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Clean-Up Time On Wall Street

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January 5, 2009

As we approach the eve of the Obama Administration’s first day, across America the new President’s supporters have visions of “change we can believe in” dancing in their heads.  For some, this change means the long overdue realization of health care reform.  For those active in the Democratic campaigns of 2006, “change” means an end to the Iraq war.  Many Americans are hoping that the new administration will crack down on the unregulated activities on Wall Street that helped bring about the current economic crisis.

On December 15, Stephen Labaton wrote an article for the New York Times, examining the recent failures of the Securities and Exchange Commission as well as the environment at the SEC that facilitates such breakdowns.  Some of the highlights from the piece included these points:

.   .   .    H. David Kotz, the commission’s new inspector general, has documented several major botched investigations.  He has told lawmakers of one case in which the commission’s enforcement chief improperly tipped off a private lawyer about an insider-trading inquiry.
*   *   *
There are other difficulties plaguing the agency.  A recent report to Congress by Mr. Kotz is a catalog of major and minor problems, including an investigation into accusations that several S.E.C. employees have engaged in illegal insider trading and falsified financial disclosure forms.
*   *   *
Some experts said that appointees of the Bush administration had hollowed out the commission, much the way they did various corners of the Justice Department.  The result, they say, is hobbled enforcement and inspection programs.

On December 18, Barack Obama announced his intention to name Mary Schapiro as the Chair of the Securities and Exchange Commission.  Many news outlets, including National Public Radio, presented an enthusiastic look toward the tenure of Ms. Schapiro in this office:

Speaking at the news conference on Thursday, Schapiro said there must be “consistent and robust enforcement” of regulations to protect investors, saying it will be her top priority as SEC chief.

On the other hand, in the December 18 Wall Street Journal, Randall Smith and Kara Scannell provided us with a more informative analysis of the SEC nominee’s track record:

She was credited with beefing up enforcement while at the National Association of Securities Dealers and guiding the creation of the Financial Industry Regulatory Authority, which she now leads.  But some in the industry questioned whether she would be strong enough to get the SEC back on track.
*  *  *
Robert Banks, a director of the Public Investors Arbitration Bar Association, an industry group for plaintiff lawyers  . . .  said that under Ms. Schapiro, “Finra has not put much of a dent in fraud,” and the entire system needs an overhaul. ” The government needs to treat regulation seriously, and for the past eight years we have not had real securities regulation in this country,” Mr. Banks said.

Since Ms. Schapiro took over Finra in 2006, the number of enforcement cases has dropped, in part because actions stemming from the tech-bubble collapse ebbed and the markets rebounded from 2002 to 2007.  The agency has been on the fringe of the major Wall Street blowups, and opted to focus on more bread-and-butter issues such as fraud aimed at senior citizens.

Out of the gate, Ms. Schapiro faces potential controversy.  In 2001 she appointed Mark Madoff, son of disgraced financier Bernard Madoff, to the board of the National Adjudicatory Council, the national committee that reviews initial decisions rendered in Finra disciplinary and membership proceedings.  Both sons of Mr. Madoff have denied any involvement in the massive Ponzi scheme their father has been accused of running.

It appears as though we might see Ms. Schapiro face some grilling about the Madoff appointment, when she faces her confirmation hearing.  Beyond that, the points raised by Randall Smith and Kara Scannell underscore the question of whether Mary Schapiro will really be an agent of change on Wall Street or just another “insider” overseeing “business as usual”.  To assuage such concern, many commentators have emphasized that Ms. Schapiro has never worked for a brokerage firm or investment bank.  Her Wall Street experience has been limited to regulatory activity.  Despite this, one must keep in mind a point made by Michael Lewis and David Einhorn in the January 3 New York Times:

It’s not hard to see why the S.E.C. behaves as it does.  If you work for the enforcement division of the S.E.C. you probably know in the back of your mind, and in the front too, that if you maintain good relations with Wall Street you might soon be paid huge sums of money to be employed by it.

Michael Lewis is the author of Liar’s Poker, a non-fiction book about his own Wall Street experience as a bond salesman.  With David Einhorn, he wrote a two-part op-ed piece for the January 3 New York Times.  The above-quoted passage was from the first part, entitled:  “The End of the Financial World as We Know It”.  The second part is entitled:  “How to Repair a Broken Financial World”.  The first section looked at the Bernie Madoff Ponzi scheme, using it to underscore this often-ignored reality about the Securities and Exchange Commission and its inability to prevent or even cope with the current financial crisis:

Indeed, one of the great social benefits of the Madoff scandal may be to finally reveal the S.E.C. for what it has become.

Created to protect investors from financial predators, the commission has somehow evolved into a mechanism for protecting financial predators with political clout from investors.  (The task it has performed most diligently during this crisis has been to question, intimidate and impose rules on short-sellers — the only market players who have a financial incentive to expose fraud and abuse.)

In the second section of their commentary, Lewis and Einhorn suggest six changes to the financial system “to prevent some version of what has happened from happening all over again”.  Let’s hope our new President, the Congress and others pay serious attention to what Lewis and Einhorn have said.  Cleaning up Wall Street is going to be a dirty job.  Will those responsible for accomplishing this task be up to doing it?

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