I've been paying close attention to the scandal involving Bernard Madoff and the $50 billion Ponzi scheme that's come crashing down around his (and many others') ears, not to mention the ears of an economy that could scarcely afford yet another shock wave, much less one of this magnitude. I have more than an academic interest in scandals like this, since, in an earlier life, I was at the tip of the spear that enforced state and federal securities laws. In fact, more years ago than I care to number, I successfully prosecuted the first case of criminal securities fraud ever brought by a state.
While I was an enforcement attorney at the Washington, D.C. headquarters office of the Securities and Exchange Commission, I investigated cases of "insider" trading, as well as the frauds that eventually brought down the likes of Ivan Boesky and Michael Milliken, massive accounting frauds at several major financial institutions, and the systemic "pay-to-play" culture in many American corporations that ultimately resulted in the enactment of the federal Foreign Corrupt Practices Act whose provisions are every bit as necessary today as they were when it was enacted, 30 years ago. It was a heady time for me, a not-yet-30, damp behind the ears punk who could call the CEO of a Fortune 500 company, announce I was calling from the S.E.C.'s Division of Enforcement, and actually get him on the phone.
Forgive me for waxing nostalgic, but one of my proudest moments was watching Walter Cronkite announce on the CBS Evening News, in that unmistakably stentorian voice of his, a lawsuit I filed earlier that day, on behalf of my employer, against a public company that I was primarily responsible for investigating. I knew I had arrived when Mr. Cronkite, at the time, the most trusted man in America, announced on that night, as he did at the end of every one of his broadcasts, "and that's the way it is." In the time since I left the S.E.C. to practice law in Memphis, I have been involved in a number of securities class action cases and quite a few cases of alleged fraud by securities brokers and other investment professionals. So, as you can see, I have had some skin in this game.
I have watched, sadly, as my brethren at the S.E.C. have come in for more than their share of opprobrium for being asleep at the wheel while the whole mortgage meltdown took place, and in particular, when the tangled web of deception woven by Bernie Madoff came undone. Without, in any way, trying to be an apologist for my old employer, I must observe that the Madoff scandal is a prime example of a pigeon coming home to roost, and by that I mean that the seeds of this disaster were sown many years ago, and by many actors, all of whom share the blame/responsibility for this tragedy.
Securities fraud is a big business, and has been for as long as there have been shareholders. It has been estimated that its cost to the American public is on the order of $50 billion annually, a number that has now, in one fell swoop, been doubled. It's no accident that names like Enron and Worldcom have become household words. The economic harm that results from fraud has always been far worse than the economic harm that results from run-of-the mill crime, including the violent kind.
But, the massive fraud we've experienced in the securities markets just recently, and the failure of the regulators responsible for reigning it in, has been foreseeable for some years, and owes its genesis in the decisions made by all three branches of the federal government, as well as the policy priorities of the agencies charged with enforcing the laws against securities fraud. The federal agency I worked for was always woefully underfunded. In spite of the fact that the S.E.C., unlike most other agencies in Washington, brought in millions of dollars in fees from the industry it regulated, it was always treated like a stepchild by congress and the president when it came to funding its budget. It was constantly outgunned, outspent and out-manned by the securities industry and the corporations it was charged with regulating. And then, beginning with the "regulation is bad" mantra of Reagan, and taken up wholeheartedly by GWB, it was decimated even further.
So, while the securities industry mushroomed in size, activity and impact during the go-go days of the 80's and 90's, to the point where two in every three Americans was "in the market," the S.E.C. continued to labor with a short staff and ever-declining (in real dollars) budgets, because, in fact, the powers that be didn't really want effective regulation or enforcement of the industry's private preserve. The industry lobbied against it and made generous campaign contributions to members of Congress who shared its aversion to regulation. I remember my boss, the legendary Stanley Sporkin, telling us that, if we were lucky, we would ferret out less than 5% of the fraud that existed in the market. There was no way the Commission was ever going to be able to effectively examine the thousands of broker-dealers and investment advisers who registered with it, much less review the thousands of filings made by public companies, or police a burgeoning market in IPO's and various secondary offerings. Instead, it relied for the supplementation of its oversight responsibilities on a system known as "self regulation." What that meant was that organizations like the New York Stock Exchange and the National Association of Securities Dealers were given the responsibility to exercise supervision, oversight and enforcement powers over their own members. If you think about it, you'll realize what a bad idea that was. It's a little like putting the Medellin Cartel in charge of the "war" on drugs.
