The Securities and Exchange Commission should overhaul management and take advantage of the hungry, experienced lawyers it employs, so that when the next Bernard Madoff is staring in its face, it will catch him.
That's the assessment of lawyers who once held top positions at the SEC, whose own inspector general blasted it this week for bungling repeated chances to snare the now imprisoned mastermind of a $65 billion Ponzi scheme.
What needs to change is the message from the top, said Michael MacPhail, a former SEC branch chief who is now a partner at Holme Roberts & Owen LLP in Denver.
There are very skilled examiners, but the agency has traditionally cared more about its statistics than high-quality examinations, leading to a check-the-box mentality, he said. They need to show they want to find problems.
Inspector General David Kotz's report sets forth a battery of missed opportunities to catch Madoff, in part because inexperienced staff lacked the drive to follow up on leads.
Madoff would admit to being astonished that the SEC did not rein him in after a 2006 interview in which he provided account information that, if reviewed, could have unearthed his fraud.
The key is, are they properly trained to find the bigger things? said former SEC Commissioner Harvey Goldschmid, now a professor at Columbia Law School.
ENDING THE ATROPHY
SEC Chairman Mary Schapiro wants to invigorate enforcement after some agency critics said it atrophied under her predecessor, Christopher Cox. Emails to Cox seeking comment were not returned.
Schapiro is making it easier for staff to issue subpoenas, negotiate penalties and hold investment advisers more accountable for their customers' funds.
Some lawmakers in Congress, meanwhile, are trying to find new ways to funnel money to the agency to aid enforcement.
Money alone may not fix the SEC's failings. Goldschmid and former Chairman Harvey Pitt have called for an overhaul of the agency's compliance, inspections and examinations office.
The place needs to be run less like a bureaucracy and more like a business, said Barry Barbash, a former SEC director of investment management and now a partner at Willkie Farr & Gallagher LLP in Washington.
In 2004 and 2005, the SEC's compliance office conducted two examinations of Madoff, but made no real effort to analyze red flags indicating that his trading activity and reported steady returns for his clients were a fiction, Kotz wrote.
He described how SEC examiners never sent a letter to an outside regulator seeking trade data, figuring it would be too time-consuming to review the information they obtained.
The image that comes through is not that of professional personnel seeking to advance and protect the public interest, but bureaucrats content to punch the clock at 5 p.m, said James Cox, a law professor at Duke University.
Even when whistleblower Harry Markopolos in 2000 and 2001 presented information that led him to conclude Madoff's operation was nothing more than a Ponzi scheme, the SEC ignored him. Kotz said he could find no explanation why.
It is the stunningly bad judgment exercised by numerous people that makes the report such a depressing read, said Mercer Bullard, a former SEC assistant chief counsel in investment management and now a University of Mississippi law professor. What was most damning was the internal working of the inspection process, and ignoring blatant red flags.
Part of the problem is the many rules that examiners must follow, which can distract them from the substantive wrongdoing they might uncover, experts say.
There is a distinct possibility of an exam becoming a checklist, Barbash said. Trying to find the fraud of the century is not something on the checklist.
MANY RESPONSIBILITIES, FEW STAFF
SEC enforcement chief Robert Khuzami plans to create new practice groups focused on such areas as asset management, foreign crimes, market abuse, municipal and public pension securities, and structured products.
He also plans an improved intake office that ensures the next Harry Markopolos will not get the brush-off.
They should be sure more senior people review complaints coming from the outside public and have the subject-matter expertise, said former SEC branch chief Christopher Cooke, now a partner at Cooke Kobrick & Wu LLP in San Mateo, California.
Getting that expertise may not always be easy.
Schapiro wants new hires to have market experience in derivatives, forensic accounting, risk management, securities trading, structured products and valuation.
Yet as a government employer, the SEC cannot offer the high six- and seven-figure pay packages that many lawyers can get in private practice.
They need to go to more job fairs, former SEC branch chief MacPhail said. Advertising positions on a website is not going to do it.
The SEC is also understaffed. With around 3,650 employees, it must police Wall Street and supervise corporate America, stock exchanges, more than 10,000 investment advisory firms, some 5,000 broker-dealers and thousands of mutual funds.
It will also soon gain oversight of hedge funds and the $450 trillion private derivatives market.
By contrast, the Federal Deposit Insurance Corp, which supervises banks, has a staff of about 6,100.
While SEC alumni welcome reform, mistakes will happen, and some wrongdoing is sure to slip through the agency's grasp.
I suspect the SEC will do a good job to detect the next big Ponzi scheme, Cooke said. The problem is, you can't predict what other types of frauds will surface.