SEC: always playing catch-up

Readable Research | ByRaphael Pope-Sussman | Corporate influence, Regulation

The SEC brings insider-trading charges against Dennis Levine, a managing director in mergers and acquisitions at the New York investment bank Drexel Burnham Lambert. The case against Levine (who will later lead federal investigators to Ivan Boesky’s massive insider trading scheme) is seen as a high-profile victory for the SEC. But the revelation that Levine’s fraud occurred over six years and brought the banker more than $12 million in profits sheds light on the enormity of the task the SEC faces in controlling insider trading.

Richard Phillips, a former SEC staff attorney and head of the American Bar Association’s securities regulation committee, expresses his concern for the agency’s capabilities to Martha Hamilton and Peter Behr of the Washington Post: “It’s not a great display of enforcement power to catch someone who allegedly did 54 transactions over six years…they need help.” Writing in the Post, Hamilton and Behr note that because the agency is “unable, by virtually everyone’s account, to monitor” an industry that dwarfs it in size, wealth, and influence, the SEC “must count on deterrence to help limit abuses.” The agency, explain Hamilton and Behr, has only 600 staffers in its enforcement office; its budget has not increased in the past five years, despite “a 300 percent increase in the volume of trading on the New York Stock Exchange.”[15]

Martha Hamilton and Peter Behr, “Is the SEC Big Enough for the Job?” Washington Post, 25 May 1986.

 

1988

Regulatory lapses are cited as one of the causes of the October 19, 1987 “Black Monday” market crash, in which the Dow Jones Industrial Average dropped 508 points and $500 billion in market value evaporated within a matter of hours. The proliferation of index-arbitrage program trading is identified as a significant factor leading to (or driving) the crash, and the SEC is criticized for its failure to identify the systemic risks posed by the intensification of that program trading.[16]

“The consensus approach to regulatory coordination is destined to fail…the SEC will constantly be outvoted and crippled by those who value ideology more than confidence in our capital markets.” — Rep. John Dingell, 1988

An aide at the General Accounting Office tells Time Magazine that the agency lacks the capability to “go in and analyze a computer system to see if it functions correctly.”

In March of 1988, the White House convenes a working group of administration officials to study the causes of the crash. The working group is composed of Federal Reserve Chairman Alan Greenspan, Undersecretary of the Treasury for Finance George D. Gould, Commodity Futures Trading Commission Chairman Wendy Gramm, and SEC Chairman David Ruder. The group, Nathaniel C. Nash reports in the New York Times, is “dominated by three members — Mr. Gould, Mr. Greenspan and Mrs. Gramm — who are avid believers in the efficiency of markets that operate with a minimum of Government regulation and interference,” and who are “almost automatically predisposed against legislative proposals.”

The working group rejects a proposal by Ruder for more stringent margin rules for investors. It suggests no further restrictions on computerized trading.

Frustrated with the group’s report, Rep. John Dingell (D-Mich.) tells the Associated Press, “The consensus approach to regulatory coordination is destined to fail…the SEC will constantly be outvoted and crippled by those who value ideology more than confidence in our capital markets.”[17]

Martin Crutsinger, “Administration Proposes Modest Steps in Response to Crash,” Associated Press, 16 May 1988.

Rick Gladstone, “Biggest Government Inquest Yet Into ‘Black Monday,’” Associated Press, 30 January 1988.

 

1988-1992

In the late 1980s, the SEC asks Congress for the power to regulate stock-index futures, a class of securities overseen by the Commodity Futures Trading Commission. The agency’s effort to expand its regulatory reach sets off a heated turf-war with the CFTC. The conflict between agencies escalates in the spring of 1990, when the Bush Administration advances legislation to shift the regulation of index futures from the CFTC to the SEC.[18]

Testifying in front of the Senate Committee on Banking, Housing, and Urban Affairs in July, Thomas Eagleton, former senator from Missouri and former official at the Chicago Mercantile Exchange, says the CFTC “trembles at the sight of Chicago” and calls the agency “a pygmy of federal regulation.”[19]

Legislation to shift oversight of index futures to the SEC stalls in Congress. When legislation is finally passed, as the Futures Trading Practices Act of 1992, it includes only superficial changes to the CFTC and leaves stock-index futures under that agency’s oversight. Wendy Gramm, a free-market economist, president of the CFTC, and wife of then-Senator Phil Gramm (R-Texas), is credited as a major force behind the CFTC’s jurisdictional victory.

White House Backs SEC In Turf Battle over CFTC,” Associated Press, May 9, 1990.

