Dismantle the SEC

Court’s Slap over Hedge Funds is Latest in a Litany of Failures

New York Post
By Christopher Byron
July 3, 2006

It looks like the Securities and Exchange Commission has finally come up with a plan for dealing with the devastating Court of Appeals decision two weeks ago that nullified the SEC's efforts to regulate the hedge fund industry.

The strategy: Do nothing - except perhaps pout a bit and blame everything on the media.

Eighteen months ago in this space, I called for dismantling the SEC - a bureaucratic anachronism from the New Deal that lacks the power, the resources or the political support to oversee and enforce the law on Wall Street. Now I repeat the call.

For its thoroughly inept handling of the hedge fund industry alone, the 72-year-old agency should either be reorganized top to bottom, with a new charter and new leaders armed with broader powers of criminal enforcement, or it should be shut down entirely and its existing functions distributed to other government agencies.

Faced with a federal budget cash deficit that the Congressional Budget Office expects to top $477 billion in the year ahead, taxpayers simply cannot afford to be wasting nearly $1 billion a year on a 3,916- employee federal bureaucracy, sprinkled across 11 regional offices, that doesn't do the basic job for which it was created - namely, to enforce the law.

The SEC's three-year- long struggle to regis ter and regulate hedge funds is the climax to this legacy of failure. The initiative was launched with laudable enough intentions in early 2003 by then-SEC Chairman William Donaldson, who wound up resigning in defeat two years later with the job half-done.

Donaldson's successor, an Orange Country, Calif., conservative Republican named Christopher Cox, vowed to continue with the program. In doing so, Cox placed the prestige and credibility of the SEC on the line again - only to have a federal appeals court declare the effort null and void as an arbitrary and illegal use of the SEC's rulemaking powers.

The Court of Appeals gave the SEC 45 days, until Aug. 7, to appeal or ask for a rehearing, stipulating that if the SEC takes no action and simply sits on its hands, the roughly 1,000 hedge funds that have been registered under the program to date can simply de-register themselves.

So how has the SEC decided to deal with this self-created debacle? According to one well-placed commission official, there will be no appeal of the Court of Appeals ruling. Instead, the SEC will simply wait until the 45 days are up and then see just how many funds actually decide to de-register themselves from what will then become nothing more than a voluntary program.

Said the source, "Hedge funds ought to find it helpful to be able to promote themselves to potential investors as being 'SEC-registered' whether the program is voluntary or not." The source added that "some of our critics in the media" haven't been helping by constantly bringing up topics like the competence of the SEC itself.

But competency is only one of the questions that properly comes up when a regulatory body like the SEC behaves this way.

Wall Street's official cop on the beat set out three years ago to police a rising tide of fraud in an unregulated sector of the market that is rapidly taking over all of Wall Street.

Three years later we now find the very same agency, having made a total hash of its ensuing regulatory effort, suggesting that its best way out of the mess will be, in effect, to turn the great seal of the SEC into a kind of SEC Stamp of Approval for any hedge fund willing to stay registered in the program.

Has it occurred to any of the brilliant minds at the SEC just who would hold the real power in this arrangement? A voluntary program is just that - voluntary - meaning that any hedge fund can drop out at any time, for any reason - or even no stated reason at all.

Under such circumstances, how willing will the SEC be to bring cases against voluntarily registered funds when keeping the program alive involves maintaining the goodwill of the funds still in it? Human nature being what it is, one can well foresee a time when the program winds up overflowing with crooked funds, while the SEC hems and haws about investigating any of them.

There is no doubt that the unregulated profileration of hedge funds represents a direct threat to the stability and integrity of America's capital markets. An SEC staff study estimated that somewhere between 6,000 and 7,000 hedge funds, having roughly $700 billion of assets under management, were operating in the U.S. in the autumn of 2003. Now, says the SEC, just those funds registered under the program have somewhere between $1.2 trillion and $2.4 trillion of assets on their books.

But the SEC already had all the power it ever needed to uncover hedge fund fraud without demanding that they register with the commission. And the best evidence that more power wasn't needed is what happened once the doomed hedge fund program went into effect at the start of this year - the opening of just 12 hedge fund fraud cases by the SEC since January, which is typical for the agency during any such six-month period in recent years.

Here are four things the SEC can and should do now to clean up this mess. And to do them it doesn't need a single new law or ruling from anyone. All it needs is the willingness to use the powers it already has.

1.    Track domestic and offshore hedge fund auditors. So far as I have been able to determine, the SEC has set up no institutionalized system for tracking the activities of auditing firms involved with any hedge funds, let alone the fishy ones. To compile such a list, the SEC could begin with the names, addresses and phone numbers of auditors for publicly traded penny stocks; the linkages between penny stocks and hedge funds would astonish them, often leading to offshore hideouts in places like the Netherlands Antilles.

Such a list would also be useful for names that are not on it, instantly disclosing, for example, that the accounting firm of "Richmond-Fairfield Associates," listed as auditor of record by the now defunct Bayou Management hedge fund group, was bogus and did not exist.

2.    Read SEC Forms 13D and 13F. From these forms, which holders of significant stakes in public companies must file with the SEC, can be teased a vast array of information on fraudulent investment schemes involving hedge funds. The SEC rarely looks at any of it. The forms can disclose when a fund acquires a controlling block of stock in a company that suddenly spurts in price. And often, when a fund fails to file the forms, the evidence of control can be found in the audited financials of the issuing companies.

3.    Read private litigation cases for leads. Nearly all major SEC investigations lead eventually to parallel private lawsuits by victimized plaintiffs. But SEC investigators seem largely oblivious to what can be found in the resulting case files.

Following the collapse of the Lancer hedge fund three years ago, private lawsuits produced a mind-boggling array of documents directly implicating Citco Fund Services, one of the biggest hedge fund administrators, in the Lancer fraud. The SEC has acted on none of it.

4.    Have a "Show Trial" or two. For years now, the entire mindset of the SEC has been focused on the filing of complaints and little else. After that, the cases are simply left to gather dust, at the end of which process they are settled by plea bargain agreements in which the defendant promises never to break the law again - without even being forced to admit that he broke it the first time.

Last week, I asked the SEC's national office in Washington for a list of current and recent cases that the commission had actually pursued to trial, and they could not cite even one. This simply must be changed if the lawbreakers of Wall Street are ever to take the SEC seriously again.

These are the sorts of things the SEC can do, and should do, to rescue itself from the rubble of its hedge fund fiasco. But my guess is you'll hear 20 excuses for why they can't do any of them - if indeed you hear anything at all. And that's why I say, to hell with them. They've had their shot and they've blown it. So shut 'em down.

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