Hey, Obama, the SEC And CFTC Are Ripe for Consolidation

This week, Obama asked Congress for the power to consolidate several federal agencies such as the Small Business Administration and the Commerce Department because they were performing overlapping functions. Oddly, he did not mention the financial regulatory space, which is even riper for combination. Perhaps, he was mindful of the copious contributions to his campaign from Wall Street. 

Having two regulators, the SEC and the CFTC, did not prevent MF Global from failing. In fact, it might have hastened its decline. Professor Cornelius Hurley, director of Boston University’s Center for Finance, Law, & Policy, advocates combining the SEC and CFTC into one agency. He asserts that a merged agency would save money by eliminating the duplication of oversight and allow for a more efficient deployment of a staff and other resources.

“The collapse of MF Global suggests that we are paying a price for not combining the CFTC and SEC, which was suggested in a white paper about financial reform developed by the Treasury Department soon after Obama arrived in town,” he said. “Anyone can see that an organizational chart where two regulators are regulating the same space is absurd.”

He inveighs against the greed of members of Congress killed the unification efforts. “The House and Senate Financial Services Committees oversee the SEC while the Agriculture Committee administers the CFTC.  Members of the agricultural committee did not want to lose the tremendous contributions to their campaigns from the commodities firms,” explained Hurley.

Jonathan Katz, the former Secretary of the SEC, observed that SEC Chairmen from both political parties have supported merging the two regulatory agencies since 1980. “The United States is the only country in the world where the regulations of securities and derivatives is separated,” he said.

Mike Koehler, a professor of business law at Butler University, challenges the current practice of  the SEC and the Department of Justice (DOJ) to announce concurrent settlements with the same violating entity. With limited enforcement budgets, Koehler doesn't understand why the SEC is still prosecuting cases once the DOJ became involved. He thinks “the SEC step down after a case is referred to the DOJ”.

 He asks, “What purpose does it serve to have two separate enforcement actions of the same course of conduct?  Basking in the klieg lights, while holding a press conference to take credit for the enforcement action, sadly appears to the only purpose of dual prosecutions.

Federal Judge Jed Rakoff’s rejection of the SEC’s punishment in the Citigroup cast has caused many to reassess the types of penalties that should be levied against serial violators of securities laws. Low fines and SEC settlements have become a cost of doing business not a deterrent. "Companies will think twice about committing fraud if they can’t settle for chump change,” said Hurley.

Robert Fusfeld, a former SEC employee of 31 years and manager of litigation in the Denver office of the SEC for 15 years, suggests that current settlements include the potential punishment of the company if they break the law again. “If you violate again, the SEC will bring an administrative proceeding. We will pull your ticket (license), close you down for 6 months, or deny your right to bring in new business for a period of time,” he said. “If corporations knew that they could be barred from soliciting new customers or could potentially be closed for a period of time, they might think twice about violating the law.”

Although the SEC has rarely rescinded the license of a major New York firm, he emphasized that that the pulling of a license is standard procedure in law enforcement.  He noted, “When a business is caught serving someone under aged alcohol, they lose their license immediately. The SEC bars mom and pop, no name firms in the Midwest all the time. Yet, they do not use this weapon in their arsenal against major New York firms.”

Katz, who described his position at the SEC as the last set of eyes before an enforcement action was voted on, wants to see more SEC enforcement actions end in criminal prosecutions.

“Ponzi schemes are criminal activity. Injunctive relief, which is the sole weapon of the SEC, is not effective. There should be a criminal prosecution,” said Katz. “While the SEC routinely cooperates with the DOJ, I would propose that it become standard practice that they refer cases to local law enforcement if the DOJ declines to prosecute.”

It was shocking too many that Citigroup’s recent settlement was their fifth violation of the nation’s securities laws. Former NY Governor Spitzer, known as the “Sheriff on Wall Street during his tenure as NY State Attorney General, believes the first step in tackling the problem of corporate recidivism is to establish a career criminals unit that would be modeled after similar unit at the Manhattan District’s office.  He recalled, “When I was assistant district attorney in the career criminal’s unit, those that had committed more than two felonies were punished more severely. They were sent away for a long time,” he said. “For corporations that repeatedly offend, we need to increase exponentially the financial penalties and insist on structural changes such as compensation.”

“Right now, the SEC now uses restitution as a proxy,” said Spitzer. Under that current system, it is the shareholders, not the corporate executives that committed the wrongdoing, that bear much of the financial pain of a corporation’s malfeasance. Spitzer wants to change that. “There must be individual responsibility. Executives of violating corporations must be held responsible."