Agency called unfit to regulate stock-index futures,” Reuters, 12 July 1990.

 

September 1989

After a multi-year SEC investigation into insider trading at Drexel Burnham Lambert, the firm pleads guilty to six counts of mail and securities fraud. Drexel also agrees to pay a penalty of $650 million. The discovery of the massive fraud at Drexel had begun in 1986, with the arrest of managing director Dennis Levine. The continuing investigation of insider trading widened, ensnaring a litany of major figures on Wall Street. Investigators also uncovered massive fraud at Drexel, concentrated in the Beverly Hills-based junk bond division run by Michael Milken.

 

February 1990

U.S. banks will soon become an endangered species if they are not allowed to compete in the broader market for financial services both at home and abroad.”
— Thomas P. Rideout, former president of the American Bankers Association, 1990

Unable to weather increasing volatility in the junk bond market and the fallout from its criminal activities, Drexel’s parent company, Drexel Burnham Lambert Group, defaults on a $100 million loan and files for bankruptcy protection, under Chapter 11. Reporting in February of 1990, Time magazine notes, “The 152-year-old titan  —  with 5,300 employees and $3.6 billion in assets  —  will vanish almost overnight.” At the time, the firm’s collapse is the largest in Wall Street history.

 

March 1990

Writing in American Banker, Thomas P. Rideout, former president of the American Bankers Association, calls for the deregulation of the banking industry. Rideout warns that, “U.S. banks will soon become an endangered species if they are not allowed to compete in the broader market for financial services both at home and abroad.”[20]

Thomas P. Rideout, “U.S. Banks Need New Rules To Win on Global Ballfield,” American Banker, 15 March 1990.

 

April 1990

Milken pleads guilty on six felony charges of securities fraud and conspiracy. He is sentenced to 10 years in prison and ordered to pay $600 million in fines and penalties. Including later settlements with investors he defrauded, Milken’s fines total $1.3 billion. In August of 1992, a federal judge reduces Milken’s sentence to two years. He is released from prison in January 1993, having served only 22 months in prison.

 

July 1990

A bill to add consumer protections to the Investment Advisers Act of 1940 is introduced in Congress after a GAO report finds that fraud and abuse by financial planners cost consumers between $90 and $200 million annually. Consumer losses are thought to be even greater than these figures suggest, as much fraud goes unreported.

SEC Commissioner Mary L. Schapiro applauds Congress’s effort to strengthen regulation of the investment advisory industry, but warns that the agency will be unable to provide “meaningful, direct…regulation over the investment advisory industry unless the resources dedicated to its responsibilities…are significantly increased.” The American Institute of Certified Public Accountants, a trade group, attacks the bill for covering “an unduly large array of individuals and services.” It stalls in Congress.[21]

The SEC will be unable to provide “meaningful, direct…regulation over the investment advisory industry unless the resources dedicated to its responsibilities…are significantly increased.”
— Mary L. Schapiro, then-SEC commissioner, 1990

The SEC’s ability to police the investment advisory industry is tested further in 1991, as the agency cuts the number of investment advisor inspectors to 46 from 64, a decrease of more than 25 percent. John M. Doyle reports in the Associated Press on the Congressional testimony of Richard L. Fogel, an official at the GAO. Fogel says the SEC lacks the statutory authority and the resources to oversee the 17,500 registered financial planners managing more than $5 trillion — up from 4,580 planners managing only $440 billion in 1981.[22] Rep. Edward Markey (D-Mass.), chairman of the House Energy and Commerce subcommittee on telecommunications and finance, tells the Associated Press that under the current regulatory regime, “an SEC registration comes perilously close to being a license to plunder.”[23]

Bills regarding the regulation of investment advisers are introduced in both houses of Congress. In the Senate, Phil Gramm (R-Texas), a long-time foe of regulation, proposes a number of amendments to weaken the Senate version of the bill. The Associated Press reports on Gramm’s successful attempt to eliminate from the bill “a provision that would have barred advisers from recommending investments that are unsuitably risky for their clients.” Ultimately, no bill on the matter will pass Congress. No further action is taken.[24]

John M. Doyle, “House Panel Told Tougher Laws for Financial Advisers Needed,” Associated Press, 4 June 1992.

John M. Doyle, “Investigator: Problem Growing But SEC Staff Shrinking,” Associated Press, 4 June 1992.

Senate Panel Clears Financial Planners Bill,” Associated Press, 21 May 1992.

Margie G. Quimpo, “Financial Planners Blamed for Up to $200 Million a year in Fraud,” Washington Post, 22 July 1990.

 

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