Good Regulation Requires Good Regulators

As the SEC comes to grips with the Bernie Madoff scandal, I am reminded of a law school course that I took 25 years ago where I was taught that good regulation requires good regulators. Unfortunately, the SEC has turned into a bad regulator and has lost the respect of the public it is supposed to protect.

The SEC leadership doesn’t understand or acknowledge why the SEC exists or what its role is supposed to be. Missionless and confused, the SEC is currently a lost agency that needs to be refocused and remotivated.

The SEC used to know its mission. On the SEC web-site, it still articulate why it exists when it states that “First and foremost, the SEC is a law enforcement agency.” (bold, italic and underline for emphasis). That means, first and foremost Chris Cox is the “Chief of the SEC Enforcement Police.” Unfortunately, Mr. Cox appears never to have embraced or understood his enforcement responsibilities or the SEC’s role to protect the public.

Instead, the SEC indirectly encouraged scamsters and fraud artists through lax enforcement standards. Crime prevention is the most important role of any law enforcement agency and prevention takes place because potential criminals know that they will be caught and prosecuted by a tough but fair cop.

Instead of being a cop, Chris Cox had a nonsensical theory of law enforcement that primarily relied upon self regulation and enforcement. The invisible hand of capitalism was supposed to ferret out frauds and act as the main barrier to illegal and dishonest behavior. However, real criminals don’t self regulate and enforcement usually means economic intimidation and extortion.

In the Madoff scandal, the SEC’s performance as a law enforcement agency is beyond horrible. I was hoping that Cox’s statement that Madoff “lied” to the staff when he was asked if he stole from investors was a misprint or a bad joke. But it wasn’t. Of course Madoff lied to the staff. But then again, what law enforcement organization takes the word of the person that they are investigating?

I have watched enough Law and Order to know that very few people confess unless they have to, and then it is as a result of vigorous investigations and vigilant prosecutions. And I am pretty sure self regulation and market enforcement never entered into Bernie Madoff’s mind when he stole $50 billion. Madoff confessed because he ran out of money to keep on perpetuating his lies. Until the end, Madoff was trying to keep the Ponzi scheme going and was actively marketing for new investors by promising “special deals” for those that he could rip off.

Cox and his immediate subordinates are responsible for not investigating Madoff. Cox was in charge and clearly didn’t have an internal reporting system to keep track of open investigations, cases and clearance. After all, if he did he would have noticed a $50 billion fraud tip that had credibility and might have asked questions. Instead of taking responsibility for the scandal, Cox threw his staff under the bus and blamed them for the mess. He is an out of touch leader who showed little courage or backbone.

I think that most of the SEC staff are good hard working Americans who don’t like being humiliated in public. If they are like most people they also can’t wait to get rid of Cox and get a real leader.

Fortunately, the SEC won’t have Chris Cox much longer. President Elect Obama is nominating Mary Schapiro to be the new Chairman of the SEC. She is known to be a tough and effective regulator who understands the role of law enforcement. Ms. Schapiro has a big job ahead of her but her reputation suggests she is up to the challenge. Her staff will need strong leadership and rebuilding. Ms. Schapiro is going to be a fixer, leader and good regulator.

After all, good regulation requires good regulators.

Comments

[Tom Armistead:]

Before he leaves, Cox should be asked for a list of any other "specific and credible" allegations the SEC may have been ignoring. A few months ago they were looking into possible manipulation involving naked short-selling and CDS, but I guess there was nothing there, as we have heard nothing further.

Recently the SEC bagged another insider trading group: including a former Playboy Bunny and a man who stole insider information from his wife. Good PR, just like Mark Cuban and Martha Stewart. The bunny was very photogenic, nice picture in the WSJ.

I don't want PR ploys, I want Perp walks and prison terms for the real offenders.

2008 Dec 20 10:57 AM

[LoebA:]

I completely agree, but I would add one thing that also needs to be said. Chris Cox was not remiss because he was a bad person, though his actions are condemnable. He was remiss because he was following a philosophy that told him that deferring to the market was the right thing to do. At bottom it was a misguided belief that the market can do all things that caused the problem. As the article points out, people cannot regulate themselves, which should be self-evident. If we trick ourselves into thinking anything else we pay the price. So, it was a philosophical failure more than anything that led to the present crisis.