If the SEC is going to effectively change, Katz opines that it must be restructured from the top down. “The commissioners are overburdened,” he said.  “The problem is that too many decisions are being made at the staff level.”

 In his opinion, the number of commissioners needs to expand from five to seven. Currently, all five commissioners must vote on an enforcement action. Katz proposes that number be reduced to rotating working groups of three.

Barbara Roper, director of investor protection at the Consumer Federation of America, recommends changing the way the commissioners are chosen. She laments, “SEC commissioners can’t be straight up and down consumer advocates, which is the job that they are appointed to do. They must be acceptable to the financial industry, the very industry that they have been appointed to regulate.”

Most financial regulation experts are in consensus that no additional regulations are needed. “The collapse of MF Global violated long existing securities laws about customer account segregation not newer regulations like Dodd Frank, said Hurley. “Regulation is about individuals, culture.  Former Federal Reserve Chairman Alan Greenspan could have protected the mortgage borrower with powers given to him in the Home Owners Equity Protection Act had he been a different person – not a free market champion and devotee of Ayn Rand.”


The research for this article was supported by the community report site spot.us

Outsourcing the SEC's Oversight Function Could Strengthen the Agency

Many consider the SEC’s nadir was their failure to detect the Madoff and Stanford frauds. Jonathan Katz, the former Secretary of the SEC, admits that the investment advisory division has always been “the Achilles heel of the Commission.”  He said, “The SEC does not have the resources to adequately monitor investment advisors and Congress refuses to allocate additional money. State regulators can’t be relied on to do the SEC’s work because there is too much variation in the law state by state.”                                                                        

Robert M. Fusfeld, , who worked at the SEC for 31 years, said, “The system is clearly broken. The SEC needs to do a major rethinking.”

Barbara Roper, director of investor protection at the Consumer Federation of America, believes that an increase in funding would solve many of the SEC's problems. The case of Spencer Barasch, the former head of enforcement at the SEC’s Fort Worth office, is illustrative that the SEC is a Gordian knot that money alone can unravel. Barasch, now in private practice, is expected to settle charges that he improperly represented Stanford before the commission. A scathing report by SEC Inspector General David Kotz, who is not your typical mealy mouthed SEC employee, found that Barasch was involved in repeated attempts to quash investigations into Stanford while in the employ of the SEC. After leaving the SEC, he then represented Stanford despite this being a violation of SEC ethics rules and being explicitly denied permission three times.

Barasch explained his egregious behavior this way- “Every lawyer in Texas and beyond is going to get rich over this case. Okay? And I hated being on the sidelines.” His greed illustrates that the revolving door between the SEC and Wall Street is one of the major causes of the SEC’s ineffectuality. The SEC lawyers, many of whom intend to eventually move to the more lucrative private sector, avoid launching investigations that will antagonize potential well-heeled clients.

Fraud examiner Harry Markopolos warned the SEC in great detail about the likelihood of something wrong in Madoff's operation. In addition, the SEC conducted several onsite inspections and audits. The vast majority of fraud by investment advisers escapes exposure simply because there has been no audit. 

Buddy Doyle, a founder of regulatory and compliance consulting practice Oyster LLC, said, “The SEC only audits 9% of all investment advisers each year. In practical terms that means that investment advisers are audited, at the most every ten years. I have clients that have never been audited.”

Even if an investment adviser is audited, the fraud could still go undiscovered. “Examiners are under pressure to finish their audits quickly. The SEC likes to issue press releases trumpeting their record number of enforcement actions and fines, said Fusfeld. “This discourages investigators and examiners from doing complex investigations that take time and money.”

Katz, who recently wrote a 130 page report on reforming the SEC for the Chamber of Commerce, thinks the best way to combat investment adviser fraud is to mandate private regulatory audits. Compulsory regulatory audits would be analogous to the current requirement for public companies of an annual accounting audit. 

Privatization of SEC functions may not be as radical as it seems.  The SEC already outsources some of its oversight to the Financial Industry Regulatory Authority (FINRA), the self-regulatory organization (SRO) of the financial industry. Possibly due to its reliance on the financial industry for funding, FINRA was inefficacious in its supervision during the financial crisis.

