03/18/2013 09:00 am ET | Updated May 18, 2013

The SEC Embraces Irony -- its Enforcement "Inflection" "Point"

Many readers doubtless shared my doubt that the SEC was capable of exercising the critical self-examination and sense of humor about itself as a flawed institution that would make it capable of deliberate irony. When I accessed the Wall Street Journal's home page I found the most delicious example of SEC (and WSJ) irony. The WSJ synopsis of its article on the SEC reads: "The SEC is filing significantly fewer civil fraud cases this year, as its efforts to punish misconduct related to the financial crisis start to ebb."

"Start to ebb?" Is it only me, or have other readers missed the tidal bore of SEC enforcement cases "punishing" the "misconduct" of the most culpable, elite perpetrators of what even conservative finance scholars describe as "pervasive" accounting control fraud by our "most reputable banks"?

Asset Quality Misrepresentation by Financial Intermediaries: Evidence from RMBS Market by Tomasz Piskorski, et al. (February 2013)

(Essentially all of these control frauds were publicly traded, so they also engaged in securities fraud when they failed to disclose their frauds and their liability for those frauds.) The SEC should have been a key source of criminal referrals against these elite banksters, so I also apparently slept through the flood tide of prosecutions that "punished" their "misconduct."

Actually, at full tide there were zero prosecutions of elite bankers for the accounting control frauds that drove the financial crisis. And there were zero civil or enforcement cases by the SEC against the elite officers who grew wealthy through the frauds that drove the financial crisis that actually left the officers suffering a net loss from their frauds and required them to admit their frauds. The last time the SEC "tide" of enforcement actions against elites resembled even a pale imitation of the Bay of Fundy was a decade ago in response to the Enron-era frauds. Even then, Eliot Spitzer, then the Attorney General of New York, put the SEC to shame with his far greater success with far fewer resources.

The SEC enforcement actions in response to the elite, fraudulent officers who grew wealthy by directing the control frauds that drove this crisis were an embarrassment at the time when they were purportedly at their highest tide. SEC enforcement numbers are rarely meaningful because any SEC enforcement director can produce hundreds of meaningless, worthless, and "precedent-less" consent decrees by suing small, bankrupt companies.

One of the inherent corollaries of "too big to prosecute" is that any fines must pose no risk to the bank's ability to survive. The art is to make the number sound large to fool the rubes, but to insure that the fine poses only a modest inconvenience to our "most reputable" fraudulent banks. But the SEC has tired of even going through the motions to fool the rubes. The article notes that SEC officials have announced that: "'We're at a point of inflection in our enforcement program,' George Canellos, acting SEC enforcement head, told a conference in Washington, D.C., last month." Wonderful, we now know that the SEC considers it recent pathetic record a "local maximum" and we should fear that they are headed towards a "global minimum" of enforcement actions against elite bank frauds - an ever weaker series of neap tides. (Again, material bank control fraud almost invariably also constitutes securities fraud because it cannot be disclosed.)

The SEC's claim of enforcement vigor is belied by its own self-praise.

"The financial crisis has given the SEC some of its highest-profile cases in recent years. The agency's website showcases its record of crisis-related actions against more than 150 firms and individuals, with sanctions totaling $2.7 billion."

The $2.7 billion figure is supposed to sound enormous. It is orders of magnitude too small. Losses caused by the fraud epidemic in the U.S. are well in excess of $15 trillion. A trillion is a thousand billion. Losses in the S&L debacle were $150 billion ($1993), so the current crisis (adjusted for inflation since 1993) is in the range of 70 times larger than the S&L debacle. Our enforcement sanctions from accounting firms alone were $1 billion ($1993). The government recovery from a single case against Drexel Burnham Lambert, which we aided as S&L regulators, but did not conduct, was $1.3 billion (Akerlof & Romer 1993: 53). If simply those two cases against the audit firms and Drexel are added and adjusted for inflation the SEC's failure to hold the vastly larger and more lucrative (for the senior officers) and destructive frauds accountable becomes clear. Most of the entities we sanctioned would have been at a high risk of failure if we had secured substantially larger recoveries. The SEC could have sanctioned (and collected from) many of the world's deepest (and most fraudulent) pockets because of the "pervasive" accounting control fraud that even finance scholars now concede occurred at our "most reputable banks." (As that last phrase makes clear, studying the epidemic of control fraud had led even finance scholars to become adept at irony.)

To sum it up, the "good news" is that SEC enforcement actions against the elite banksters have been rare, rarely litigated, routinely settled without any useful admissions of guilt, and never pressed to the point that crime does not pay - magnificently. The bad news is that the SEC is getting worse. The non-news is that the media has never reported on the SEC's failure to make vital criminal referrals and whether the Department of Justice has failed to prosecute elite banksters even in response to what seems likely to be the small number of criminal referrals made by the SEC against elite banksters. Prompting and assisting a criminal prosecution of an elite bankster is a vastly more effective means of holding the bankster accountable and deterring future fraud epidemics than is any SEC enforcement action, particularly one that leaves the banksters wealthy and requires no admissions of their fraudulent conduct.