SECs Image Suffers in a String of Setbacks
By Stephen Labaton
The New York Times
December 16, 2008
The Securities and Exchange Commission, a once-proud agency with an impressive history as Wall Streets top cop, finds itself increasingly conducting autopsies of leading financial institutions after failing, in the first instance, to perform adequate biopsies.
The latest black eye for the commission came when inspectors and agency lawyers missed a series of red flags at Bernard L. Madoff Investment Securities. If it had checked out the warnings, the commission might well have discovered years ago that the firm was concealing its losses by using billions of dollars from some investors to pay others.
The firm was the subject of several inquiries over the years, including one last year that was closed by the agencys New York office after it received a referral of potentially significant problems from the Boston office.
Similarly, the agencys chairman, Christopher Cox, assured investors nine months ago that all was well at Bear Stearns. It collapsed three days later.
Between those two events, H. David Kotz, the commissions new inspector general, has documented several major botched investigations. He has told lawmakers of one case in which the commissions enforcement chief improperly tipped off a private lawyer about an insider-trading inquiry.
Another report criticized investigators in the commissions Miami office who inexplicably had dropped an important inquiry involving securities sold by Bear Stearns. A third report documented the lack of any significant oversight by the commission over Bear Stearns in the months leading to its collapse.
The enforcement division has been hamstrung by budget cuts and changes adopted by the S.E.C. that make it harder to impose penalties on corporations, even when there has been egregious wrongdoing, Arthur Levitt Jr., the S.E.C. chairman from 1993 to 2001, told Congress in October. The result has been a demoralizing of the enforcement staff, Mr. Levitt said.
There are other difficulties plaguing the agency. A recent report to Congress by Mr. Kotz is a catalog of major and minor problems, including an investigation into accusations that several S.E.C. employees have engaged in illegal insider trading and falsified financial disclosure forms.
The report said that a senior employee had used her position in violation of agency policy when dealing with a dispute with a broker about a family members account. It said that a commission lawyer had not maintained his status as a member of the bar for 14 years. And it found repeated instances of the failure by officials to pursue investigations.
Some experts said that appointees of the Bush administration had hollowed out the commission, much the way they did various corners of the Justice Department. The result, they say, is hobbled enforcement and inspection programs.
You are dealing with a commission whose effectiveness in fraud deterrence is open to serious question after cases such as Bear Stearns and Madoff, said Joel Seligman, the president of the University of Rochester and a leading authority on the history of the commission.
Mr. Seligman said there were three causes to the current problems at the commission: A Congress thats been comfortable with vast unregulated areas, such as hedge funds and credit-default swaps, which sends a message to enforcement. The failure since 2005 to increase the enforcement budget. And some commissioners whose skepticism about enforcement may have undermined the S.E.C.s effectiveness.
Mr. Seligman and other experts said that there had been many signs for investigators, as well as investors, that the Madoff firm had been manipulating returns. The firm posted consistently smooth returns even in periods that were turbulent for the overall market. There was no independent custodian for the securities that the investment management firm was said to be holding. The auditors were Friehling & Horowitz, a tiny storefront operation based in New City, N.Y.
This case says volumes about the need to re-evaluate our ability to inspect broker-dealers and advisers, said James D. Cox, a securities law expert at Duke University. There has been a terrific series of misfires.
John Nester, a commission spokesman, declined to provide details about the 2007 investigation, which was closed by the New York office. Investigators from the commission and the United States attorneys office in Manhattan have been examining the firms books since Mr. Madoff told others that his firm had been one huge Ponzi scheme.
The company was registered by Mr. Madoff as an investment adviser in September 2006. The commission as a practice tries to examine advisers within a year of registration, and then at least once every five years afterward. But commission officials said Mr. Madoffs firm had never been examined.
Sixteen years ago, the agency sued two Florida accountants who had collected more than $440 million from investors to be managed by Mr. Madoff. The agency sued the accountants, but not Mr. Madoff, who said he did not know that the accountants were selling securities that had not been registered.
The agency said at the time that a court-appointed trustee had concluded all the money invested was accounted for. Former commission officials recalled that they closely examined the firm at the time and did not uncover evidence that Mr. Madoff had broken any rules.
In 2005, an examination by the commissions office of compliance, inspections and examinations scrutinized the broker-dealer unit of the firm. It found that the unit had three relatively minor technical violations.
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