SEC Budget Crisis Prompts Plea for Public Record System

Feb. 24, 2011 - PRLog -- The recent debate surrounding the U.S. Securities and Exchange Commission (SEC) budget crisis has raised doubts regarding the agency’s abilty to act in the interests of shareholders and for the protection of investors.

The debate begins with criticism from House Subcommittee Chairman Jo Ann Emerson, "There's some skepticism among my colleagues that the SEC can actually do its job."

Although the efforts of organizations such as Shareowners.org, Consumer Federation Of America, and the Council of Institutional Investors to encourage individuals to write their representatives in Washington to support an increase in budget for the SEC is admirable, questions still remain about the integrity and efficacy of the agency.

A recent report by SEC’s inspector general shows that the investigation of Bernard L. Madoff was not the only one to go badly awry. “The inspector general, H. David Kotz, raised significant concerns about how the SEC conducted itself in its investigation of Allied Capital. The report made available by The Washington Post gives a fairly damning picture of the SEC staff ignoring serious allegations of corporate misconduct while different offices failed to communicate about the subject matter of the investigation,” (Peter J. Henning, New York Times, March 24, 2010)

Some critics contend that the SEC is too cozy with Wall Street.

“The SEC repeatedly has promised to get serious about enforcement and protecting the interests of investors, but the agency's support of dismantling one of the few investor protection reforms in recent years shows that its interests are ultimately more aligned with Wall Street than individual investors,” (Jacob Zamansky, iStockAnalyst, March 23, 2010).

The Wall Street Journal reported in March 2010 that the SEC is supporting Wall Street's efforts to dismantle the provisions of a 2003 global settlement designed to ensure the integrity of Wall Street's research; i.e, provisions that prevent research analysts from talking to their firm's investment bankers without a compliance officer being present.

Then there’s the question of whether the SEC should publicize details of its probes of banks, which came into sharp focus after a federal judge challenged the agency's handling of its lawsuit accusing Bank of America of lying to investors. The SEC had accused the bank of concealing plans to pay billions of dollars in bonuses to employees of Merrill Lynch, the Wall Street firm it was buying. In its settlement with Bank of America, the agency issued a cursory overview of the allegations and set a $33 million fine. The bank denied wrongdoing, saying it agreed to the settlement to avoid a costly tussle with one of its key regulators.

The judge in the case, Jed S. Rakoff of the Southern District of New York, initially rejected the settlement. "This case suggests a rather cynical relationship between the parties: the SEC gets to claim that it is exposing wrongdoing on the part of the Bank of America in a high-profile merger; the Bank's management gets to claim that they have been coerced into an onerous settlement by overzealous regulators," he wrote at the time. "And all this is done at the expense, not only of the shareholders, but also of the truth."

Then there’s the incident with the SEC whistleblower Gary Aguirre who was vindicated in June 2010 for his pursuit of John Mack.

While he worked at the SEC, Aguirre had pursued a testimony from John Mack, whom he suspected had leaked information to Pequot Capital.  Aguirre suspected that Pequot had illegally profited from trading on information from Mack, who used to work at Pequot.  Aguirre was fired, he suspected, for blowing the whistle on Mack, who would soon become CEO of Morgan Stanley.  His suspicions were dismissed until years later; they re-surfaced in a separate accusation of insider trading at Pequot having to do with Microsoft.

Then there’s the FINRA fiasco under Mary Schapiro.

Suspicions remain as to whether FINRA may have potential massive conflicts of interests in its dealing with its internal investment portfolio. A clear example is FINRA’s behavior with its Auction Rate Securities. Evidence suggests FINRA sold its Auction Rate Securities months before the market collapsed.  Was it insider information or really good luck?

Going into 2007, FINRA had $647 million dollars of ARSs.  It was holding ARSs as the credit markets started to freeze in mid 2007.  FINRA says it did nothing nefarious when it sold its ARSs. But that fails the smell test.  It sold its ARS holdings before the markets collapsed. Meanwhile, investors got stuck with approximately $150 billion of ARSs.

One would have to be exceptionally naïve to think FINRA officials did not have material, nonpublic information on the ARS market before it decided to sell its holdings. Having information about the securities and acting on it without that information being available to the public would potentially qualify as front-running and insider trading.

In 2008, FINRA paid Mary Schapiro, who's now the head of the SEC, almost $9 million ($8,985,334.02 to be exact), on par with Wall Street executives.  For comparison, $9 million is what Lloyd Blankfein made in 2009.

Then there’s the recent report from the Government Accountability Office (GAO) regarding internal control failures at the SEC.

At the end of 2010, the GAO issued its report on the government's financial statement. Among many other things, the report revealed that the very agency responsible for monitoring financial statements and reports from the country's public companies has made a mess of its own books.

As The New York Times reported in early February 2011, the GAO has faulted the SEC's financial statements for seven years running – particularly the agency's failure to track income from fines, fees and "the return of ill-gotten profit." The continuing problems with basic accounting, according to the auditor, mean that a material misstatement of the agency's financial position is not only possible, but also that it would go undetected for a significant period.

On the other side of the debate is a strong plea for increasing the SEC’s budget.

At a House Appropriations Subcommittee on Financial Services and General Government hearing on February 10, 2011, the Securities and Exchange Commission (SEC) Inspector General (IG) told members that if the SEC’s budget is pared back to 2008 funding levels, some 600 SEC staff would need to be cut from its ranks.

SEC IG David Kotz said that while the SEC has had problems in the recent past, including missing the Bernard Madoff and Allen Stanford ponzi schemes, he does not believe that there are “600 people in the SEC that are not providing value.”

When asked “Do you have the staff and budget to protect investors?” SEC Chair Mary Schapiro responded, “ We clearly don't in order to do the job I want to be done. We are 3,800 people total, and we regulate 35,000 public entities: 12,000 public companies for their disclosure, 11,300 investment advisers, 8,000 mutual funds, 5,000 broker-dealers, 600 transfer agents, exchanges, clearinghouses.”

What will it take to restore our confidence in the SEC?

In the interests of shareholders and for the protection of investors, zEthics plans to create a public record system by conducting an external risk assessment on a consistent and regular basis that will improve transparency and accountability of the SEC.

The intent is to ensure that the SEC receive adequate funding by monitoring their performance; identifying and reporting on material weaknesses in internal controls, compliance and reporting; and, holding leadership accountable for strategic accomplishments.

After a second financial crisis in a decade, and a lost decade for investors, the public and investors alike need greater transparency and accountability of the agency tasked with enforcement of our securities laws.

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zEthics is a start up based in Phoenix, Arizona that takes a holistic view of risk, integrating External Risk Assessments with Enterprise Risk Management (ERM) systems. zEthics introduces the first cloud computing application for Enterprise and External Risk Management (EERM), providing Corporations, Investment Companies as well as Federal and State agencies a holistic view of risk. zEthics provides the diagnostic tools to align risk and performance to create a risk intelligent organization.