New SEC Scandal: Can we solve this mess?

February 10, 2011

Wall Street's regulators have a penchant for giving speeches, which often raises the question as to why there isn't enough pressing work to keep them busy back at the office.  Nonetheless, these public pronouncements provide us with an insight into the thought processes and motives of those who are tinkering with the financial markets.   

No Solutions

Recently, Securities and Exchange Commission ("SEC") Commissioner Elisse Walter appeared at the "SEC Speaks in 2011" seminar and, among other comments, stated:  

So, now that I've waxed a bit philosophical about kvetching and box checking, what about the essence of regulation itself?  

A wise securities regulator and my dear friend, David Becker, once said:  

[W]e need to remember that there are no solutions, only improvements. We are, after all, dealing with shaping human conduct. Until they come out with a better model of human, we will be stuck with doing better, not doing perfectly.  

Let me be quite clear: I disagree with former, current, and soon-to-be former SEC General Counsel and Senior Policy Director Becker's quote. Also, I disagree with Commissioner Walter's exaltation of it. Many will read the Commissioner's quote and not find much to be troubled by - yet another musing at yet another seminar on the rubber chicken circuit. If only the comment were that innocuous.  

Commissioner Walter is an accomplished Wall Street professional with an admirable resume and an impressive record of accomplishment.  By no means do I intend to diminish either the sincerity of her service as a career regulator or question her integrity.  I see no reason for such personal attacks.  However, her publicly expressed philosophy of regulation is fair game.  

Taken at her word, Commissioner Walter does not believe that the SEC can provide solutions - only some amorphous substitute that she characterizes as "improvement."  During the last presidential election, we were confronted with a similar lexicon that trumpeted "change" in lieu of the more meaningful term "reform."  In fact, we got a change of administration, a change of majority party, a change among the appointed heads of government agencies but very, very little (if any) meaningful reform.  Clearly, voters should have paid more attention to what was promised.  

Bureaucrats see government as a self-perpetuating institution to further endless (often mindless) change that masquerades as improvement.  In reality, modern government in the United States seems incapable of reforming anything - it routinely fails to provide solutions.  The public is asked to accept one quick-fix after another.  To that end, our government is little more than a gas that expands to fill any space.  

Making Do And Getting It Done

To accept the flowery prose of Mr. Becker is to accept failure as a simulacrum of success. Frankly, such a philosophy is nothing more than a capitulation.  The white flag is waved by those burned out within the bureaucracy and hoisted by those who often lack the vision and skills to persevere.   How much easier it is to simply re-set the definition of success: from solution to improvement - from reform to change. The unwillingness to demand workable solutions in the regulatory workplace is the byproduct of a hermetically sealed political and regulatory system inbred with revolving-door cronyism that has suffocated innovation.   

To follow Mr. Becker's quote to its illogical conclusion, there are no mathematical solutions but only faulty theorems that do nothing more than "improve" our ability to calculate.  Thankfully, the laws of science do not concur.  What Mr. Becker and Commissioner Walter fail to distinguish  between  is "solutions" and "perfect solutions."

Alas, those of us in business are often forced to opt for the imperfect solution to a problem, when we would much prefer perfection. Men and women in business make that difficult choice every day.  We learn to make do with our limited resources; whereas, those in government always attribute their managerial failures to a lack of staffing and insufficient funding.     

Yet Another SEC Scandal

On  February 25, 2009, the SEC filed an emergency action in the U.S. District Court for the Southern District of New York,obtaining an asset freeze and a temporary restraining order against Paul Greenwood, Stephen Walsh, and their companies, WG Trading, a registered broker-dealer, Westridge a registered investment advisor, and WGTI, an unregistered investment vehicle. According to the SEC Complaint, since at least 1996, Greenwood and Walsh had been misappropriating as much as $554 million in investor assets in the operation of a Ponzi scheme. 

