Post-Madoff SEC scrambles to put its house in order

Prodded by the failure to detect the Madoff Ponzi scheme, Securities and Exchange Commission officials hope a series of internal reforms will reinvigorate the commission’s sorely weakened enforcement efforts and improve protection for investors.

But some experts think that the SEC is so far off course that it will take a huge effort to restore the public’s confidence.

“It needs a makeover,” said John P. Freeman, the John T. Campbell professor emeritus of business and professional ethics at the University of South Carolina Law School.

“The SEC has lost its way,” said Mr. Freeman, a former SEC attorney.

Some experts think that the SEC needs better funding.

“The best scenario for the SEC would be to get the resources needed to pay their experts on par with the private-sector counterparts they are charged to monitor,” said Mark Anson, president and executive director of investment services at Nuveen Investments Inc.

Sen. Charles E. Schumer, D-N.Y., said in a Sept. 3 statement that he would introduce legislation to allow the SEC to finance its operations by keeping all the fines and fees it collects, “so it can afford to recruit and retain better-trained personnel.”

In 2007, though the SEC brought in $1.54 billion in fees, it secured just $881.6 million in funding. Had the commission been able to hold on to the full amount, it would have represented a 75% increase from the funding through the congressional budget appropriation process.

SEC inspector general H. David Kotz told Congress that he expects to issue reform recommendations focused on the SEC’s Office of Compliance Inspections and Examinations by the end of the month.

In Sept. 10 testimony before the Senate Banking Committee, he said that the recommendations would ensure that the office has direct access to financial data from the Depository Trust Co. and self-regulatory organizations.

Mr. Kotz has developed 41 other enforcement-related recommendations. Among them: adding a requirement that specialists with appropriate skills and experience review tips and complaints, and strengthening the SEC’s tip and complaint handling system.

In their jointly written testimony to the Senate committee, Robert Khuzami, director of the SEC’s Division of Enforcement, and John Walsh, acting director of the compliance office, said that they already have been putting extensive reforms in place, including expanding training, hiring staff members with new skills and revamping their procedures.

In an Aug. 5 speech before the Association of the Bar of the City of New York, Mr. Khuzami announced the creation of five specialized investigative units with the following areas of responsibility:

• Asset management, focusing on oversight of investment advisers, investment management companies, hedge funds and private-equity funds.

• Market abuses, covering complex manipulation schemes.

• Structured and new products, policing complex derivatives and financial products, including credit default swaps, collateralized-debt obligations and securitized products.

• Municipal securities and public pensions, focusing on arbitrage, underfunded pension liabilities and pay-to-play schemes.

• Foreign Corrupt Practices Act unit, leading anti-bribery efforts.

In addition, Mr. Khuzami said that his division is streamlining its management structure and decision making to increase resources for investigative efforts and encourage autonomy and accountability among staff members, including giving senior officials authority to issue subpoenas without approval from the commissioners.

Also, the SEC created the office of market intelligence, which will oversee collection, analysis, referral and monitoring of hundreds of thousands of tips and complaints the SEC receives, he said.

The SEC also is working to beef up its staff. It has hired Henry T.C. Hu, a professor at the University of Texas Law School, as director of the newly established Division of Risk, Strategy and Financial Innovation.

The division, the SEC’s fifth, will oversee risk and economic analysis, strategic research and financial innovation, according to a statement by SEC Chairman Mary Schapiro.

But Mr. Freeman doubts that reform recommendations will strengthen the SEC unless it tackles conflicts of interest in its relations with the investment industry.

“Something has to be done about this revolving door” in which top SEC staff members often take jobs in the investment industry or come from the industry to work at the SEC before returning, he said.

“We are aware of the phenomenon,” said SEC spokesman John D. Heine. He noted that government ethics rules and specific SEC ethics rules apply across the agency.

But some say that investment industry executives who join the SEC can offer insight into problems.

“A lot of people who come to work in the government from the industry have seen things they know are wrong and see their jobs at the SEC as an opportunity to fix them,” said Tim M. Simons, a former SEC compliance official who is a partner and senior managing director of compliance at Ashland Partners & Co. LLP.

Barry B. Burr is a reporter for sister publication Pensions & Investments.

Related Topics: Money Management Institute (MMI), Securities and Exchange Commission