September 8, 2009

Another IG Report: SEC Bears Barrage of Renewed Madoff Criticism

Last Wednesday, the SEC released this 22-page executive summary from it’s Inspector General David Kotz regarding the SEC’s failure to nail Bernie Madoff, ahead of the full 477-page report released late Friday (note that it’s the “public” version, some names have been redacted). SEC Chair Schapiro released this statement with the executive summary – and this one with the full report, both of which highlight the 13 reforms undertaken post-Madoff.

As could be expected, the IG’s report resulted in front-page news as the gruesome details of the SEC’s failures would sink any former Staffer’s heart. And this is a story that won’t end for quite some time (FEI’s “Financial Reporting” Blog notes Senate Banking Committee hearings commence this Thursday) and is likely to produce more heartache. For example, I can’t bear the thought of the SEC promoting the fact that they may create a “Fraud College,” as noted in the Bloomberg article. Such nomenclature screams out that the SEC hasn’t been doing the basics when it comes to training.

The repeated bashing of the SEC – unfortunately, much of it warranted – over the past year surely has made a folk hero of its Inspector General David Kotz. This is notable from a historical perspective because the SEC’s IG was someone that hardly knew existed for decades and decades. Now it is among the highest profile jobs at the agency.

Given that the Madoff report is 477 pages, it’s likely that Kotz had a lot of assistance writing it. That’s quite a tome. The IG’s organization chart indicates that the office includes 18 Staffers (including Kotz himself) – but page 7 of the report lists a total of nine in the Office (including two summer interns) that worked on the Madoff investigation. On page 5 of the report, it’s noted that 4 forensic contractors were hired to help investigate (as well as an email recovery expert). Someone will get smart and publish this thing as a book…

Upshot of Madoff Mess? SEC to Finally Be Self-Funded?

Ironically, this Bernie Madoff mess may result in the SEC finally getting funded more adequately. Cries for self-funding have resurfaced, led by Senator Schumer who issued this press release last Thursday noting that he is drafting legislation that would enable the SEC to fund itself from the fees it collects. The SEC historically has collected a level of transaction and registration fees for the US Treasury Department that far outweighs – by about 50% – the funds that Congress appropriates to the SEC to operate. It’s a gravy train that will be hard for the US government to wean itself from.

Beginning in early August, SEC Chair Schapiro began beating the drum for self-funding, as noted in this Financial Times article. This follows a long-line of SEC Chairs seeking the same thing, as it’s hard to run an independent agency when you are dependent on politicians for funding. The SEC is one of only two financial regulators in that must go through the annual Congressional appropriations process. Banking regulators got self-funding a couple of decades ago.

Drilling down into the details, the SEC is part of the appropriations and budget request that includes the Departments of Justice and Commerce. Indirectly, Congress uses the fees that the SEC collects to help balance the budgets of the DOJ and Commerce, even though those paying the fees are not receiving benefits from those agencies. Essentially, the excess fees that market participants pay serve as a “tax.” Here is a mid-’02 GAO report that provides numerous details about a self-funding alternative.

Ah, perhaps a silver lining to the Madoff fiasco…

– Broc Romanek