On October 26, 2010, the Securities and Exchange Commission's ("SEC") Office of Inspector General ("OIG") issued a report (just recently posted for public consumption on the SEC's website) titled:




Case No. OIG-533  

Investigation of the Failure of the SEC's Los Angeles Regional
Office to Uncover Fraud in Westridge Capital Management
Notwithstanding Investment Adviser Examination Conducted
in 2005 and Inappropriate Conduct on the Part of Senior
Los Angeles Official  

The Report informs us that on March 15, 2010, the OIG received an anonymous complaint, alleging that a Supervisor in the SEC's Office of Compliance Inspections and Examinations (the  "Supervisor") (the "OCIE") in the investment adviser examination program in the SEC's Los Angeles Regional Office (the "LARO") "instructed (and even bullied) examiners to not pursue certain red flags in an examination [of Westridge Capital Management and WG Trading] where the LARO exam staff uncovered a massive fraud" and that the Supervisor's motive was related to his involvement in a previous 2005 examination of Westridge. The anonymous complaint also alleged that the Supervisor had lied to OIG investigators during testimony in a previous OIG investigation.  

Frankly, a breathtaking allegation.  

An SEC supervisor was accused of bullying his subordinates to willfully ignore red flags in an examination involving massive fraud.  Moreover, the motive for this cover-up was to apparently protect the Supervisor's reputation that would be tarnished given his apparent failure to uncover the fraud during an earlier 2005 examination under his supervision.  

During its investigation of the LARO failure to timely detect the fraud at Westridge during the 2005 examination, the OIG concluded that LARO missed a significant opportunity to uncover the Ponzi scheme and failed to conduct a competent and thorough examination of the investment adviser, Westridge, and did not take the necessary steps to ensure that a follow-up examination of the brokerdealer,WG Trading, was conducted. The OIG found that the 2005 examination was flawed.  

Perhaps there are those still in management at the SEC who view the failures uncovered by the OIG as an unavoidable fact of life in a bureaucracy that dismisses solutions in favor of lesser improvements.  As such, corruption, incompetency, nonfeasance, and malfeasance are simply viewed as human foibles.  You know, that whole Becker/Walter philosophy: Until they come out with a better model of human, we will be stuck with doing better, not doing perfectly.

The OIG has unearthed a regulatory culture at the SEC that nurtures the protection of one's turf and reputation at the expense of failing to protect the public. Those in charge at the SEC must not opt for the expediency of improving or changing this threat.  The regulator's management team must solve the problem and reform their corrupted system.  If they are not up to that task, then they need to retire or be fired.  

Lasciate Ogni Speranza Voi Ch'entrate?

Recently, I authored Shifting to High Gear In America: No can do. (The "Street Sweeper" by Bill Singer, January 28, 2011), in which I complained about the bureaucratic infighting and malaise that has hobbled our nation.  In concluding my article, I stated:  

Sadly, America's Can Do spirit has become a museum piece, displayed in a case with long-ago collected moon rocks. The people who first landed on the Moon can't even reform Wall Street.  Instead, we stand on the shore, a wet finger forever raised to find the wind - but we never set sail.    

Whatever happened to high gear in America?  

Oddly enough, in that same article, I reported on a January 19, 2011, published statement by Commissioner Walter in which she criticized an SEC Staff Study that seemed lukewarm to her in terms of its tepid support for the idea of utilizing a self-regulatory organization (SRO) to oversee investment advisers.  Reading between the lines, Commissioner Walter, a former executive at the Financial Industry Regulatory Authority (FINRA) SRO, thinks that there is much to commend the integration of the SRO concept into the investment adviser arena. 

In noting the extent of her disappointment with the SEC Staff's Report, Walter noted in her statement that:  

[I] am quite disappointed with the result. Although I voted to release the study, for the first time in my tenure as a Commissioner, I feel that it is necessary for me to write separately in order to clarify and emphasize certain facts, and ensure that Congress knows that the current resource problem is severe, that the problem will only be worse in the future, and that a solution is needed now. I have spent many years considering these issues, and have definite and clear views on them. . .   
[Note: emphasis provided by Bill Singer and is not in the original statement]  

Not to split hairs with Commissioner Walter but which is it?  First you cite Mr. Becker's quote about there being no solutions but only improvement; yet, in your profound disagreement with the Staff's Report, you complain that "a solution is needed now." 

If you don't believe in "solutions," then why are you lambasting the Staff for not providing one?  

Let me commend to Mr. Becker, Commissioner Walter, and the rest of Washington's politicos and bureaucrats these words by former President Calvin Coolidge:  

Nothing in this world can take the place of persistence. Talent will not; nothing is more common than unsuccessful people with talent. Genius will not; unrewarded genius is almost a proverb. Education will not; the world is full of educated derelicts. Persistence and determination alone are omnipotent. The slogan "press on" has solved and always will solve the problems of the human race