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Whole Lotta Shakin' Going On

Shock and Uh at the SEC

Mary-Jo Kranacher, MBA, CPA, CFE

Our country's leaders continue to desperately search for an answer to the economic crisis facing the nation. Some think that throwing hundreds of billions of dollars at the problem is the solution. But unless regulators and legislators enforce laws equitably and with certainty, all the money spent will be in vain.

Mary Schapiro, President Barack Obama's choice to replace Christopher Cox as SEC chairman, has begun her tenure by shaking up the agency in an attempt to restore its reputation as the “investors' advocate.” The first casualty, Linda Chatman Thomsen, director of its enforcement division, stepped down in early February to make way for a new “top cop.” Some believe that Thomsen has been used as a scapegoat, but her departure definitely sends a signal that change is in the air. And any change that improves investor confidence is urgently needed to jump-start our economy.

Regulatory Failures

The SEC's failure to detect and preempt the subprime mortgage crisis hasn't gone unnoticed by investors, as evidenced by the stock market's roller-coaster ride, mostly with heart-stopping free falls. This regulatory watchdog also “watched,” silently, as some of the country's largest brokerage firms and financial institutions crumbled amid allegations of fraud. But the straw that broke the camel's back was the Bernard Madoff scandal. This alleged fraud highlights the glaring failures of the regulatory structure, procedures, and organizations that are supposed to protect investors. Many Americans listened incredulously as Harry Markopolos, a Chartered Financial Analyst (CFA) and Certified Fraud Examiner (CFE), testified before the U.S. House of Representatives Committee on Financial Services about his futile attempts to tip off SEC lawyers and investigators to the Ponzi scheme purportedly orchestrated by Madoff.

In his testimony, Markopolos stated: “As early as May 2000, I provided evidence to the SEC's Boston Regional Office that should have caused an investigation of Madoff. I resubmitted this evidence with additional support several times between 2000 and 2008, a period of nine years. Yet nothing was done.”

In addition, a recent report by the SEC's inspector general was critical of a common practice at the agency of allowing outside attorneys who represent organizations under investigation by the commission to communicate directly with staff lawyers who are conducting the investigation. This could potentially compromise significant, nonpublic information related to the investigation.

The Whistleblower's Advice

Markopolos offered some good advice in his testimony to help rebuild the SEC and the country's financial regulatory structure, as detailed below.

Let us know, let us know, let us know

“Only by providing investors with full transparency and allowing them to make rational investment decisions will our capital markets find the proper price levels so that buyers can find sellers and sellers can find buyers.” The ongoing sideshow regarding the role of mark-to-market accounting in the economic crisis is a red herring used by those seeking to deflect responsibility for their part in this mess.

Combine regulatory functions

“Our nation has too many financial regulators. The separation and lack of connection and communication between them leaves too many gaping holes for financial predators to engage in ‘regulator arbitrage’ and exploit these regulatory gaps where no one regulator is the monitor.” Fraudsters use a tactic similar to the way children approach each parent in turn until they get their way.

Restaff and retool

“By failing to hire industry-savvy people, the SEC immediately sets their employees up for failure, and so it should not be surprising that the SEC has become a failed regulator.” Markopolos recommended increasing the number of qualified professionals on staff with relevant financial backgrounds, such as CPAs, CFAs, CFEs, Certified Internal Auditors (CIA), and Chartered Alternative Investment Analysts (CAIA). MBAs, PhDs in finance, as well as others with industry experience, should replace the excess of lawyers now filling the SEC's payroll.

Raising the enforcement bar

“Just because it is not illegal doesn't mean the SEC should ignore unethical behavior in the marketplace. … The SEC must change its mission toward ensuring full transparency, fair play, and zero tolerance for unethical financial dealings.”

If the SEC is to serve as part of the solution in this national crisis, it will need, first and foremost, to get its own house in order. Following Markopolos' advice is one way to give this important regulatory watchdog more bite.

As always, I welcome your comments.

Mary-Jo Kranacher, MBA, CPA, CFE. Editor-in-Chief.

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