Catching the Bad Guys: FINRA’s Detective Work

In the third installment in a three-part series, The Alert Investor takes you behind the scenes at FINRA’s Office of Fraud Detection and Market Intelligence to explore the inner workings of a tenacious group of Wall Street regulators.

The Financial Industry Regulatory Authority’s Office of Fraud Detection and Market Intelligence (OFDMI) acts as a funnel taking in a broad swath of data for clues to potential bad behavior in the financial markets.

That’s particularly true for OFDMI’s Office of the Whistleblower and Central Review Group, the latter of which digs through thousands of tips and regulatory filings to flag potentially fraudulent behavior and then conducts preliminary investigations.

With all the information pouring in to these two departments, a huge part of their job is determining which cases fall under FINRA’s jurisdiction and which need to be passed along to other agencies. Last year alone, OFDMI referred 702 cases to the Securities and Exchange Commission (SEC) and other agencies.

Here’s a glimpse into how OFDMI chases down tips to find wrongdoing in financial markets.

Office of the Whistleblower

Investors call FINRA’s whistleblower hotline when they think the firm or person handling their money is doing something wrong.

Since FINRA generally only has authority over broker-dealers and their employees, many of those calls end up being referred elsewhere. If an insurance agent is promoting fixed annuities on the radio, FINRA might check that the person is a licensed insurance agent in his or her state, just to make sure a fraud isn’t afoot. But from there, state insurance commissioners must decide whether to pursue any enforcement action.

“We are a financial industry regulator, but there are aspects of the financial industry we don’t regulate,” said Joseph Ozag, head of the Office of the Whistleblower and a former detective with the U.S. Capitol Police. “But we don’t want people trying to make that distinction. It can be a very nuanced and difficult analysis. We’d rather take all the calls and make the evaluation.”

Many of the whistleblower calls that fall under Ozag’s jurisdiction are theft schemes, he said. There are Ponzi schemes, in which a fraudster scams money out of “investors” and then uses cash from new “investors” to repay old ones. Other fraudsters forego even the pretense of repayment and simply steal investors’ money.

One interesting fraud to cross Ozag’s desk was that of a registered representative in Reno, Nevada, who worked at a branch of a large financial services firm.

The advisor, Gary Lane, had promised to invest customers’ money in U.S. Treasury bonds that would mature in two years and pay 6 percent interest. But in 2010 and 2011, when Lane was running the scheme, two-year Treasury notes never yielded much more than 1 percent interest, and often paid much less. Lane, it later turned out, had deposited $2 million from six customers in his wife’s brokerage account — investing it, certainly, but not for his customers.

To keep what he was doing under wraps, Lane transferred some of the funds from his wife’s account to a bank account bearing the name of the United States, Ozag said. When it was time to make interest payments on the Treasuries his customers purportedly owned, Lane would simply obtain cashiers’ checks from the bank branch. Unsuspecting customers apparently didn’t realize at first that checks from the account bearing the name of the United States did not represent an interest payment on a bond backed by the full faith and credit of the United States government.

Lane pleaded guilty in 2013 to federal charges of mail fraud and attempted tax evasion, and he was sentenced to 10 years in prison in February 2014.

Central Review Group

The Central Review Group, OFDMI’s nerve center, triages tens of thousands of matters every year ranging from investor complaints, external tips and employee tips to disclosure events, referrals from other regulators and civil or criminal litigation, among others.

The Central Review Group takes this massive amount of information and conducts initial reviews and makes basic inquiries to determine how each matter should be handled.

“We review everything from a firm submitting a regulatory filing that says, ‘We fired so and so for stealing $X million,’ to an individual saying, ‘Hey, my rep isn’t calling me back,’” said Anthony Cavallaro, head of the Central Review Group.

One of the key tasks of the group is to be able to spot red flags of fraud from thousands of matters and to escalate each case as appropriate.

In just one example, a standard review of a regulatory filing resulted in the discovery of a $34 million Ponzi scheme targeting government employees.

Cavallaro’s team reached out to Lincoln Financial Securities about the filing against its employee, which prompted a quick review of the activities of Kenneth Wayne McLeod. The case was referred on to the SEC and it was discovered that McLeod was running a Ponzi scheme spending much of the money raised to live a lavish lifestyle.

Routine review of another customer complaint led to the arrest of former registered representative James Allen Hall for stealing almost $800,000.

No group within OFDMI, however, acts in a silo. In addition to working with government agencies, the various departments within the group also often work together.

That was the case when it came to the review of one June 2010 call to FINRA’s whistleblower hotline alleging that Joseph Mazella had been running a Ponzi scheme since 2004. Turns out the tipster was in the New York area, so Cavallaro and a staff member from the Central Review Group attempted to meet with the tipster a few times.

After missing a few scheduled meetings, “the person said, ‘Look, I’m not trying to blow you guys off, but it’s really difficult to come to Manhattan —  can you meet me in Brooklyn?’” Cavallaro and his colleague took the subway to Brooklyn to find out more.

The whistleblower alleged that the Ponzi scheme was worth $20 million and had some 40-odd victims. Convinced that the tipster wasn’t just an individual with an ax to grind, Cavallaro’s team and the Office of the Whistleblower sent the case on to the Federal Bureau of Investigation.

It turned out that the tipster wasn’t far off. The FBI arrested Joseph Mazella in October 2010 on charges of running a $12 million Ponzi scheme, and he was found guilty in 2012. Mazella is currently serving out a 10-year sentence.

While it may sound as though cases progress neatly and easily, the journey from initial tip to successful prosecution is a difficult one that requires real detective work and coordination.

“Whether it’s a customer complaint or a regulatory tip or a filing made by a firm, they usually don’t come in screaming, ‘This is a fraud! This is a misappropriation! This is a Ponzi scheme!” Cavallaro said.

Indeed. That’s where Cavallaro’s team and the rest of OFDMI come in.

This is the third part of a three-part series. Don't miss part one, Inside FINRA's Office of Fraud Detection and Market Intelligence, and part two, Inside FINRA's Fraud Surveillance and Insider Trading Groups.