SEC returns to its enforcement role
Trying to rebuild its reputation as the top securities cop, the SEC is pushing vigorously into areas it avoided under former chief Christopher Cox. On Tuesday it filed its first insider-trading case involving derivatives and The Wall Street Journal reports this morning that the agency is pursuing 150 cases that involve hedge funds.
Many of the cases involve credit-default swaps (CDSs), but other issues being investigated include how hedge funds value securities, fund managers' conflicts of interest, due-diligence failures, market manipulation and insider trading in all types of financial instruments.
Bruce Karpati, who heads the SEC's Hedge Fund Working Group, told the Journal, "We need to be policing even the most complex markets to ensure that all investors, regardless of their supposed sophistication, have a fair shake." That's exactly opposite what Cox told Congress in 2006 when he said "neither the SEC nor any regulator has authority of the CDS market."
The SEC now asserts it can police these markets, but there is some concern that Cox's earlier statements might make it difficult to pursue these cases in court.
Trading CDSs had a lot to do with AIG's downfall. It was AIG's losses from derivatives trading led to the $150 billion bailout. I wonder how much of this new investigative zeal relates to possible future payouts on derivative losses? Since AIG insured derivatives trading, if the government can prove fraud was involved, AIG won't have to make the payouts.
The new zeal does show that Mary Schapiro, SEC chairman, plans to make good on her promises to revamp the SEC and restore its clout. Some of her first acts were to remove barriers to enforcement and these cases show how quickly she wants to turn things around after the Madoff debacle.
Former SEC chairman Christopher Cox instituted policies that slowed cases and gave the indication that commissioners opposed fining companies. The GAO found that it was "widely felt" commissioners prevented the enforcement division from "doing its job." The report found that "some investigative attorneys came to see the commission as less of an ally in bringing enforcement actions and more of a barrier."
In August 2005 when Cox took over the chairmanship of the SEC, he clearly sent out messages that fines should be used sparingly. Democratic commissioners believed fines helped to deter misconduct, but Republican commissioners said that shareholders ultimately paid SEC fines, so they were opposed to them. Cox agreed with the Republican view.
In 2006, the SEC issued guidelines stipulating the agency would consider how much an alleged fraud benefited the company and the impact on shareholders before imposing a fine. In 2007, Cox required enforcement attorneys to seek approval from commissioners before negotiating corporate penalties. Schapiro is removing the barriers put in place by Cox.
Clearly this new, more aggressive SEC will benefit investors no matter what level of sophistication. I'm sure the Madoff investors would have preferred this new, more aggressive stance from the SEC.
Lita Epstein has written more than 25 books, including Trading for Dummies and Reading Financial Reports for Dummies.