Given the level of repeat offenses at some of the largest financial firms, it’s clear that the SEC needs to change its approach.
By Eleanor Bloxham, CEO of The Value Alliance and Corporate Governance Alliance
FORTUNE – Disclosure failures related to mortgage offerings are again in the sights of the SEC, this time related to Goldman Sachs GS and Wells Fargo WFC . And a recent court order describes potential
client conflicts of interest
involving advice provided by Morgan Stanley ms and Goldman Sachs (with the apparent knowledge and participation of CEO Lloyd Blankfein) related to the Kinder Morgan-El Paso acquisition. Are these and other large financial firms just too big to behave?
“These firms are enormous … [and] as we look at different areas of their business and we focus on different topics, we find problems over and over again,” SEC Chair Mary Schapiro explained in late February at a media breakfast (which was
filmed by FORA.tv
). “People have short memories [and] we have to bring cases continuously … so people don’t forget.”
Schapiro appeared before Congress
on Tuesday to defend the SEC’s
proposed 2013 budget
. Hopefully, the proposed budget is sufficient, and Congress will meet the request and then hold the SEC accountable for “expanding and focusing the investigative function” and “strengthening the litigation function,” as its budget proposal states.
Right now, however, whack-a-mole seems to be the name of the SEC’s game as it attempts to police the large banks, one incident at a time. But this approach doesn’t address the root causes of these incidents, so repeat offenses spring up in new locations. Are there ways to whip these problem companies into shape?
A full hearing into a
between the SEC and Citigroup c offers an opportunity to explore possibilities. But it’s unclear if that hearing will even take place. After federal judge Jed Rakoff ruled that the case should go to trial, the SEC promptly
the decision late last year.
Court records show that sides are now forming in the appeals case. The unlikely bedfellows of the Business Roundtable, the SEC, and Citigroup (all of whom support the negotiated settlement) are on one side.
The other side includes William Michael Cunningham, owner of investment firm Creative Investment Research, who has argued “in support of the public interest” that the proposed settlement should be examined, rather than approved, and Better Markets, an organization “that promotes the public interest in the financial markets,” which has also requested to weigh in against proposed settlement.
In court documents, the Business Roundtable says that if the settlement were to go to trial, it could put “courts in the position of micromanaging agencies’ enforcement decisions.” But Cunningham questions the SEC’s “concern for expedience over justice … especially if a fairer settlement would help prevent recidivism, and … protect investors.”
In addressing Rakoff and its critics, the SEC has used two major talking points, which Schapiro repeated on Tuesday. Settlements are less costly than litigation. If the SEC can secure a settlement similar to what they would get through a trial, without the uncertainty of litigation and the delay of investigation, it’s a good deal for everyone, Schapiro said. Yet financial institutions won’t settle with the SEC if they have to admit wrongdoing, she argued.
But the SEC has not addressed other solutions that might cost the agency even less in the long term.
Judgments against repeat offenders
There is one practical solution (which I pointed out two years ago in a
involving Goldman Sachs). The SEC could start taking Citi and other financial institutions to court when they violate injunctions they have agreed to in previous settlements. But the
SEC doesn’t track such violations
and spokesperson John Nester says nothing worthwhile would happen if the regulator brought the cases involving large firms back to court anyway. If a large firm commits the same wrong act in its different operations (like the Boston and then the Philadelphia office), a judge would treat them as two separate incidents because two different people were involved, Nester says. Because of the way incidents are viewed by judges, showing an ongoing violation at these large institutions isn’t possible, he says.
But at a November 9 hearing in the Citi case, Judge Rakoff argued that bringing these violations before the court is an efficient and cost effective way to handle repeat offenses, and could result in criminal prosecutions. Yet “in the last ten years [the SEC hasn’t] brought any contempt proceedings against any large institutions, even though they have repeatedly violated previous injunctions,” Rakoff said. If a federal judge is saying it’s a viable option to hold the largest firms accountable, why not determine who is right by at least giving it a try?
Giving settlements some fighting words
While the SEC has defended its settlements based on the dollars and cents it’s bringing in, the agency has not responded to the idea of coming up with settlement terms that have
broader and stronger requirements
. Taking this route could also help put an end to the SEC’s whack-a-mole-like approach. At the November 9 hearing, Rakoff questioned whether the proposed Citi settlement terms were merely “window dressing.”
Another angle for the agency to pursue is getting some admissions in settlements. Former SEC Chair Arthur Levitt
told Bloomberg TV
in December that while companies in the future may not admit to everything, “some of these companies are going to admit some things.” But to make that happen, of course, the SEC must believe that it is possible.
Taking it to the judge
On Tuesday, Schapiro told Congress that the SEC is going to court more than it had been. This is a welcome move because while it’s more costly for the SEC
(rather than settle) individual cases, using the courtroom to hold companies and individuals at the highest levels accountable could improve memory retention among problematic firms, which just might be less costly over the long term.
An independently funded SEC?
The SEC says its budget is hampering its ability to act more boldly. Not only is its technology way out of date, last spring the regulator had to stop hiring expert witnesses for court cases and skimp on airfare to stay within its budget, Nester says. One way to address the funding issue would be to allow the SEC to determine its own funding requirements along the lines of the FDIC,
University of Rochester President Joel Seligman made in a New York Times op-ed two years ago.
Congress determines the SEC’s budget
— and then fees are set on securities transactions to cover those costs (so taxpayers never pick up the tab). But even with an increase, beginning
, Wall Street firms (who continue to tax the regulator’s resources) will pay a
rate than they had to pay in 2000, Nester says. The irony is that by not fully funding the SEC, Congress is rewarding the very firms that continue to operate with abandon. (Corporate registration fee rates, which are also significantly lower than in 2000, don’t currently even fund SEC activities but instead go to the Treasury, Nester says.)
If the SEC were allowed to determine its own funding requirements, the fee structure could be designed to impose larger corporate registration fees on problematic firms that pose a greater risk to the securities markets, ensuring that firms that demand additional oversight and litigation pay for the extra burden they create. Ongoing, predictable funding at the level the SEC says it needs would also eliminate the regulator’s excuse that it lacks sufficient funds to do its job well.
If the will does not exist to implement these remedies, it is time to reconsider a break-up of the enormous repeat offenders, as U.S. Senator Sherrod Brown of Ohio
proposed in 2010
. It means that at least some of the large banks are not only too big to behave, they are also simply too big to be overseen.
Eleanor Bloxham is CEO of The Value Alliance and Corporate Governance Alliance (