There's no longer much debate about the fact that the SEC badly slipped up by failing to catch Bernard Madoff's alleged "$50 billion ponzi scheme." Even commission chair Chris Cox lamented "multiple failures over at least a decade" in the matter. And yesterday President-elect Barack Obama declared that the commission had "dropped the ball."
But it's also becoming clear that the Madoff failures didn't arise out of nowhere. In recent years, particularly under Cox, a former California GOP congressman, the SEC has pursued a policy of de-emphasizing enforcement, part of the broader anti-regulatory philosophy of the Bush years -- helping to make Madoff, and perhaps others like him, possible.
"[Cox] in many ways worked to dismantle the SEC," Ed Nordlinger, a former longtime enforcement director in the commission's New York office, told TPMmuckraker. "He slowed everything down. I don't think he believed in heavy regulation."
That view has been echoed by several others in a position to know. Ross Albert told TPMmuckraker for a post published yesterday: "Under Cox, SEC had de-emphasized the enforcement program. Cox worshipped at the same altar of de-regulation that the rest of the Bush administration worshipped at."
And a former enforcement division supervisor told Portfolio for a lengthy October story about the SEC under Cox: "It was like someone poured molasses on the enforcement division."
How, specifically? Let us count the ways -- many of them detailed in that Portfolio story -- which focused on what it described as Cox's scaling back of the commission's enforcement role and was titled "SEC No Evil" -- as well as a followup web piece by the same writer, Scott Paltrow.
First, the SEC under Cox did not take steps to make sure that it had enough inspectors to look into the fast-growing number of financial institutions requiring regulation.
The enforcement division has actually lost staff under Cox, even as its workload increased. "Since Cox took office in 2005, the staff count in the division has dropped 9 percent, to 1,124 people this year," reports Portfolio.
Cox's predecessor, William Donaldson, a friend of the Bush family, told the magazine, carefully: "With the kind of problems we have now, any attempt to reduce the effective role of the S.E.C. as a policeman has been a mistake."
We're hoping to have more extensive numbers on this later today, but former SEC chair Arthur Levitt recently told Bloomberg that in 2004, the agency had 477 people in its inspection office, overseeing about 8,000 investment advisers, while today, 430 people regulate 11,300 advisers.
And a union rep for SEC workers told the Washington Post for a story published today that employees were "outgunned" and "underfunded."
Cox also, according to Portfolio, didn't replace the head of the S.E.C.'s new risk-assessment office -- created under Donaldson to improve the commission's ability to anticipate financial upheavals like the one we're in now -- for nearly two years.
But it's not just a human resources problem. According to the magazine, Cox instituted new rules which gave the commissioners, rather than the enforcement staffers, the power to negotiate fines against public companies in certain cases. The result has been a drop in penalties since the rule came into effect.
A January analysis by the law firm Morgan Lewis found that S.E.C. penalties have dropped by a "staggering degree" and that "the numbers suggest a philosophical shift by the Cox commission in what constitutes an appropriate penalty."
And Cox distanced himself from the enforcement division, according to Portfolio, rarely consulting with its director. His predecessors had conferred daily with their enforcement directors.
The commission also appears to have passed over for promotion staff members who were too aggressive in their approach to enforcement. Veteran S.E.C. lawyer James Coffman told Portfolio that he was told he didn't get a promotion because he was "too tough." He left the SEC soon after.
In addition, Cox failed to fix a communications problem within the commission, which made enforcement harder. Portfolio reports:
Madoff was required to tell one S.E.C. office how much money he managed as an investment adviser, but was required to report his actual trading positions to another office.
Katz [a former secretary to the commission] said if the two had been compared, investigators may well have discovered a big discrepancy that would have triggered a focused investigation.
Cox will step down when the Bush administration leaves office. Obama's pick for the job, Mary Schapiro, has a reputation as a dedicated regulator, and close SEC watchers expect her to move the commission back toward its enforcement mission -- a shift that appears to have been necessary long before Bernard Madoff became a household name.