are guaranteed to make money. If you know about a merger in advance, you can pretty much rest assured that the stock of the company this can be acquired is going to go up.

So, in the case of a merger, we're going to get chronology information from the two companies involved, but we're also going to get chronology information from all the parties that work on behalf of the companies. So that includes the investment banks, the law firms, the accounting firms, the public relations firms, the printers. Because we want to know the entire universe of all the people that worked for those entities and were in possession of material, non-public information before it became public.

And we'll ask questions, including when did each individual come into possession of the information and what their roles were with respect to the material news announcement, in this case the merger. So we get the chronology information and we even get their home addresses, too, because proximity is important in looking at insider trading, we've had situations where we have had small towns in the United States where a small bank is located and the entire town starts trading because they know the head of the bank, who gets his haircut at the local barber shop and eats at the local Kentucky Fried Chicken and tells everybody what's going on.

11:46 - 12:03

Kaitlyn Kiernan: Sam is still heading up the insider trading surveillance team and we hope to have him back on the show this year to provide more of an update on the program, so stay tuned for that. But now we're going to head back in time one more time to one of the earliest episodes I hosted. Let's take a listen.

12:04 - 12:30

Kaitlyn Kiernan: At FINRA, economists and lawyers worked closely together to ensure that FINRA's rules are as effective and tailored as possible. On this episode, we are joined by Phil Shaikun from FINRA's Office of General Counsel and Jonathan Sokobin, our Chief Economist, to learn how this process works. Now, our listeners may wonder what do an economist and a lawyer have in common? Why are we bringing them together here today?

12:30 - 12:35

Jonathan Sokobin: It's a punch line to a bad joke, right? We just need like a pastor or priest. We'll get everybody.

12:35 - 12:37

Kaitlyn Kiernan: And if only we relocated to the bar.

12:39 - 12:40

Phil Shaikun: I didn't realize that was an option.

12:41 - 13:20

Kaitlyn Kiernan: Both Phil and Jonathan and their teams have important roles to play in FINRA's rulemaking and retrospective rule review processes. So today we have Jonathan and Phil here together to help fill us in on how those processes work, because unfortunately for all Americans, Schoolhouse Rock failed to follow up on their 1976 hit "I'm Just a Bill" with the natural follow up, "I'm Just a FINRA Rule Proposal." So, you'll be relieved to hear I'm not going to ask you to sing today, but I am going to start with this: from start to finish, what does the rulemaking process generally look like? And Phil, maybe you can kick this off.

13:21 - 13:26

Phil Shaikun: Sure, I really do wish we had a Schoolhouse Rock song to describe it...

13:26 - 13:27

Jonathan Sokobin: "Zero is My Hero," yeah.

13:27 - 16:38

Phil Shaikun: Right? In a catchy and fun way, but I'll try my best to at least give a sense of the process in an informative way. I guess one thing I'd say at the outset is that we know that our rules have significant impacts not only on the investors that they're intended to protect, but also on the industry and potentially on the capital formation process. So, we try to get this as right as we can right from the get-go. And our rulemaking process is really designed to ensure that we have really well thought out rule proposals that are informed by all interested stakeholders and that are narrowly tailored to solve the regulatory problem that we've identified.

So, it's a multi-step process, and not every rule goes through all of the steps of this process. We have all kinds of different rules, some very technical in nature, some very sweeping in nature. But the majority of the significant rule makings will cover these major steps. So first, the staff will try to develop the proposal in consultation with various stakeholders, including industry representatives and FINRA advisory committees.

One of the advantages, for those who are not familiar with our advisory committees, of being a self-regulatory organization is that we have at the ready expertise from industry experts and others to help us inform our rulemaking and to identify regulatory problems in the first instance. So, we have something like, I think, 15 standing committees. Some are subject-matter committees, some are based on firm size or business model. And also importantly, we have investor issues committee that's composed of notable investor advocates. So, we will bounce our proposals off these committees, and we'll take their feedback in and refine the proposals.

And then the next step is to take a more formalized proposal to our board in hopes that they will approve it for comment. And at that stage will inform them on the kind of feedback we receive from the committees and assuming that they approve the rule proposal, the next step typically would be for us to put it out for public comment in a regulatory notice.

And that's really the first of what's typically two, at a minimum, two opportunities for the public to comment on any given rule proposal. That's usually out for comment for about 60 days. And the staff will then read and analyze all the comments and make changes to the proposal as we see appropriate and consistent with the regulatory objective. And then the next step is to submit the proposal to the SEC for approval.

The SEC essentially has to approve all of our rule proposals, and they have their own process that they go through that also includes another round of comments. So, they publish the proposal in the Federal Register, and there is that second bite at the apple for the public. And again, FINRA staff will look at those comments, make any amendments that we think is appropriate, and then hope that the SEC will approve. And assuming that they do that, which isn't always the case, but usually the case, we will announce the approved rule in another regulatory notice that will also typically include the implementation date and increasingly guidance in the form of FAQs.

16:39 - 16:43

Kaitlyn Kiernan: When you say public comment, that's anyone out there?

16:43 - 17:07

Phil Shaikun: That's right, it's posted on our website for all to see and we regularly get comment. Of course, the industry is most interested and the trade organizations, but we hear from individuals, we hear from law school clinics, we hear from investor advocates, we hear from the state regulators sometimes. So it's completely open to anyone who has interest in the proposal

17:07 - 17:11

Kaitlyn Kiernan: And is there ever substantial changes made in response to those comments?

17:11 - 17:35

Jonathan Sokobin: Oh, all the time. Often when we're developing rules, we come from the perspective of what we know, what we hear. We go out, we talk to people, we go through this process that Phil talked about. But often there are pieces that we may not know all the information that we need to know. So, part of the process of going out in a reg notice is to ask questions. We put out options, we ask questions, we seek feedback.

17:37 – 18:13

Kaitlyn Kiernan: Phil and Jonathan are still doing great work, making and reviewing federal rules. Jonathan's team of economists has also grown tremendously to help FINRA tackle this important work.

That's it for today's episode. You can find links to all three of today's greatest hits in the show notes, as well as a link to that survey I mentioned. It really will only take you three minutes, and we'd love to see your feedback. Thank you so much for joining me today and for the last ninety-nine episodes.

Today's episode was produced by me, Kaitlyn Kiernan and edited and engineered by John Williams. Until next time.

18:13 – 18:19

Outro Music

18:19 - 18:46

Disclaimer: Please note FINRA podcasts are the sole property of FINRA, and the information provided is for informational and educational purposes only. The content of the podcast does not constitute any rule amendment or interpretation to such rules. Compliance with any recommended conduct presented does not mean that a firm or person has complied with the full extent of their obligations under FINRA rules, the rules of any other SRO or securities laws. This podcast is provided as is. FINRA and its affiliates are not responsible for any human or mechanical errors or omissions. Parties may not reproduce these podcasts in any form without the express written consent of FINRA.

18:47 – 18:52

Music Fades Out