How the SEC's Hypocrisy Is Decimating Your Nest Egg

In iconic testimony last September before the Senate Banking, Housing and Urban Affairs Committee, fraud expert Harry Markopolos stated: "If the entire SEC staff were seated in Fenway Park for the afternoon and couldn't find first base, then I'm not too sure that banking regulators could even find Boston, much less Fenway Park."

Has anything changed since then? The SEC would like you to think so. It just announced the settlement of a claim against the Quadrangle Group LLC and Quadrangle GP Investor II. The allegations involve a $100 million investment Quadrangle secured from the New York State Common Retirement Fund. I'll spare you the sordid details, but the SEC summarized its allegations as follows: "This pay-to-play scheme resulted in the retirement fund's assets being invested with Quadrangle for the hidden purpose of enriching a political operative and the Deputy Comptroller's brother."

Quadrangle agreed to settle these allegations by paying a $5 million penalty, "without admitting or denying the allegations."

So where's the hypocrisy?

The Quadrangle Group describes itself as "a global private investment firm with more than $3 billion in assets under management." If it engaged in this activity, the penalty should be more than the rounding error on its monthly petty cash report. The SEC also should have refused to enter into a settlement in which Quadrangle protected itself from civil liability by failing to admit to the allegations of the complaint. After all, the real victims of this alleged conduct, according to Robert Khuzami, director of the SEC's Division of Enforcement, were "New York State's hard-working retirees, who were entitled to have honest advisers manage their hard-earned dollars."

Why did the SEC enter into an agreement that will shift the burden to these "hard-working retirees" who want to recover their losses? If Quadrangle was innocent of the alleged bad conduct, it could have elected to fight the charges. If it was guilty, it should have been required admit its guilt in the settlement. Then the individuals harmed by the scheme could use that admission to collect any damages they could prove.

While the SEC expends its resources pursing minor claims and making sweetheart deals with well-represented investment advisers, Rome is burning and investors are getting clobbered by the really big scam: 401(k) plans.

The Best Mutual Fund Choices Are the Ones Plans Don't Include

Over $3 trillion is invested in these plans, generating over $85 billion in fees and costs for advisers and administrators. The system is infected with exactly the same conduct the SEC alleged in the Quadrangle complaint, where it claimed that Quadrangle and others engaged in a "pay to play" scheme.

The 401(k) business is a giant "pay to play" scheme. In that world, they call the scam "revenue sharing" -- a nice euphemism. Most 401(k) providers require mutual funds to pay them to be included among their plans' options. Typically, these payments are not disclosed. If funds don't pay, they don't get to play. Most low-cost index funds (such as those offered by Vanguard) won't make these payments, so they are not included as investment options in employer plans.

The damage suffered by the hard-working employees is the same as that allegedly suffered by the victims of Quadrangle's conduct: They're not getting access to objective advice. Moreover, if they received this honest advice, and the fair means to implement it, most people's 401(k) plans would consist primarily of low-cost index funds or pre-allocated portfolios of these funds. The costs incurred by employees because aren't being given these options are staggering.

Even outside the 401(k) context, "pay to play" is the daily mantra of brokers who sell mutual funds. As one industry insider
noted: "Brokers get paid to sell certain funds. Those funds are not chosen based on how good they are, but rather on which fund companies give kickbacks to the brokers selling them."

Clients of these brokers are rarely told about these kickbacks.

The hypocrisy of the SEC in turning a blind eye to these "pay to play" practices, while making a big deal out of its pathetic $5 million settlement with Quadrangle is mind-boggling.

I am not sure I agree with Markopolos that these regulators can't find Boston. I am convinced they could find it if they chose to, but that they don't have the stomach or the political will to place the interests of investors above those of the companies they regulate.