Corporate Governance

The SEC, Inspections, and Bernard Madoff: The Chairman Speaks

By J. Robert Brown

As we have noted, the SEC is taking considerable heat for the failure at having picked up the massive fraud by Bernard Madoff despite a number of investigations and inspections.  The Chairman has spoken on the matter, calling for an investigation by the Inspector General of the SEC.  As he stated yesterday:

• In response, after consultation with the Commission, I have directed a full and immediate review of the past allegations regarding Mr. Madoff and his firm and the reasons they were not found credible, to be led by the SEC's Inspector General. The review will also cover the internal policies at the SEC governing when allegations such as those in this case should be raised to the Commission level, whether those policies were followed, and whether improvements to those policies are necessary. The investigation should also include all staff contact and relationships with the Madoff family and firm, and their impact, if any, on decisions by staff regarding the firm.

This is a highly disappointing response.  First, the implication is that the Commission will look into whether the Madoff problem was a result of wrongdoing.  Why else charge the Inspector General with the task of looking into the matter?  As we have noted, however, the main problem is structural.   The main office responsible for overseeing these inspections (the Office of Compliance Inspections and Examinations) is not structurally set up to catch these types of frauds. 

Other than noting that the Inspector General will also look into "improvements" to existing policies, the Chairman's approach ignores these structural issues.  Of course, were structural issues to be the focus, there would be questions about why the Commission didn't act sooner.  As a result, this approach is designed to deflect blame. 

Second, by unleashing the Inspector General, Chairman Cox has all but made certain that any recommendations will be issued after he has gone from his present position.  In other words, the act creates the appearance of action but in reality is a mechanism for avoiding any hard decisions in the present. 

Third, this is not  much different than the GM board becoming more active only after the debacle in Washington when the CEO asked for a bailout without a plan and flew back in a private jet.  We asked on this Blog about the whereabouts of the board before the debacle since nothing about the trip to Washington changed the troubled financial circumstances of the company.

We ask the same question about Chairman Cox.  Is there a need for structural reform within the Commission?  The evidence suggests that there is.  The inspection process failed terribly in connection with the supervision of investment banking firms.  The Division of Enforcement has taken some black eyes, with the report by the Inspector General on the Bear Stearns investigation demonstrating weaknesses in the investigatory approach.  While the Madoff affair certainly highlights weaknesses in the investigatory process, it is not really news.  We can therefore ask why these problems weren't pushed to the front and center earlier.

Full post as published by The Race to the Bottom on December 17, 2008 (boomark / email).