As an aside, this is one of the reasons I find President-elect Obama's appointment of Mary Schapiro, the head of one of the so-called "self-regulatory organizations" known as FINRA, to be the new S.E.C. chairman so troubling, and I am not alone in that belief. In addition to putting what I consider to be a fox (and I don't mean that in the complimentary sense) in charge of the henhouse, I find Schapiro's previous affiliations with Bernard Madoff and his family to be even more troubling.
Well, as if the increasing disparity between the resources of the securities markets and those of the regulators charged with oversight becoming increasingly disproportional wasn't bad enough, in 1999, as a result of intense lobbying by the financial services industry (and, in particular, banks), Congress repealed the so-called Glass Steagall Act by enacting the Gramm, Leach Bliley act . The result was that the historical prohibition against banks offering investment services was eliminated, and there was an explosion of banks getting into the securities business. Congress, not surprisingly, didn't increase the S.E.C.'s budget to deal with this explosion. Indeed, the author of the new legislation was, and remains, an unrepentant advocate of less government regulation of the financial services industry. Mr. Gramm's law bears a substantial portion of the responsibility for the financial meltdown we are now suffering, which he labeled, famously, a "mental recession" fueled by a "nation of whiners." Mr. Gramm is, of course, now comfortably cosseted in the bosom of one of the major beneficiaries of his legislative largesse, the Swiss bank holding company, UBS. Sadly, Democrats have been just as guilty of tilting the balance between Wall Street and Main Street decidedly towards Wall Street, and thus share the blame for what's happened with the mortgage meltdown and the resultant economic crisis.
One of the arrows in the quiver of securities law enforcement was supposed to be, and always has been, private actions (i.e., lawsuits) by victims of securities fraud. Even our Supreme Court has recognized that public regulation and enforcement of securities laws needed to be supplemented by private lawsuits. So, in theory, some of the frauds the regulators didn't find, or couldn't get to, would be dealt with by class actions and other private enforcement remedies. That was all well and good, until the securities industry's (and many of the corporations targeted by class actions) bitching and moaning about class actions found its way to the halls of Congress.
What resulted was the Private Securities Litigation Reform Act. Passed in 1995, and originally proposed as part of Newt Gingrich's "Contract for America (a revealing fact, in and of itself), the law was passed over the veto of then-President Clinton, with support from many congressional democrats. Not surprisingly, it was also supported by most congressional Republicans, including Christopher Cox, at the time a California congressman, and now the soon-to-be former chairman of the S.E.C., who led the fight for its passage. It created substantial roadblocks to the filing of securities class action suits. The U.S. Supreme Court followed that with a series of rulings (including some by Bush's appointees to the court) that piled on additional obstacles to filing federal lawsuits for securities fraud.
As a result of the PSLRA, more securities cases wound up being filed in state courts, where the restrictions of the new law didn't apply. The Republican congress and President upped the ante in that cat-and-mouse game by enacting the Securities Litigation Uniform Standards Act, which, in essence, closed the state court loophole in the PSLRA, and forced class actions to be filed in federal courts, which, historically, have been more antagonistic to such cases, especially since Bush has stacked the federal court system with Republican appointees who are generally more receptive to corporate interests than to those of aggrieved individuals.
If you haven't fallen asleep from all that detail, the end result of these political and judicial machinations was that, in addition to handcuffing the securities regulators with inadequate resources to do the job, the Bush administration, with the help of its handmaidens in Congress and its appointees to the federal courts, also eviscerated the private enforcement of the federal securities laws.
Which brings us to Bernie Madoff. Should the S.E.C., in the best of all possible worlds, have ferreted out his scheme? Maybe. Then again, maybe it should have also ferreted out the massive tilt of the market players towards risky mortgage securities. But ultimately, I believe the S.E.C. is being scapegoated, and turned into the sacrificial lamb for a system of regulation and oversight that was skewed heavily in favor of the "bad guys." You can't have a government, and a Congress, that have been decidedly antipathetic to regulation, and have hampered the systems put in place following the Great Depression to avoid a repeat of some of the excesses that lead to that debacle, and then blame the hampered regulators for the result.
So, what's been the Commission's response to the accusations against it? Falling on its sword, of course, both with respect to the implosion of Wall Street and with regard to the Madoff scandal. And who better to take the fall for the Commission's shortcomings than the very man whose tenure at the agency advanced the cause of loosened regulation, Christopher Cox himself.
If nothing else, the Wall Street meltdown and the Madoff scandal will result in the re-regulation of the securities and financial markets/industries. And that will be a good thing. But, in the meantime, it would be well for the finger-pointers to remember the biblical phrase, "as ye reap, so also shall ye sow," and allocate responsibility for the breakdown of our regulatory system where it belongs---on the institutions of government that shunned regulation to begin with, and not on the regulators whose hands they tied in the process.