Wrist Slaps All Around at the SEC

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On Friday, we learned that the SEC had disciplined eight employees who were responsible for bungling the Madoff case. Punishments included pay cuts, suspensions, and "counseling memos." No one was fired.

Did the SEC mete out fair punishments in this case? Or did it once again miss an opportunity to tell Wall Street that it's not messing around any longer? Before answering those questions, let's briefly revisit the report on the Madoff case issued by the SEC's inspector general back in 2009.

Oh, no; they have my account number
The main takeaway from the Office of Inspector General's report was very clear. The SEC blew it big time when it came to investigating Bernie Madoff's Ponzi scheme. The report found that "the SEC never properly examined or investigated Madoff's trading" and never took the necessary steps "to determine if Madoff was operating a Ponzi scheme." If the SEC had taken the appropriate steps anytime between June 1992 and December 2008, it "could have uncovered the Ponzi scheme well before Madoff confessed." The bottom line, it seems to me, is that SEC incompetence cost investors billions of dollars, while also undermining trust in our already shaky financial system.

According to the report, the SEC received six substantive complaints that should have raised red flags during the period from June 1992 to December 2008, when Madoff finally confessed. The details of the three examinations and two investigations by the SEC make for pretty depressing reading. In the first examination, the SEC team wrote a letter to obtain trading data but decided not to send it. They felt it would be "too time-consuming" to review the data once they received it.

The most outrageous blunder of all, however, related to Madoff's trading account. At one point, he actually gave his account number to investigators, and just knew that "it was the end game, over." When Madoff learned that the SEC never actually looked at the account, he was "astonished."

The dreaded "counseling memo"
So what happened to the SEC employees who failed so miserably in this case? One person was given a 5.7% pay cut. One was suspended for seven days, while another was suspended for three days. Two others received "counseling memos." I hope there's at least a sentence in those memos that reads, "Next time, look at the freaking trading account!"

The appearance of going easy on its employees, who were clearly incompetent in their handling of the Madoff case, comes at a bad time for the SEC. Just last week, TheNew York Times reported that over the past 15 years, there were "at least 51 cases in which 19 Wall Street firms had broken anti-fraud laws they had agreed to never breach." Among that group of Wall Street firms were American International Group (NYS: AIG) , Bank of America (NYS: BAC) , and Morgan Stanley (NYS: MS) .

To be fair, the SEC has been more active in pursuing financial-crisis-related cases over the past two and a half years. Among the more prominent enforcement actions have been against Goldman Sachs (NYS: GS) and Citigroup (NYS: C) , as well as against "senior executives from Countrywide Financial, New Century and American Home Mortgage."

What would Jamie do?
So should the SEC have been tougher on its employees in the Madoff case? First of all, we don't have all of the facts -- the SEC hasn't released all of the relevant information in its decision making -- so we need to tread carefully. That having been said, could you imagine if these bunglers were brought before Jamie Dimon, CEO of JPMorgan (NYS: JPM) , and asked to explain how they screwed up so royally? Would any of them be receiving "counseling memos" after such an encounter?

And there lies the problem, in my opinion. Wall Street approaches the business of making money with a ruthlessness and single-mindedness that needs to be respected, though not admired. If the SEC has any chance of effectively overseeing such opportunistic institutions, then it needs to toughen up, fast.

Machiavelli once said that it is better to be feared than loved, since "fear preserves you by a dread of punishment which never fails." Maybe we don't need the same sort of cold-bloodedness that was required back in Renaissance Italy, but I definitely think a more unyielding SEC could make a big difference.

If you'd like to stay updated on Wall Street and financial reform, shoot a blank email toimoscovitz@fool.com.

At the time this article was published John Reeves doesn't own shares in any company mentioned. The Motley Fool owns shares of Bank of America, JPMorgan Chase, and Citigroup. Motley Fool newsletter services have recommended buying shares of Goldman Sachs. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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