Cole Porter, The SEC And Insider Trading
“And that’s why birds do it, bees do it,
Even educated fleas do it,
Let’s do it, let’s …”
“Let’s Do It” by Cole Porter
We might say (with apologies to Mr. Porter): “Wall Street bankers do it, big time brokers do it, even white shoe lawyers do it, let’s do it … .” Let’s – insider trade? At least that is what the FBI and federal prosecutors are considering – did two SEC enforcement attorneys insider trade, thus meaning that those who usually prosecute this type of securities fraud might become the prosecuted?
While Chairman Mary Schapiro is working hard to establish a new tone at the top and move the agency forward, it continues to be dogged by scandal. The latest — a report by the SEC’s very busy inspector general, David Kotz, stating that stock trading over a two year period by two SEC enforcement attorneys raised questions of suspicious insider trading. The report details other possible staff abuses. The implications of the trading by the enforcement attorneys has been turned over to the Fraud and Public Corruption Section of the U.S. Attorney’s office in Washington.
To be sure, this is only an investigation. Final conclusions should not be made until the inquiry is finished. In any organization, people do things that are foolish and sometimes violate the rules. Wall Street bankers, brokers and law firms have all suffered the embarrassment of having one their employees named as a defendant in a SEC or DOJ insider trading action. If the SEC turns out to have employees who violated the rules, it will, as the revision to Mr. Porter’s song suggests, be following a well traveled road.
What is more troubling however, is the report by Mr. Kotz, and released in redacted form by Senator Charles Grassley, which states that the SEC “has essentially no compliance system in place to ensure that … employees, with the tremendous amount of nonpublic information they have at their disposal, do not engage in insider trading themselves.” According to a report at MSNBC.com, there is no internal system regarding SEC employee trading other than a self-reporting honor system.
Yet, the SEC is the enforcer of internal controls and an advocate for compliance programs. If a broker dealer failed to have compliance programs, the SEC would bring an enforcement action against it. If a public company had inadequate internal controls, the Commission would bring an enforcement action against it. The SEC cannot engage in “do as I say not as I do” enforcement. It cannot be an effective enforcer of these requirements, while failing to adhere to such standards. Nor can the Commission claim it is working on the problem. The agency would not accept that answer from others — it cannot offer it.
This is not the first time the Commission has been cited for failed internal procedures, however. In the on-going and seemingly never-ending Pequot Capital debacle, a Senate report was highly critical of the agency’s performance, citing its lack of procedures as discussed here. A report by the SEC’s inspector general cited lax internal procedures in the Division of Corporation Finance in the demise of Bear Stearns as discussed here. Mr. Kotz is currently probing enforcement procedures in the Madoff debacle, trying to determine how the division detoured off the road map it was handed to the largest Ponzi scheme in history.
If Ms. Schapiro is going to bring a new tone to the top of the SEC and restore its lost luster, she must start inside the agency. Announcing one new senior staff appointment after another is a beginning. Announcing new procedures to streamline enforcement is a step forward. Announcing a series of rule making initiatives to protect investors is constructive. None of this will restore confidence in the SEC however, if the agency continues to fumble and blunder from one scandal after another.
Swift, decisive and effective action is critical. It is essential that the new Chairman ensure that the agency has what it requires of every public company – effective internal procedures and controls. Only when those procedures are in place and effectively implemented can the Commission move forward with its critical mission. At a time when there are proposals to redraw the entire regulatory landscape, what may be at stake here is the survival of the SEC as an independent agency.