Unfortunately, the effect of the minimal punishment track record is compounded by the agency's failure to enforce its responsibility to ensure that market participants have access to all the useful, relevant information for a security in an appropriate, timely manner.
This blog has frequently highlighted two examples of inadequate disclosure: structured finance and banks.
At the beginning of the financial crisis, structured finance securities became permanently associated with two adjectives: opaque and toxic. It was the failure of the SEC to require through Regulation AB an appropriate level of disclosure that allowed Wall Street to sell such a toxic security.
In my discussions with the SEC, they explained that the reason they did not require all the useful, relevant information on the underlying collateral be disclosed in an appropriate, timely manner (think updating each mortgage for every observable event like an interest payment or default that occurs with the mortgage) is they thought it was too expensive.
The Bank of England's Andy Haldane estimated that the global cost of these opaque, toxic securities was $4 trillion. A number that is not one, not two, but three orders of magnitude higher than the cost of providing all the useful, relevant information to all market participants (I know the cost as I designed and patented an information system to provide this information).
Since its inception in the 1930s, the SEC has not required banks to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details. There are two reasons for this:
- Disclosure of all its accounts was considered in the 1930s to be the sign of a bank that could stand on its own two feet. The industry did it voluntarily.
- The agency deferred to the bank regulators who had access to the exposure details. By deferring to regulators who have access to the exposure details, the SEC ended up with disclosure requirements that leave banks looking like, in Mr. Haldane's words, 'black boxes' to all other market participants.
Ultimately, ultra transparency allows investors to actually protect themselves as it provides them with the information they need to independently assess risk and adjust the amount and price of their exposures based on this assessment.
Even as the Securities and Exchange Commission has stepped up its investigations of Wall Street in the last decade, the agency has repeatedly allowed the biggest firms to avoid punishments specifically meant to apply to fraud cases.
By granting exemptions to laws and regulations that act as a deterrent to securities fraud, the S.E.C. has let financial giants like JPMorganChase, Goldman Sachs and Bank of America continue to have advantages reserved for the most dependable companies, making it easier for them to raise money from investors, for example, and to avoid liability from lawsuits if their financial forecasts turn out to be wrong.
An analysis by The New York Times of S.E.C. investigations over the last decade found nearly 350 instances where the agency has given big Wall Street institutions and other financial companies a pass on those or other sanctions. Those instances also include waivers permitting firms to underwrite certain stock and bond sales and manage mutual fund portfolios.
JPMorganChase, for example, has settled six fraud cases in the last 13 years, including one with a $228 million settlement last summer, but it has obtained at least 22 waivers, in part by arguing that it has “a strong record of compliance with securities laws.” Bank of America and Merrill Lynch, which merged in 2009, have settled 15 fraud cases and received at least 39 waivers.
Only about a dozen companies — Dell, General Electric and United Rentals among them — have felt the full force of the law after issuing misleading information about their businesses. Citigroup was the only major Wall Street bank among them. In 11 years, it settled six fraud cases and received 25 waivers before it lost most of its privileges in 2010.
By granting those waivers, the S.E.C. allowed Wall Street firms to have powerful advantages, securities experts and former regulators say. The institutions remained protected under the Private Securities Litigation Reform Act of 1995, which makes it easier to avoid class-action shareholder lawsuits....
“The ramifications of losing those exemptions are enormous to these firms,” David S. Ruder, a former S.E.C. chairman, said in an interview. Without the waivers, agreeing to settle charges of securities fraud “might have vast repercussions affecting the ability of a firm to continue to stay in business,” he said.
S.E.C. officials say that they grant the waivers to keep stock and bond markets open to companies with legitimate capital-raising needs. Ensuring such access is as important to its mission as protecting investors, regulators said.
The agency usually revokes the privileges when a case involves false or misleading statements about a company’s own business. It does not do so when the commission has charged a Wall Street firm with lying about, say, a specific mortgage security that it created and is selling to investors, a charge Goldman Sachs settled in 2010. Different parts of the company — corporate officers versus a sales force, for example — are responsible for different types of statements, officials say.
Thomas Lee Hazen, a securities law professor at the University of North Carolina at Chapel Hill, said that it is understandable that the S.E.C. might relax some potential sanctions on Wall Street firms — where it appears that lessons have been learned, or when a fine is thought to be sufficient punishment.
“The ripple effect of having a sanction that could shut them down or could seriously impede a company’s operations would seriously affect a lot of innocent customers,” he said. “It’s a very fine balance. That’s not to say that the S.E.C. is striking the balance properly. That is in the eye of the beholder.”I prefer to avoid the debate over striking the balance properly and simply ensuring that all the useful, relevant information is disclosed in an appropriate, timely manner.