Privatization of law enforcement duties has a long history. Abraham Lincoln probably regrets not being guarded by his regular Pinkerton detectives the night that John Wilkes Booth entered the theater. Municipalities regularly use private security officers to guard government buildings, the care of prisoners is often privatized, and bounty hunters are rewarded for catching fugitives. While the city provides a minimal level of police service, San Francisco is divided into patrol areas and licenses were auctioned off to private security firms. The private contractors, who can make arrests, write tickets, and conduct investigations, customize their patrol services to the individual needs of the resident. The independent companies answer to both a government body and the individual consumer.

Lawrence Reed, president emeritus of the Mackinac Center for Public Policy, said, “Communities that have experimented with alternative and private-sector police services introduce market principles such as accountability to the customer, cost consciousness, and competition into what is regarded as strictly a government function. The possibilities for privatization are limited only by the ingenuity and political courage of local leaders.”

“Privatization of some SEC functions is what my firm has been doing for 30 years,” said Todd Collins, a partner at Berger Montague. “The plaintiff’s securities bar is demonized for doing too much, just as the SEC is criticized for doing too little.”

The state of Indiana has been utilizing private contractors to audit broker-dealers since the 1990’s. With only a staff of 30, Chris Naylor, the zealous Indiana Securities Commissioner, has no choice but to use private firms to supplement his regulatory monitoring of more than 1800 broker-dealers and 132,000 brokers registered with the state. “In 2011, we sent out letters to 181 broker-dealers mandating that they undergo a compliance audit within 45 days,” said Naylor.

This program has allowed Indiana to earn a stellar record in prosecuting fraud. “During my term in my office, we have sent more than 50 people to jail. Vaughn Reeves, the family patriarch, was sentenced to 54 years in prison after being convicted of selling millions of dollars of fake church bonds in the name of the holding company Alanar,” he said.

Naylor credits the successful prosecutions to the close coordination between his Prosecution Assistance Unit with local prosecutors. “We don’t just send over fifteen boxes to prosecutors. We work complementary, hand to hand with them.”

 

It is doubtful that the SEC will implement a program using private contractors in the near future. The Occupy Wall Street movement has railed against Goldman Sachs, the Supreme Court, and the Fed, but has largely stayed silent about the SEC. It was not an outcry from the public but a cri du couer from Federal Judge Jed Rakoff that forced the SEC to modify their decades old "neither admit nor deny" policy.

CLSA bank analyst Mike Mayo, author of the revealing “Exile on Wall Street” wants investors to become more militant in their repudiation of bad behavior by withholding business from the offending banks. When he tried to raise the alarm that Citigroup violated Sarbanes Oxley by not disclosing a letter from the Office of the Comptroller of the Currency in their 2008 10-k, the public and media yawned.

 “Despite several securities law violations, Citigroup has not seen a mass exodus of clients. I would like to see the day come when customers award their business to the brokerage houses that provide the best research, even if it is critical of the company,” said a clearly frustrated Mayo.

The research for this article was sponsored by the community reporting site Spot.us

Goldman Gouges the Poor Again

While Matt Taibbi's of Rolling Stone colorful description of Goldman Sachs as a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money could be interpreted as anti-Semitic by some, there is some truth to the description. The New York Post reports today that Goldman Sachs and Veritas Capital plan to turn a quick profit on their investment in Global Tel Link (GTL), which is the largest provider of phone services in prisons. Goldman Sachs earned that profit from prisoners and their families, who often are poor or middle class.

Prisoners can only make outside calls by calling collect in most prisons. These calls can be as much as 630% higher than a regular consumer call. GTL, which has consolidated the industry, charges some of the highest per minutes rates in the country. Prison Legal News found the rate for interstate collect calls in Arkansas'prisons is $10.70 for 15 minutes.

The cost of the actual telephone call is not the end of the cost. GTL charges family members a $4.75 service fee for each $25.00 payment to a prepaid phone account via credit card, which is a 20% markup for using credit cards. If an account is not used for 90 days, the balance is not returned to the owner of the account, but kept by GTL.

GTL wins a majority of their contracts by paying kickbacks as high as 60% to the states that award them the contracts. While the kickbacks are legal and part of the bidding process, they further burden the families of prisoners. After a hard fought campaign, then Governor Eliot Spitzer eliminated the commission payouts in New York State. Not surprisingly, Goldman Sachs did not lift a finger to end the commissions even though the abolition did not cut into their profitability.

While many are not sympathetic to prisoners, it is the families of these prisoners that bear the lion's share burden of the phone calls. Often, they are forced to choose between eating and letting a child talk to their parent in jail.