2008 Dec 20 12:05 PM

[john s. gordon:]

the regulators did not regulate because the bush white house told them to not regulate.
> jack

2008 Dec 21 08:02 AM

[derryl:]

At the risk of being REALLY pesimistic just before Christmas I'll say I'm not confident President Obama or anyone else will be able to find regulators who are both good and effective.

I think that over the past 3 or 4 decades there has been a general decline in economic morality because personal income has become separated from corporate economic productivity or even monetary gain. Today CEOs and upper managers who oversaw their company's loss of 10s or 100s of billions of dollars walk away with 10s or 100s of millions of personal cash. There is some impotent outrage, but these guys get to keep the money and the next guys line up for their turn.

At the highest levels of business and government there is no longer any effective requirement to "earn" your income. You get paid the big bucks whether you earned it or not. What you don't get paid above the table you just steal below the table, either directly as Madoff did or more 'legitimately' with stock options that you cash out just before you see your company collapse.

They call it "executive compensation". Everybody is doing it so why not me? Leaders lead. If the CEO is taking home $10 million then the union guy sees no reason to take a pay cut, regardless of the company's profitability or viability. It's like there is some magic pool of money and you just take your share.

We rightly bemoan the entitlement mentality but today's executive compensation schemes are the most blatant entitlement scheme of all. Many readers will argue these people deserve to be paid $10 million plus per year and walk away after a few years with $100 million plus. You make my point for me. Every entitled person can explain eloquently why they are entitled to their entitlements. Welfare mothers and elite executives have this in common.

People at the upper levels of business, finance, politics and bureaucracy transfer smoothly between these roles. Halliburton cum Vice President, for example. Or Fed chief cum Treasury Secretary. Politicians and upper bureacrats end their public careers with juicy seats on corporate boards or lucrative upper management or 'consulting' jobs in private corporations.

If there is a culture of entitlement at this upper level, which there is, then who in this system is going to appoint an SEC chief cop who effectively does his job of enforcing regulations against entitlements? There are good private sector jobs to be had after public life, so what SEC chief is going to bite the hands he expects to be fed by later?

Democracy devolves into entitlement after the country gets rich enough and politicians realize they can stay perenially in power by promising to keep the entitlement train rolling. George Bernard Shaw observed, A government that robs Peter to pay Paul can count on the support of Paul.

As the entitlement culture matures the nation devolves from democracy to kleptocracy. There is a mad rush to get your millions while the gettin's good! Once you systematically violate the morality that built your country, the morality of earning your living and living within your means, the nation is corrupt.

Corruption cannot support democracy which depends on a sense of sharing the costs and benefits of building the common good. Kleptocrats game the economy into dysfunction because personal gain is all that counts and damn the country.

When it gets real bad and the system either teeters or actually collapses, a savior presents himself. "I am Caesar and you are my subjects. I will fix this and take care of you in the style to which you are entitled."

Caesar cannot fix this and take care of us, but by the time we know this we have traded our freedom for Ponzi Caesar's false promise of 'free' wealth and security.

A wise American democrat said, Those who trade their freedom for security will have neither. Another said, The price of freedom is eternal vigilance.

But aren't we 'entitled' to freedom and security?

2008 Dec 21 09:45 AM

[fanning:]

In the case of Hollinger, the CEO just have a few months in prison and parole out of prison still as a millionaire because the parole broad said white crime did not hurt people. No wonder the stock market is just like a casino. Long term hold is no longer feasible as the old days. Free market survives with profit growth, fair share of the profit by the shareholders with transparency and monitored by regulators to gain public trust. May be GIC and real estate are still the best bet.

2008 Dec 21 11:01 AM

[ATLBob:]

As a former corporate VP/Chief Audit Officer of a fortune 500 company, I can assure you of two things:

1) self-regulation is not an adequate internal control, and

2) anyone who thinks it is doesn't belong in a position responsible for enforcement.

Although many will do the right thing and embrace/abide by the regulations/internal controls, there will be always be some who ignore regulations unless they are prevented from doing so or detected when they cross the line. I also agree that "...Mr. Cox appears never to have embraced or understood his enforcement responsibilities or the SEC’s role to protect the public", and I'm stunned that he's been able to keep his job in the face of such ineffective performance.

The job of a regulator isn't significantly different from that of an auditor: you first need to understand what the controls/regulations are supposed to be, then you perform tests to see that these have been followed by those who are being regulated. There is an old audit saying that goes something like this...'you don't get what you EXPECT, you get what you INSPECT..."

