The SEC, Efficiency and Investor Protection

The Government Accountability Office (GAO) will issue a report today critical of the SEC. The report focuses on the relationship SEC and Self Regulatory Organizations (SROs) which police the markets and frequently conduct the initial portion of inquiries insider trading cases. Specifically, the GAO report notes that the SEC fails to review SRO internal audit reports and that the agency lacks the computer capability to efficiently analyze data provided by the SROs from their insider trading and other inquiries, according to an article in the New York Times by Gretchen Morgenson. “Quick, Call Tech Support for the SEC,” New York Times, December 16, 2007, Sunday Business at 1. The GAO report, entitled “Opportunities Exist to Improve Oversight of Self-Regulatory Organizations,” was prepared at the request of Senator Charles E. Grassley following Pequot Capital Management debacle and hearings discussed here. While the report raises questions about efficiency, Ms. Morgenson’s article ends by noting that if the inefficiencies are not remedied it is “one more data point for those who increasingly wonder whose side the SEC is on.”

It is not surprising that a GAO study (or any study) would find that the SEC is inefficient. That does not mean, however, that the agency is not doing a good job which is the usual implication of such a finding. Likewise, that finding says nothing about “whose side” the agency is on, as suggested by the Times article.

The SEC is a relatively small regulatory agency. Nevertheless, it has long enjoyed a reputation for excellence and efficiency. This well-deserved reputation does not come from superior systems, model internal procedures or other similar advantages that many Wall Street players may enjoy. Nor does it come from having armies of highly paid lawyers, paralegals and expert consultants like most of the law firms which defend the investigations and enforcement actions brought by the SEC and conducted by its enforcement division.

As Ms. Morgenson acknowledges at the beginning of her article, the SEC has long been overwhelmed by the number of professionals and the amount of talent and money those which it regulates, investigates and litigates against can throw at any matter. That fact has been true since the days of its first Chairman, Joseph Kennedy, and will continue to be true long after Chairman Cox is a distant memory.

The SEC’s well-deserved reputation for excellence and efficiency has come from the dedication of its people. The small band of dedicated professionals who work at the agency are charged with overcoming the well-known inefficiency of its internal procedures, outdated computer systems and lack of resources. And they do. Time after time the Commissioners and staff rise above these limitations and produce excellent results. This is a reason the U.S. capital markets are the envy of the world.

This is not to say that the agency does not make mistakes, have its short coming, or need improvement. It does. Posts in this blog have repeatedly pointed out shortcoming of the SEC and its enforcement program. There is no doubt the SEC needs better equipment, more staff, and that it needs to be more efficient, bringing cases which are based on solid evidence more quickly.

The GAO report is thus clearly correct in suggesting that computer and other systems at the SEC need improvement. That might start by returning to the agency a fraction of the huge fees it pays to the pays to the U.S. Treasury each year. A return of even part of those fees can enable the SEC to upgrade its systems and make them more efficient.

At the same time, any suggestion that system inadequacy or the lack of a quick fix of its inefficiencies reflects a lack of dedication to investor protection is simply wrong. Over the past year there has been endless speculation over whether the agency is properly protecting investors stemming from the botched Pequot Capital investigation to its positions in Tellabs and Stoneridge. The botched Pequot inquiry is not only hard to understand, but inexcusable. The flurry of discussion about the two Supreme Court cases is keyed to the debate about the propriety and usefulness of private securities class actions and their contribution to policing the markets, not the efforts of the SEC.

The focus of the GAO report is SEC efficiency in policing the markets. While the SEC may be inefficient and lack resources, there should be little doubt that it is aggressively policing the markets. This past year, as has repeatedly been discussed here, the SEC has been very aggressive in bringing insider trading cases. There is every indication that the agency intends to continue its aggressive war on insider trading. Giving the SEC more money and more resources can only help it win that fight.