New Oversight Report Criticizes the S.E.C.

The Securities and Exchange Commission may be doing its best to enhance up its public image these days, but a new report (.pdf) criticizes its past performance. The Republican wing of the House Committee on Oversight and Government Reform, lead by Rep. Darrell Issa (R-CA), released the scathing document this week criticizing the regulator. It provides 10 findings of inadequacy and provides five recommendations for improvement. The report explains that the SEC's problems are fundamental in nature, so deep reform is necessary.

So where did the SEC go wrong? If you haven't seen anything screwed up in the financial markets over the past few years, then you really haven't been paying attention. They missed a few big Ponzi schemes, including those run by Bernard Madoff and R. Allen Stanford. They didn't do their job to adequately oversee investment banks, which partially led to the collapse of a few and the near-demise of them all. They also missed the opportunity to eliminate gray areas or wrongdoing that existed in the financial markets that helped create the financial crisis.

As you might guess, some of the findings had to do with precisely these failings. Here are all 10 (summarized):

  • The SEC missed Madoff because investigators didn't understand his business and failed to coordinate to identify the fraud.
  • The Consolidated Supervised Entity (CSE) program to supervise investment banks didn't address systemic problems that led to the financial crisis, so the SEC canceled it.
  • The disclosure process for new securities is archaic (think paper and pencils) and is run like an amateur shop, with SEC staff using services like Yahoo Finance to analyze filings.
  • Virtually all major fraud since Enron has been found by outsiders, not the SEC staff.
  • The SEC was investigating fraudster Allen Stanford for seven years, and concluded four times that he was guilty of fraud, but never brought suit.
  • Despite the claim that funding is to blame for failures, its budget has nearly tripled in the past decade. The problems result from its culture and structure.
  • One structural issue is a "silo problem" that prevents adequate collaboration among divisions, which leads to poor performance.
  • It has a lawyer-heavy approach to regulation, which prevents it from developing better expertise in financial products and industries.
  • Due to the SEC's unionization in the 1990s, it's hard to fire employees who perform poorly.
  • Overly burdensome procedures and rules impose excessive cost on financial firms and ultimately harm transparency for investors.

How does the report say these problems should be remedied? It recommends Congress requires the SEC to do the following (also summarized):

  • Simply its structure
  • Insist its Chairman appoint a Chief Operating Officer with the power to bring lasting change
  • Reform its hiring, firing, and review practices, as well as staff culture and incentives
  • Overhaul, update and simplify its securities disclosure rules and forms
  • Be subject to an independent study of its mission, organization, and work force

Considering the regulator's massive failures over the past decade, these requirements sound pretty reasonable. The SEC serves a vital function in the financial markets. If it cannot perform its job adequately, then something needs to change. In particular, its staff must possess the understanding, collaboration, culture, and drive to uncover fraud and identify activities that can lead to problems in the market.

The entire 33-page report contains a lot of fascinating detail regarding specific findings. You can find it here (.pdf).