2008 Dec 21 12:25 PM

[mhelburn:]

There is a massive stock manipulation scheme that has been going on for years, involving financial journalists, hedge funds, persons with high profile in the industry, class action attorneys. The SEC could have brought this down two years ago when the SEC issued subpoenas to journalists. What happened? Cox withdrew them. The connection between the class action attorneys and this scam was ignored when they put Weiss and Larach on trial... Wouldn't want this to spread around and soil anybody else. These guys were not caught by the SEC... it was some local cops following up after a domestic dispute and an insurance fraud.. and the investigators only followed it as far as the class action attorneys. You have to ask why they didn't pursue it any further... Probably because of the "juice" and the higher ups at the DOJ taking direction from the White House. Wouldn't want to embarrass thos big campaign contributors from Wall Street. What was a failure for the SEC was a tremendous sucess for the local cops.. just doing their job.

The head of enforcement Linda Thomsen is now being looked at as if she is co-opted, rooting out celebrities for media attention instead of pursuing cases involving someone like John Mack. Mack will never be vindicated, because the way it was handled. The investigator got fired, blew the whistle and there was a Congressional inquiry that showed how pathetic enforcement was and nobody was demoted or fired... instead there was an inhouse whitewash . All the work of the GAO folks and the IG who all did commendable jobs was basically ignored. There was a shake-up but nobody knows if the people were asked to resign or if they left voluntarily... Chris wouldn't want to hurt anyone's feelings by asking for a resignation. and he sure as hell doesn't recognize incompetence or he would have left graciously on his own at Senator McCain's suggestion.

Why would anyone want to work at the SEC with the Commission micromanaging cases and sending the message that you can can break any rule... and get off with a small fine.. CDB. It is far more profitable to do illegal transactions and risk getting caught only to pay a tiny portion of the ill-gotten gains. The real market risk is getting caught.. and that is pretty darn slim..

There are emails between a hedge fund operator and journalist that had to be secured via discovery in a privatecivil case rather than through a subpoena by the SEC. The journalists could have fought the SEC with money from their hedge fund friends and conspirators secured lawyers who can out "juice" the SEC. When Cox backed down, he basically said, "You can continue to manipulate the markets." This showed he was afraid he would lose or was kowtowing to media pressure... who employed the very journalists who were active in the manipulation scheme.

Instead, private citizens had to pursue it at great expense through the courts because there was no enforcement or willingness to protect the market from predatiory and illegal behavior. This is an excellent story.

deepcapture.com/bethan.../ Note the presence of a former regulator having a prominent position ... this was so clandestine he needed a code name.
What exactly did he do while at the SEC? Was he in a position to determine who would or wouldn't be investigated? Did his ethics suddenly change from being a fair and honest regulator to someone who could willingly associate with
these people? Maybe he is working undercover... That's it.. that's the ticket.

Didn't see the red flags at Madoff for 10 years. Dinked around fine-tuning trading rules until the market collapsed, but they got Martha... We are just so glad that they put her in jail because she was such a threat to our society and our economy... and she was so likely to set about to repeat the mistake that she made... She took her sentence like a grown-up... did the time and probably ended up with more fans than before... and she made the SEC and the DOJ look like a bunch of unbalanced, vindictive thugs.

Spitzer had to get the market timers because the SEC wouldn't...

Mr Cox has had the most expensive lesson in history. He learned that self-regulation doesn't work... You would have thought that this was just a lemonade stand instead of the nation's economy he was tinkering with. Cox has proven himself to be indecisive, unable to take responsibility for failure, lacking the most basic knowledge of human behavior and a meddler who didn't know enough about the markets to be effective. He spent most of the time touting how the SEC was the gold standard of regulation., while the investors across America were trying to hold onto their lunch.
Perhaps if the SEC had followed up on John (we let the statute of limitations run out) Mack, the massive market manipulation scheme would have been discovered then as Pequot Capital is included on page 21 of the Fairfax lawsuit.. Aguirre would have rooted it out if he hadn't been fired for doing his job so well. He's the kind of person we need at the SEC. I hope that Mary Shapiro recognizes that.

2008 Dec 21 02:21 PM

[lonie:]

If i understand correctly , this Made-off scam has run over several SEC heads terms , so why not round them all up for prosecution for being bad cops ?

2008 Dec 22 05:53 AM