Can the SEC ever improve?
The U.S. Securities and Exchange Commissionâs case against Citigroupâs Brian Stoker, a director in the bankâs Global Markets group, seemed clear-cut. Stoker structured and marketed an investment portfolio consisting of credit default swaps. The agencyÂ accusedÂ him of misrepresenting deal terms and defrauding investors for not disclosing the bankâs bet against the portfolio while pitching the investment vehicle to customers. But when it came to trial earlier this summer, the government could not prove that Stoker knew or should have known that the pitches were misleading, and the jury didnât convict.
Itâs hardly surprising. The SECâsÂ failureÂ to secure a guilty verdict is one more sign that the commission still has not climbed out of the morass in which it was mired for most of the Bush years. The agency tasked with overseeing some 5,000 broker-dealers, 10,000 investor-advisers, 10,000 hedge funds, and 12,000 public companies, as well as mutual funds, the exchanges and even the rating agencies, is ailing because of outdated rules, systems and structures.
What exactly ails the SEC? For starters, the legal framework in place to prosecute securities fraud is flawed. The commission was established to create rules thatÂ prohibitÂ âany manipulative or deceptive device or contrivance.âÂ But intent or recklessness is required to prove fraud or misrepresentation, and that can be difficult because the agency doesnât have enough staff to comb through reams of documents for rare evidence that someone intended to cheat. In the Citigroup case, the agency instead relied on a rule that simply required a showing of negligence, but the prosecution could not prove even that.
The Stoker case underscores the legal framework’s penchant for punishing midlevel managers rather than those in charge. As the foremanÂ toldÂ the American Lawyer, the jury could not find Stoker liable because âhe did not act in some kind of vacuum where his behavior was not tolerated or encouraged by his bosses âŚ To try to hang all this on Stoker didnât work.â But the government rarelyÂ goes after higher-ups or CEOs like Dick Fuld and Jon Corzine because they are removed from day-to-day operations and often donât leave evidence of intent or negligence. It faced this conundrum while building the case involving the Abacus deal that led to a $550 million settlement with Goldman Sachs and will have to overcome the same hurdle when former Goldman Sachs trader Fabrice Tourre is tried for his role in that deal.
Even so, accountability for wrongdoing can be fleeting because the agency still collects significantly less money from people as opposed to institutions. As a result, shareholders of corporate entities oftenÂ get penalized financially for the deeds of midlevel managers and advisers. While this is changing, there still is a culture of punishing institutions, rather than wrongdoers. U.S. District Judge Jed Rakoff has been a vocal critic of this approach. In November, heÂ refusedÂ to approve an SEC settlement with Citigroup that allowed the bank to âneither admit nor denyâ wrongdoing. While the U.S. Court of Appeals for the Second Circuit likely will approve the settlement, in January the SEC stopped allowing wrongdoers who settle with the SEC and also are criminally convicted to âneither admit nor denyâ charges.
Another glaring structural problem at the agency is that any changes in securities laws require congressional approval, but the SEC also relies on Congress for annual appropriations to continue running.Â Sensible reform would need a green light from Congress, which has no incentive to enact it. (Dodd-Frank merely made it easier to hold accountants, lawyers and other aiders and abettors liable.)Â After all, its members rely on institutions âÂ banks, for example, for campaign contributions âÂ that might be affected negatively by reform. Theoretically, there are other funding models. The U.S. TreasuryÂ Department collects $2.94 trillion in revenue, which runs its core operations. The Federal Deposit Insurance Corporation runs on taxes from banks that form its membership. If the SEC were funded independently, securities fraud would presumably be more easily and effectively regulated and prosecuted.
The SECâs bureaucracy is a common complaint among bankers, traders and other financial services workers. Officials spend years launching, investigating and charging parties engaged in wrongdoing. In June, Peter MadoffÂ was chargedÂ with fraud, four long years after his brother Bernie. It took a decade for the SEC to hold an Ohio fraudster accountable financially, except by then he was no longer living. In 2002, a tipster alerted the commissionâs Midwest Regional Office that Cleveland-based investor adviser Robert Pinkas engaged in fraud. Seven years later, the SECÂ allegedÂ that Pinkas overstated the value of equity and debt investments in two private companies. PinkasÂ diedÂ before the SECâs scheduled hearing in March to determine whether he misappropriated more than $800,000 of client money to pay fines and penalties associated with the charges filed in 2009. Itâs possible that Pinkasâs earlier activities didnât merit an inquiry, but unlikely.
More to the point, the agency is paper-heavy, short-staffed and underfunded. The number of reports and opinions it releases is staggering. Regulators might consider adjusting rules and procedures to facilitate efficiency. It also might benefit from using new technologies, such as sites that crowd-source whistle-blower information.
And, finally, the agency also suffers from low morale. Last year, the SECÂ rankedÂ 27th out of 33 federal agencies for workplace happiness, according to a survey by the Partnership for Public Service. In 2007, it came in third. The revolving-door issue also is worth repeating. Young lawyers who start their careers in government often do so to jump, eventually, into the private sector. A former SEC lawyer in TexasÂ was finedÂ $50,000 for violating rules of conduct when he billed for hours related to client matters that he had participated in while working at the agency. This underscores the commissionâs entanglement with the private sector that might lead a lawyer to pursue less aggressively entities represented by firms that might later employ him.
Itâs hard to tell whether the commission is evolving. In 2011, the SEC brought a record 735 enforcement actions and received $2.8 billion in penalties and disgorgements. But Bloombergâs Josh GalluÂ notedÂ that one-third of the matters werenât new, and there were actually fewer accounting fraud cases. Still, for 89 accounting-related actions, 113 individuals were charged, including 53 senior directors and 5 independent directors.Â And it still only collects minuscule penalties that offer little deterrence and are like slaps on the wrist for multimillion-dollar corporations. But the SEC has cracked down on insider trading, created a group that handles companies with overseas headquarters that trade on U.S. exchanges and is investigating âzombie funds,â or inactive ones where managers continue to get fees. The inquiry into the exchanges is also a big shift for the commission, though its effort toÂ overhaul money-market funds has stalled.
Reform of an elephantine agency is hardly a prospect anyone wants to contemplate. But if the SEC continues to lose high-profile enforcement cases, itâs possible that Americans will lose faith in the agency in the same way, as Chairman Mary SchapiroÂ said, they have lost faith in the markets regulated by it.
PHOTO: Mary Schapiro, chairman of the Securities and Exchange Commission, testifies before a House Financial Services Committee hearing on “Examining Bank Supervision and Risk Management in Light of JPMorgan Chase’s Trading Loss” on Capitol Hill in Washington, June 19, 2012. REUTERS/Kevin Lamarque