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Monday
Jan052009

The SEC and Responsibility for the Financial Crisis (Part 2)

We are discussing the editorial in the NYT ("The End of the Financial World As We Know It") that contends that the SEC is partly to blame for the current turmoil because it has excessively close relations with Wall Street. 

The article claims that those in the Enforcement Division want to "maintain good relations with Wall Street" in order to "be paid huge sums of money to be employed by it."  The evidence?  That the most recent director of enforcement is the general counsel of JPMorgan and the one before him is general counsel at Deutsche Bank.  Finally, "one of his predecessors became a managing director for Credit Suisse before moving on to Morgan Stanley."  As a result, a "casual observer could be forgiven for thinking that the whole point of landing the job as the S.E.C.’s director of enforcement is to position oneself for the better paying one on Wall Street."

The statements about the employment history of the former directors is true enough but decidedly incomplete.  Additional facts demonstrate exactly the reverse.  If anything, the former directors to a person had a reputation for being hard on Wall Street.  Let's assign some names to these anonymous descriptions and take a look at a more complete version of the facts.

The current director of the Division of Enforcement is Linda Thomsen, who was appointed in 2005

Her predecessor, Stephen Cutler, served as Director from 2001 to 2005.  The article is correct that Cutler is currently the general counsel of JP Morgan.  But the implication that he left the SEC to go to Wall Street ignores the fact that Cutler was in Wilmer Cutler before joining the SEC and went back to WilmerHale after leaving the SEC.  This hardly smacks of positioning. 

Moreover, the notion that he "positioned" himself for Wall Street presumably means he was not a rigerous Director of Enforcement.  During his four year tenure, however, Cutler oversaw:

  • enforcement actions totaling more than $6 billion in penalties and disgorgement, more than $4.5 billion of which is being returned to harmed investors. Among them were WorldCom's $750 million penalty (the largest against a public company in Commission history) and the more recent $300 million penalty against AOL-Time Warner. Of the 12 largest penalties in Commission history, ten were obtained in cases brought under Mr. Cutler's leadership.
  • led the Commission's groundbreaking efforts against banks, insurance companies and other financial intermediaries for their roles in a number of public company financial reporting failures, including the Commission's cases against Merrill Lynch, Citigroup, J.P. Morgan and CIBC in connection with Enron's collapse; and the cases against AIG for its transactions with two different public companies;
  • helped bring some of the agency's significant financial reporting cases involving foreign companies, including Parmalat, Royal Ahold, Royal Dutch Shell, Hollinger, TV Azteca and Vivendi;
  • oversaw the agency's investigations that led to historic cases against the New York Stock Exchange, its specialist firms and a number of individual specialists for inter-positioning and trading ahead violations;
  • spearheaded the agency's crackdown against illegal IPO allocation practices on Wall Street, leading to significant cases against Credit Suisse First Boston, J.P. Morgan, Goldman Sachs and Morgan Stanley;
  • led the agency's enforcement efforts against mutual fund abuses, including the agency's revenue sharing (or "shelf space") cases against Morgan Stanley, Pimco, Franklin Templeton, Putnam, MFS, Edward D. Jones and others, as well as the agency's cases involving market timing and late trading against Bank of America, Strong Capital Management, Janus, Pilgrim Baxter, Alliance Capital, Invesco and others;
  • played a key role in the historic "global settlement" with Wall Street brokerage firms over research analyst conflicts of interest, which called for payments totaling nearly $1.5 billion, as well as significant reforms;and
  • stepped up the Commission's efforts to hold audit firms (as well as their personnel) accountable for misconduct, including significant cases against, among others, KPMG for its audits of Xerox and Gemstar, and Ernst & Young and PriceWaterhouseCoopers for their violations of the auditor independence rule.

This is hardly the record of someone trying to curry favor with Wall Street.

Cutler's predecessor was Richard Walker.  Walker served from 1998 until 2001.   Again, the article is correct that he is the general counsel to Deutsche Bank.   It is a large financial institution to say the least (ranked the 26th largest global company in the 2008 Fortune 500 list).  But it is hard to equate Deutsche Bank with Wall Street.  The universal bank has a strong position in Europe but has traditionally not been in the upper leagues within the United States. 

In any event, Walker served under Chairman Levitt who most view as very pro-shareholder and pro-enforcement.  During his tenure, the Division brought actions against a host of well known issuers, including W.R. Grace, Livent, Cendant, McKesson HBOC, Microstrategy, Sunbeam, and Arthur Andersen.

Of the two division directors before Walker, one was Bill Mclucas, the longest serving director of the Division and currently a partner at WilmerHale.  Presumably he wasn't using his reign as Division Director to position himself for Wall Street. 

The other was Gary Lynch.  Lynch is the Division Director who the editorial notes was at CSFB before traveling to Morgan Stanley.  What the editorial omitted was that Lynch left the SEC in 1989 and went to the law firm, Davis Polk, only joining CSFB in 2001.  In other words, his stint as head of Enforcement "positioned" him for private practice, not the investment banking firms that came later.

More importantly, both Lynch and McLucas were known, not for a lite touch when it came to Wall Street, but the exact opposite.  They were the top SEC officials probably most responsible for bringing down Michael Miliken and Drexel Burnham, the investment banking firm on Wall Street.  (Lynch in a subsequent interview indicated that he spent approximately 30% of his time on those cases).  In other words, the only positioning they did with respect to Wall Street was to bring down the hammer. 

As we noted, there are issues at the SEC.  But one of them is not excessive kowtowing to Wall Street.  Top enforcement officials get high paying jobs in the private sector because they are talented lawyers who have credibility within the SEC (among other things).  Credibility comes from ethical and hard nosed attitudes about enforcement, something that would be lost if they were viewed either inside or outside the agency as little more than sieves for industry.

On this issue, the editorial in the NYTimes got it wrong.

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