THE BLOG
09/17/2012 12:54 pm ET Updated Nov 17, 2012

Oversight: Why Congress Needs to Back the Securities and Exchange Commission

As the US grapples with a recession, and as financial scandals continue to rock the economy on a weekly basis, the issue of Wall Street Reform is quickly reaching critical mass. It is clear that something must be done urgently to protect our financial system and to ensure its stability. The government body with the biggest responsibility for this, the Securities and Exchange Commission (SEC), must step up to the plate and meet its promise to the public.

Right now the agency is on the firing line. From articles alleging favoritism by the SEC for JPMorgan Chase and Goldman Sachs, to questions about the closeness of the agency with the industries it regulates, rumors are flying and the knives seem to be out.

But as our economic problems pile up, we need to stop playing the blame game and find real solutions to our problems. The SEC has always been a convenient scapegoat for both Washington and Wall Street but it is worth asking if the real failure here is that of Congress. As this frenetic election cycle has revealed clearly, the nexus between business and politics is not only a reality but one that could shape our economic future for decades to come.

First of all, let's be fair. The SEC's failure to stop Bernard Madoff was an immense black eye for the agency, and more recently, its efforts to change the dubious way in which money-market funds report their share price to customers fell flat in the face of pressure from banking lobbies. The SEC's track record is far from perfect.

Yet, all this bad press fails to capture the other side of the story: despite its shortcomings, the SEC has also executed vast reforms since 2008 and improved its performance considerably (even the Madoff whistleblower and vocal critic Harry Markopolos has acknowledged that he is impressed by the changes and by current Chairman Mary Schapiro). To judge the agency purely on the basis of failures is misleading because it does not take into account all the things it does right or the scope of the fight that the Commission engages in every day, not to mention it ignores the budgetary constraints that it functions under.

In order for the SEC to do its job properly, it needs adequate resources, and for that it needs the support of Congress. To understand why the budgetary issue is so important, and why the SEC deserves more funding now than ever before, let's look at the trajectory of the Commission since the Madoff scandal.

The SEC's directive is broad: to protect investors, facilitate capital formation and to ensure the fair and efficient functioning of markets. This includes investigating and prosecuting securities fraud, inspecting public company disclosures and financial statements to ensure transparency and legality, and promoting fairness in dissemination of market-related information and trading activities. By itself, that is no small task, but the burden on the Commission has also increased considerably with the Dodd-Frank Act.

To meet these challenges, the SEC has streamlined its management structure to reduce bureaucracy, created better cooperation between the field offices and headquarters, strengthened the working relationship with other agencies such as the FBI and the Department of Justice, instituted a robust system to handle tips and complaints, and built up its investigative and enforcement muscles through new technology and additional manpower.

A lot of this is due to the efforts of Schapiro, who was formerly the head of the Financial Industry Regulatory Authority (FINRA) and the Chairman of the Commodity Futures Trading Commission (CFTC) and has as an extensive background in financial regulation. More to the point, she makes no excuses for the past failures of the agency and is on a constant crusade for improvement. This fact too, however, gets overlooked in the criticism of the SEC.

On the technology front, the agency has created standardized systems for enforcement, examination management, risk analysis, and other core functions, and waded into high-tech analytics, collecting real time trading data and analyzing it with sophisticated "quant" technology - the same technology that is used by funds on Wall Street for trading and hedging.

In terms of enforcement, the agency has set up a comprehensive tips and complaints process that also includes the ability to detect patterns of fraud. Stephen Cohen, Associate Director in the Enforcement Division, says that the focus is on speed and accountability, and on ensuring that nothing falls through the cracks. The Commission has also started hiring ex-bankers, who bring industry expertise to the process of investigation and evidence gathering.

The overhaul seems to have worked: in the fiscal year ended September 30, 2011, the SEC filed a record 735 enforcement actions and distributed more than $2.8 billion in disgorgement and penalties to harmed investors. Its Trial Unit prevailed against 87% of defendants and won record penalties against Galleon founder Raj Rajaratnam, Charles Schwab, Citigroup, Bank of America, (and yes) Goldman Sachs and JPMorgan Chase - the same firms that people have suggested get preferential treatment from the SEC, in some cases for their roles in the subprime mortgage crisis.

But despite all this, the SEC faces a budget challenge. For 2013, the agency has asked Congress for $1.57 billion, which will enable it to hire about 700 more people, strengthen its market monitoring activities, prevent a wider array of corporate crimes, and enable it to stay on top of complex and evolving financial instruments. It is also useful to know that the SEC collects matching funds from securities transactions, which means that it costs taxpayers nothing. And yet the Appropriations Committee in the House of Representatives has refused to approve the budget, leaving the agency in limbo till the issue is resolved.

Given the urgency of financial reform, this is appalling.

Consider what the SEC is up against today. Wall Street alone spends $1.4 million a day to lobby Washington against banking reform; and total lobbying spending in 2011 was $3.3 billion - a lot of it directed towards defeating regulation and enforcement. The fact is that the SEC's resources are inadequate for the Herculean task that is laid on its shoulders even at full capacity, but with a budgetary shortfall it is absolutely impossible.

Another kink in the system is the legal framework governing the SEC. A common criticism of the agency is that the damages recovered by it are often a fraction of the true size of the crime. That is true, but what most people don't realize is that the SEC is restricted by law to recovering only double the ill-gotten gains - in other words, the actual profits made by a criminal - even if the transaction involved a bad investment or trade that was several times larger in amount. There are some exceptions to this but the ceiling imposed by the law is illogical and should be lifted.

And finally, there is the political factor. Even though the SEC goes out of its way to avoid politics, it is no secret that Republicans do not favor financial regulation and consider the agency a hindrance to business. The refusal by the Republican-controlled House to approve the latest funding request seems to confirm this attitude. But whatever the personal beliefs of our politicians, they should understand that the SEC, by ensuring a level playing field for all parties, is protecting our free market system. As Schapiro says, "We cannot have a strong economy without strong capital markets and that requires a solid rulebook and competent enforcement."

Ironically, the private sector already knows this. Even as companies lobby to decrease regulation, they are also working diligently to make the SEC's job easier. According to Bhavna Sethi, Founder and Managing Director of Cinapse LLC and a Technology Consultant in New York, firms are reviewing their technology infrastructure, refocusing priorities and re-allocating budgets to meet the SEC, FINRA and Dodd Frank requirements. Even hedge funds, who have been notoriously secretive, are now registering with the SEC in record numbers.

But competent enforcement comes at a price, and should the SEC's latest budget request remain in Congressional purgatory for long, it could derail the agency's reforms and stall its progress. We cannot afford that. There are enough banks out there willing to gamble with our economic future without our leaders aiding it too. It is easy to level blame at the SEC but if our government is serious about reform, then it needs to stop dragging its feet and help the agency achieve its directive instead. Now.


Sanjay Sanghoee has worked at leading investment banks Lazard Freres and Dresdner Kleinwort Wasserstein as well as at a multi-billion dollar hedge fund. He is also the author of the financial thriller, "Merger" (available below). Please visit www.sanghoee.com for more information.