Finance & economics | The Securities and Exchange Commission

Pots and kettles

Misleading numbers and a confused mission, the hallmarks of troubled financial firms, dog one of their regulators too

|New York

TWO of the five seats on the Securities and Exchange Commission (SEC), the main Wall Street regulator, are about to be filled. The process is a partisan one, with Barack Obama, a Democrat, picking one new commissioner and the Republican leadership of the Senate the other. That, naturally, is a recipe for discord at an already bruised agency. Its clout has diminished thanks to its poor oversight of investment banks before the financial crisis, to say nothing of its failure to spot the Ponzi scheme of one Bernard Madoff. Now new research suggests that the SEC is doing less well at its main job—policing firms that list shares or issue bonds, among other investments—than its own data suggest.

Start with the new commissioners. Even as the SEC’s standing among regulators has diminished, the Dodd-Frank act of 2010, which overhauled financial regulation in America, has added to its responsibilities, from gathering better data on corporate pay to supervising credit-rating agencies. The two new arrivals are likely to undermine, or at least complicate, much of this additional work. That is because the two nominees, who have yet to be approved by the Senate, have diametrically opposed views on financial regulation.

Mr Obama has nominated Lisa Fairfax, a professor of law at George Washington University and an advocate of shareholder activism. In 2011 she published a paper on the gender and ethnicity of corporate boards, which argued that calls for greater diversity on business grounds had been unsuccessful, so “social and moral justifications” should be used instead. That is important because Dodd-Frank requires the SEC to create an Office of Minority and Women Inclusion which “shall develop standards for…assessing the diversity policies and practices of entities regulated by the agency”.

Senate Republicans, meanwhile, have put forward Hester Peirce, a former Senate staffer who is now a research fellow at the Mercatus Centre, a free-market think-tank. She co-edited a book, “Dodd-Frank, What It Does and Why It’s Flawed”, which asserts that “the underlying assumption that regulators can effectively micromanage the market is flawed. Giving regulators more levers to pull and buttons to push with respect to the financial system only creates a false sense of security.”

The confusion at the SEC is not just philosophical, however. It also appears to be manipulating its own statistics—the sort of conduct it is supposed to be weeding out at the firms it regulates. Every October, the SEC tots up its legal accomplishments for the year and releases the data to the public, usually with a press release suggesting it is becoming ever tougher on corporate crooks. Yet research by Urska Velikonja, a professor at Emory University, calls these numbers into question.

Ms Velikonja examined 9,679 “enforcement actions” taken by the SEC between 2000 and 2014. She calculates that the SEC inflates the number of actions it brings each year by 23-34% by double-counting and other forms of padding. That means that the number of substantive cases has not risen steadily in recent years, but stagnated (see chart). “The SEC has used invalid and unreliable statistics in congressional reports and testimony, press releases, and public speeches,” Ms Velikonja argues, in an effort “to suggest an increase in activity, to calm wary investors and the general public after scandals and to suggest a better use of resources.”

Ms Velikonja cites the example of a person sued several times for the same offense, initially for fraud, then to be barred as an attorney, then barred from the securities industry and then again from appearing before the SEC as an attorney. Such duplicative actions have become more common in recent years. So have redundant ones, such as moves to ban convicted financial criminals from associating with brokers, investment advisers and the like, even though they are already in jail.

There has also been a surge in the number of cases involving relatively minor offences, such as late filings. Sometimes these can be indicators of more serious wrongdoing; often they stem from simple clerical errors. The SEC has likened its pursuit of such cases to “broken windows” policing, arguing that by clamping down on small violations, it deters bigger ones. But there is no evidence that preventing securities fraud bears much resemblance to fighting street crime.

The SEC also likes to tout its ever-rising tally of “monetary penalties ordered”. But this, too, is misleading, since it includes fines that other agencies are also claiming, as well as many that are subsequently waived. In practice, the SEC only collects about half the sum it advertises, Ms Velikonja says.

The SEC readily admits that many of its cases are follow-ons or actions against late filings—something it made explicit in its annual report this year. It says it is focusing on quality rather than quantity. But analysing its data is difficult, because there is no single public record of all its enforcement actions. Instead, researchers must piece them together one by one—a huge task. Ironically, this could be fixed with the sort of remedies the SEC often prescribes to the firms it oversees, including better disclosure and greater consistency in reporting.

The urge to fudge things is understandable. The SEC must constantly justify its existence to a sceptical Congress, and, like many government agencies, is under pressure to defend its budget. It does not help that the Federal Reserve has become the main regulator of investment banks, or that Dodd-Frank has created a new outfit, the Financial Stability Oversight Council, to take charge of overall regulatory strategy. But there is no excuse for the agency charged with stamping out corporate misbehaviour to fiddle its own figures.

This article appeared in the Finance & economics section of the print edition under the headline "Pots and kettles"

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