The SEC and Investor Protection (Part 1)

The Commission has a tough mission.  Protecting investors and ensuring the integrity of the capital markets is a continuous struggle that must overcome constant impediments.  They include new regulatory burdens and inadequate resources.  But some of the harm to the agency comes from within.  

Commissioner Aguilar, who was recently nominated for a second term at the SEC, noted some of these issues in a recent speech before the Social Investment Forum.  As he described: 

• In the near term, the Dodd-Frank Act requires the SEC to promulgate over 100 new regulations, create five new offices, and undertake about 20 studies. To say this is a significant undertaking is a massive understatement. The SEC is currently right in the middle of this process.

More than a spate of additional rules, the Commission was tasked with additional areas of oversight.

• Dodd-Frank Act charges the Commission with on-going oversight responsibilities on the previously unregulated over-the-counter derivatives market. The Commission’s new responsibilities include direct regulation of participants such as security-based swaps dealers, venues such as swap execution facilities, warehouses such as swap data repositories, and clearing agencies set up as central counterparties. In addition to regulating the derivatives market, the Commission has also been given the responsibility for the oversight of hedge fund advisers, and new responsibilities for the registration of municipal advisers.

Despite these responsibilities, a much needed budget increase was voted down in the House.  Why?  In part it was punishment.  The report accompanying the decision "faulted the SEC’s handling of Ponzi schemes.  The agency failed to stop Bernard Madoff's fraud, despite repeated warnings over the years.").  So to punish the SEC for not protecting investors, the House will deny the SEC the funds it needs to protect investors.

The main explanation, though, was essentially financial mismanagement.

• Accusing the agency of shortcomings in its handling of information technology contracts, a major office lease and preparation of its own financial statements, the panel said it was reluctant to provide more funding until the SEC achieves efficiencies recommended by an outside consultant.   “The Committee believes that these lapses demonstrate a concerning lack of ability to manage funds,” the report said.

No doubt there could be improvements in this type of management.  But the sense of financial mismanagement at the Agency was unnecessarily stoked by what looks to be gratuitous criticism by the SEC's Office of the Inspector General (OIG). 

The OIG conducted an investigation into the execution of a large lease by the SEC.  Apparently, the  lease proved to be unnecessary but saddled with SEC with excess space.  Certainly the OIG ought to look into these sorts of matters.  Investigations might reveal deficiencies in the internal process used for approving leases and result in appropriate reforms. 

But rather than focus on the lease, the OIG chose to lump in practices that had occurred at eaerlier dates.  As the report noted:

• The OIG investigation found that the circumstances surrounding the SEC's entering into a lease contract with David Nassif Associates ("DNA") for 900,000 square feet of space at the Constitution Center facility in July 2010 represents another in a long history of missteps and misguided leasing decisions made by the SEC since it was granted independent leasing authority by Congress in 1990. We found that notwithstanding this significant authority, the SEC had not even established a Leasing Branch until April 2009 and did not put into place leasing policies and procedures until August 2010.

The report, therefore, suggested that there have been problems with leasing decisions since the 1990s.  In other words, the OIG chose to put the Constitution Center lease in a broader context.

Fair enough.  To the extent there is a bigger problem, it should be addressed.  Only the report doesn't support this contention.  While suggesting that problems have taken place since 1990, the first "misguided" decision it mentions occurred in 2005.  Second, while emphasizing "misguided leasing decisions" (the Constitution Center after all involved a lease), it gives as additional examples two events that do not really involve leases.  

The problem in 2005 involved cost overruns for the new building ("In May 2005, the SEC disclosed to a House Subcommittee that it had identified unbudgeted costs of approximately $48 million attributable to misestimates and omissions of costs associated with the construction of its headquarter facilities near Union Station") and the one in 2007 involved a reconfiguration of the building once it was finished.  ("In 2007, merely a year after moving into its new headquarters, the SEC embarked on a major "restacking" project in which various SEC employees were shuffled to different office spaces at a cost of over $3 million."). 

In addition to selecting what appears to be inapposite transactions, the basis for criticizing them was noticeably thin.  Take the restacking project.  OIG's criticism was based upon a "review" of the project.  The review found "serious questions" about whether the project was necessary.  Here is what the report had to say:

• The OIG's audit unit conducted a review of the project and found that there were serious questions about whether the restacking project was necessary and whether it had any meaningful impact on communication among or productivity of the staff. !d. at iv. The OIG found that there was no record of a cost benefit analysis having been conducted before embarking on this restacking project. !d. at iii. Moreover, an OIG survey of Commission staff found that only 34 percent of staff surveyed believed that the restacking project would improve effectiveness or efficiency oftheir office or division. !d. at iv, 13. This OIG survey also found that 89 percent of the responding staff had been satisfied with the location of their workspace before the restacking project was initiated, and 81 percent of the responding staff did not believe the restacking project benefits were worth the cost and time of construction, packing, moving, and unpacking. Id. at 11, 15.8

In other words, the "review" doesn't appear to be much of a review at all.  Apparently the file on the project was opened (there was no piece of paper undertaking a cost benefit analysis) and some attempt was made to survey employee views.  But restacking was designed to configure the operating divisions in a particular manner in an effort to make them more effective.  That doesn't mean that it was a correct decision.  The old building for the most part organized divisions on a single floor.  But it does mean that the "serious questions" posed by the OIG were not administrative inefficiencies like the Constitution Center lease but policy questions about how to maximize efforts by employees.  Had the OIG examined the way that contracts had been executed for the restacking project, it would have been more in line with the lease issue.  But commenting on and disagree with policy decisions was not.

Yet by expanding the discussion from the lease to past practices and giving an impression that these issues had been around since 1990, the report potentially harmed the SEC by providing an inappropriate impression about the degree of administrative mismanagement at the agency. 

Moreover, while the report may have harmed the SEC, the OIG may well come out of the budget battle better off than the agency as a whole.  As the article in the Washington Post notes:

• The committee made a point of guaranteeing a minimum level of funding — almost $6.8 million — for the office of the SEC inspector general, whose probes have criticized the agency and given its critics ammunition. 

An active and vigorous OIG is an important component of accountability.  The SEC probably needs to change its practices with respect to executing large leases.  But unnecessary criticism of under investigated topics takes away from the credibility of the office and should be avoided.