Why the SEC Has Failed
Where are the customers' advocates?
Traders Magazine Online News, December 18, 2008
The Declaration of Independence, believed to be mainly the work of Thomas Jefferson, states that governments "derive their just powers from the consent of the governed." Strange as it seems, the political reality expressed by this famous document also explains why the SEC and other administrative agencies have failed in their mission.
Administrative agencies generally are created to protect the public from the harm that may be inflicted by some industry. The Interstate Commerce Commission was perhaps the first federal administrative agency. It was created in 1887 because of the harm inflicted on the US economy by railroads engaged in predatory pricing. A series of bank panics in 1873, 1893 and 1907, and resulting national recessions, led to the formation of The Federal Reserve Bank in 1913. Congress instituted the Securities and Exchange Commission in 1934. At that time, the voting public and Congress strongly believed that the fraudulent antics of the securities industry were the primary cause of the Great Depression, an enormous social calamity and economic disaster.
We are in the throes of a major banking panic. The country's largest banks are on taxpayer life support. Hundreds of smaller banks are zombies, hanging on only because the FDIC has not yet determined to put them out of their misery.
The Madoff firm, now undergoing SIPC liquidation, was a broker-dealer, an institution that is the most heavily regulated of any business entity overseen by the SEC. Nonetheless, a commonplace Ponzi scheme running into the tens of billions managed to escape the highly touted regulatory oversight of the SEC and its handmaiden, FINRA. The misallocation of resources resulting from this regulatory failure alone, if invested in General Motors, would probably have staved off its imminent collapse. Coming on the heels of a failed investment banking industry, also regulated by the SEC, the Madoff fraud is truly shocking.
The administrative agencies created to protect the public from banking panics and frauds in the securities industry have failed in their missions. Only blind optimism can sustain the hope that this country can escape a major recession accompanied by widespread unemployment and untold social calamity. Anger will replace fear and as night follows day, the voting public will demand change. We live in a democracy, and Congress will respond to the will of the people. Therefore, I think it is entirely likely that existing regulatory agencies will be scrapped and new ones created to fill the void.
Since those who cannot learn from history are doomed to repeat it, it is worth considering how we found ourselves in this sorry state of affairs.
While administrative agencies are created to protect the public, they regulate someone else - persons working in industries that in some way threaten the public welfare. In other words, the regulated are a different crowd than the beneficiaries of regulation.
Nonetheless, Jefferson's words are still true: Regulators regulate by consent of the regulated. As a practical matter, regulators are unable to do their job effectively without good information about the industries they regulate. That information is, in turn, known only by the regulated. The cooperation of the regulated is therefore essential for the regulator to do its job.
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