S.E.C. Chairmen, 2001-08

Here’s an excerpt from Bailout Nation, about a subject under much discussion today: The incompetence of the S.E.C.

Part IV: Market Failure
Chapter 14. Casting Blame

Over the course of two terms, Bush appointed three SEC Chairmen, each ill-suited for the position. It was a veritable parade of poor choices for the role of regulating stock markets. His first appointment, Harvey Pitt, was a securities industry defense attorney and was wholly unsuited to the position. Instead of representing the interests of investors, Pitt was an industry lapdog. Pitt pledged a “kinder and gentler” SEC just when the opposite was needed in the midst of a huge run of corporate misfeasance.

In an era of corporate accounting scandals, Pitt had close ties to the accounting industry. And for inexplicable reasons, Pitt met with the heads of companies under active SEC investigation. As a Wall Street lawyer, Pitt had “recommended that clients destroy sensitive documents before they could be used against them – advice that seemed to find echoes in the SEC’s investigations into Enron and its shredder-happy auditor, Arthur Andersen.” Pitt had to recuse himself from many of the SEC’s votes — they were frequently about the clients he had represented as a defense attorney. By July of 2002, Senator (and future GOP presidential candidate) John McCain was calling for Pitt’s resignation.

Pitt, not surprisingly, demoralized the agency. To investor advocacy groups, having Pitt as SEC chief was like putting Osama bin Laden in charge of Homeland Security.

The next SEC Chairman Bush appointed was William Donaldson. He is the one who allowed the net-cap rule to be exempted for the five biggest banks in 2004. Instead of 12 to 1 leverage, banks levered up 30 and even 40 to 1 after the waiver. It isn’t glib to say the financial meltdown was three times as bad as it might have been for Donaldson’s SEC agreeing to this waiver. It would be charitable to call his chairmanship undistinguished.

Then there is Christopher Cox, a stumblebum of an SEC Chair. Cox was more hapless than anything, unable to successfully navigate the fierce lobbying thrown up by Wall Street.

In July 2007, Cox eliminated the so-called uptick rule, removing a key restraint on shorting just as the credit crunch was getting started. (Not very smart). The market peaked shortly afterwards, and began heading south — with no uptick rule to prevent indiscriminate short selling. Then in September 2008, with the crisis in full flower, the clueless dolt made shorting financial stocks illegal. Apparently, he was unaware that fierce market selloffs are often slowed by short sellers covering their positions (to lock in profits on their bearish bets). Without any short-sellers in the market, the downturn became even worse. From the market highs of October 2007, the S&P 500 and the Dow Jones Industrial Average were cut in half in 12 months. Much of the damage came after the no-shorting rule went into effect. (As GOP Presidential candidate in 2008, Sen. Johh McCain called for Cox’s resignation.)

As this book went to press, an extraordinary scandal was erupting that should give the SEC another black eye: Madoff Investments had made off with as much as $50 billion in investor assets. Madoff himself called his 40-year operation a “giant ponzi scheme.” Madoff was infamous for consistently reporting 1% to 2% monthly returns – rarely having a down month, much less a down quarter.

Numerous people, including hedge fund manager Doug Kass, had warned years before that the ability to provide such unusually smooth returns with so little volatility was more likely the result of fraud than investing acumen.  Other red flags as to the firm’s stated returns had been previously identified, including in a letter to the SEC in 1999. There was no investigation. The fraud was only discovered only after Madoff spontaneously confessed (an act which makes me wonder what the full story really is).

Indeed, there is little evidence that even as late as 2008, the SEC is using any of the quantitative methods for searching out and indentifying fraud now so common on Wall Street.

Harvey Pitt: Accounts angel who supped with the devil
Jason Niss
UK Independent, Sunday, 11 August 2002

The Free Market Needs New Rules
NYT, July 8, 2002

The SEC goes AWOL
Arianna Huffington
Salon, May. 14, 2002

Madoff Was Made Up
Doug Kass:
The Street.com, 12/12/08 – 09:27 AM EST

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