Counter Economics

The SEC uses the concept of “change of course” in order to rationalize their internal corruption and their disinterest in policing the securities industry. Their aggressiveness is tempered by the fact that they come from, and go back into the industry for employment.

First its important to consider that there are only a few protections against corporate malfeasance in the United States. One is the SEC and the other is personal and class action lawsuits. It is because individuals have so few protections against corporate structures that the operating effectiveness of the SEC is of such critical importance. While the SEC does some good things like prosecute some securities fraud and make court documents available on their website, a sober analysis of their real effect on insider trading and corporate fraud is critical and the purpose of this article.

SEC in Action

The SEC’s ostensible purpose is to regulate the securities market. However in practice the SEC limits its investigations into insider trading conducted by either high profile individuals (such as Martha Stewart), or politically disconnected individuals like Greg Brady at i2 Technologies. John Mack, of Morgan Stanley is a “Ranger” in the lexicon of the Bush Administration, which means he has raised vast sums of money for the Bush campaign. This makes him untouchable. John Mack is certainly guilty of insider trading, however the SEC attorney who tried to pursue an investigation against him was fired from the SEC. Charges have not even been brought against John Mack. A person like John Mack is effectively immune from prosecution. Of course you won’t read about this on the SEC website.

Real Purpose of the SEC

Among the public, there seems to be some confusion as to the real purpose of the SEC. The SEC was started for public relations reasons. It was created in 1934 in order to improve confidence in the stock market after the 1929 crash. The actual wording regarding the purpose of its creation is interesting:

“Its goal is to increase public trust in the capital markets by requiring uniform disclosure of information about public securities offerings.” – Original phrase from US Government upon the creation of the SEC

“Increase the Public Trust”
Notice it states to “to increase the public trust.” It does not state “to improve justice and remove corruption from financial markets” Thus, from the beginning the SEC had a strong public relations (i.e. propaganda element). Secondly it has never been filled with impartial leadership. It was, and has been since it inception staffed by individuals drawn from the investment banking industry. Cronies is a good word for it. Old boy network might be another good term to think of when you think of the SEC. Because the SEC was created by concentrated power for a public relations purpose, and run by individuals drawn from the concentrated financial power areas of the US economy, it would be logical that it would be designed to meet its needs. The SEC’s actual objective is to control the enforcement of the supposed rules in the securities business. Contrary to popular notions, the SEC was not the first attempt at regulation in securities in the US. Prior to the SEC, the US had what was called Blue Sky Laws which were products of the state. This was one of the early attempts to regulate securities markets. However, investment banks soon found that they could bypass the Blue Sky Laws by offering securities through the mail or across state lines. These activities were encouraged by the Investment Bankers Association at the time. Presently, the SEC requires that public companies issue quarterly and annual reports. However, as with the Blue Sky Laws, the SEC’s quarterly and annual reports were gradually diluted with creative accounting and finding new ways to corrupt auditors. Because of these shenanigans the Sarbanes-Oxley Act of 2002 was made law. Sarbanes Oxley, while more focused on accounting changes can be seen as another attempt, along with the SEC, to provide public confidence over a stock system which is continually manipulated. Most these institutions are in fact useless. New rules are passed but conveniently miss the market on making real change. For instance at the large accounting firms instead of getting to the heart of the matter, which was corrupt partners selling their audits for consulting business, have medium level employees fill out their holdings of companies which the accounting company audits. Its a very pleasant smoke screen they offer to the regulators to prevent them from making any meaningful change.

Overall SEC Protection

Overall, the protection the SEC provides can be described as weak and mostly illusory. In addition to the double standard applied to politically connected individuals, there are several areas that could greatly improve the accuracy of stock information which have not been taken for obvious reasons. The fact that these corrupting elements are allowed means that the SEC can not possibly be considered a serious institution. These include:

1. The expensing of stock options so they show on the balance sheet. Currently they simply dilute existing shareholders (through the issuance of more shares) therefore these options appear “free” to the company that issues them. This practice misrepresents earnings. This is real compensation for high level employees and executives and should be expensed as a part of employee compensation.
2. The allowance of pro-forma earnings. When the SEC came into being the rules regarding earnings were more strict. Recently companies have moved away from issuing earnings which match what they need to report to the government, also called GAAP earnings and have moved towards pro-forma as a way to excite investors with fake numbers
3. The allowance of hedge funds to follow different reporting standard as mutual funds. Hedge funds are not only not responsible for sharing the same information as mutual funds, they also engage in tax evasion. Why a special classification of investment funds exists that is not responsible for reporting or paying taxes as other funds do has never been properly explained.

Conclusion

The fact that these simple items have not been vigorously promoted by the SEC indicates that they and Congress not particularly serious about reducing stock fraud. The SEC, as with an increasing number of regulatory bodies, is a fascia agency which consumes public money but does very little to protect against corruption and stock fraud. Given its leadership, the SEC would naturally want to keep the profits of investment banks and publicly traded companies high, at the expense of smaller investors and overall market stability. They have many friends and associates who work in these industries and are soon to join them again through the revolving door between the SEC and the investment banking industry.

Epilogue

No doubt many people will see the present action against Goldman Sacks as an example that the SEC is serious again. While the SEC will not be as corrupt as it was under Bush, it still has not proven it has teeth. I would encourage people to watch the actual output of the case against Goldman Sacks and take a wait an see attitude. Getting beat up here and there in congressional testimony and have an investigation against it is not the same as actually reigning the firm in. Currently Goldman Sacks receives free money from the government (0% interest) loans, which it invests in T-Bills and makes 3% interest. It would seem if the government were at all serious about reducing Goldman Sack’s power, they would stop this practice. In fact, Goldman Sacks is so out of contol, drunk with power and a continually operating illegal enterprise that they should simply be shut down. When SEC shuts down Goldman Sacks then the SEC is serious.

Reference

http://www.guardian.co.uk/commentisfree/cifamerica/2010/apr/19/goldman-sachs-civil-suit-feds