Securities and Exchange Commission

The Securities and Exchange Commission, commonly referred to as the SEC, is the United States governing body which has primary responsibility for overseeing the regulation of the securities industry. It enforces, among other acts, the Securities Act of 1933, the Securities Exchange Act of 1934, the Trust Indenture Act of 1939, the Investment Company Act of 1940 and the Investment Advisors Act. It removed regulatory authority from the Federal Trade Commission.

The SEC has five Commissioners who are appointed by the President of the United States with the advice and consent of the U.S. Senate. Their terms last five years and are staggered so that one Commissioner's term ends on June 5 of each year. To ensure that the SEC remains non-partisan, no more than three Commissioners may belong to the same political party. The President also designates one of the Commissioners as Chairman, the SEC's top executive.

Organization of the SEC

The SEC headquarters are stationed in Washington, DC and has 11 regional offices across the country. The regional offices mainly focus on investigations and bringing enforcement actions regarding securities' law violations in addition to reporting to the office of Compliance Inspections and Examinations. The agency has five main divisions: Enforcement, Corporation Finance, Investment Management, Trading and Markets, and Risk, Strategy and Financial Innovation. Additionally, the Washington DC SEC office contains 16 offices.

The Division of Enforcement heads up the law enforcement function of the agency by recommending that the SEC bring civil actions in federal court of before an administrative law judge. SEC investigations are conduct in private. "The Commission can authorize the staff to file a case in federal court or bring an administrative action. In many cases, the Commission and the party charged decide to settle a matter without trial."

The Division of Trading and Markets assists in the maintenance of fair and efficient markets. This division handles oversight of self-regulatory organizations (SROs) such as the New York Stock Exchange and the American Stock Exchange.

The Division of Investment Management "assists the Commission in executing its responsibility for investor protection and for promoting capital formation through oversight and regulation of America's $26 trillion investment management industry. This important part of the U.S. capital markets includes mutual funds and the professional fund managers who advise them; analysts who research individual assets and asset classes; and investment advisers to individual customers."

The Case Against Goldman Sachs

On April 16, 2010, the SEC enforcement division in Washington DC filed a securities fraud action against Goldman Sachs and Goldman Sachs employee, Fabrice Tourre for making materially misleading statements and omissions in connection with a synthetic collateralized debt obligation that Goldman Sachs structured and marketed to investors."

As the complaint sets forth: "Goldman created Abacus 2007-AC1 in February 2007 at the request of John A. Paulson, a prominent hedge fund manager who earned an estimated $3.7 billion in 2007 by correctly wagering that the housing bubble would burst. Mr. Paulson is not named in the suit. Goldman told investors that the bonds would be chosen by an independent manager. In the case of Abacus 2007-AC1, however, Goldman let Mr. Paulson select mortgage bonds that he believed were most likely to lose value, according to the complaint. Goldman then sold the package to investors like foreign banks, pension funds and insurance companies, which would profit only if the bonds gained value. The European banks IKB and ABN Amro and other investors lost more than $1 billion in the deal, the commission said."

“Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio,” Robert Khuzami, Director of SEC Enforcement Division. This case looks to connect home loans originating from Countrywide Financial all the way to the trading floors of Wall Street. The case goes into uncharted territory. The SEC must prove that Goldman Sachs defrauded investors by failing to disclose that the hedge fund that was betting against them on the market also played a role in creating what they bought. “The question is whether Paulson’s undisclosed role in portfolio selection was material,” said Larry Ribstein, a law professor at the University of Illinois in Champaign who has written about 140 articles and 10 books on topics including securities law and professional ethics. “There’s no clear and well-defined definition of what you have to disclose in this type of transaction.”

This case impacts both Goldman and the SEC. For Goldman, it is already damaging their reputation as a giant, untouchable investment bank on Wall Street. The same day that the SEC announced its case against Goldman, Goldman's stock dropped drastically. Furthermore, Goldman faces possible lawsuits from Great Britain and Germany as banks in those countries are the investors, who were defrauded by Goldman. In terms of the SEC, all eyes are on this case and whether or not the SEC can succeed against Goldman. It is a chance for the SEC to redeem their reputation after the Madoff messup, and send a strong message to Wall Street firms about their status as Securities Watchdog of the U.S. Government.

Goldman Sachs is also being investigated by the Department of Justice as well. The DOJ probe from the Manhattan offices are not the result of an SEC referral. Rather, this investigation was underway prior to the SEC opening their investigation against Goldman. "Although the SEC frequently sends its cases to the Justice Department for possible criminal prosecution, the stakes are higher because the Goldman case involves one of Wall Street's most storied firms, a business that had survived the financial crisis with its profitability intact but now faces accusations that it misled clients. It is rare for the government to indict a company, and even the threat of criminal prosecution can doom a business. A criminal investigation destroyed the Wall Street firm Drexel Burnham Lambert in the 1980s even though the firm settled with authorities."

Recent Financial Crisis and Criticism of the SEC

The SEC has come under great criticism in recent years first for the financial crisis within Wall Street and later with the Bernard L. Madoff ponzi scheme. Madoff created the largest Ponzi scheme in US history leading to $50 billion in losses. Madoff was arrested by federal agents December 11, 2008. He was sentenced to the maximum of 150 years in jail.

The SEC Inspector General compiled a report looking it how the SEC failed to detect a Ponzi scheme of this magnitude. The report lays out the tips that the SEC received but failed to pursue fully. "On May 21, 2003, an unnamed hedge-fund manager sent an email to an SEC examiner laying out concerns that Mr. Madoff's self-described trading strategy didn't add up. The manager said the strategy wasn't duplicated by anyone else in the market, Mr. Madoff's accounts were in cash at month end, and there was "always replacement capital." These could be "indicia of a Ponzi scheme," he wrote." Despite the tip, "the SEC didn't open an examination until December 2003, and an agency memo said the focus would be on front-running, a potentially abusive trading practice. The memo didn't raise questions cited by the hedge-fund manager, such as why there was an apparent lack of volume in the market to reflect Mr. Madoff's supposed trading strategy."

"The report details six substantive complaints against Mr. Madoff received by the agency, which were followed by three investigations and two examinations. Yet the agency never verified Mr. Madoff’s trading through a third party. Time and again, it was noted that the volume of his purported options trades were implausible. When the enforcement staff received a report showing that Mr. Madoff indeed had no options positions on a certain date, the agency simply did not take any further steps."

As a result of the SEC's failure to uncover Madoff's scheme, several investors filed a lawsuit against the SEC, alleging reliance on the SEC's clearance of Madoff, when investing with Madoff. While the lawsuit will probably be dismissed because of sovereign immunity, the lawsuit further highlights the ineptitude of the SEC.

The SEC also played a significant role in the recent financial crisis plaguing the U.S. economy. In 2004, five major investment banks, Lehman Brothers, Bear Stearns, Morgan Stanley, Merrill Lynch, and Goldman Sachs, approached the SEC in an effort to increase their debt to cash ratio. The investment banks asked the SEC to provide them exemptions from an old regulation that limits the amount of debt the investment banks could take on. "The exemption would unshackle billions of dollars held in reserve as a cushion against losses on their investments. Those funds could then flow up to the parent company, enabling it to invest in the fast-growing but opaque world of mortgage-backed securities; credit derivatives, a form of insurance for bond holders; and other exotic instruments." At the time, Henry M. Paulson was the head of Goldman Sachs.

After a 55 minute discussion and a vote, the SEC loosened the Net Capital rule, allowing investment banks to increase their debt. "the agency also decided to rely on the firms’ own computer models for determining the riskiness of investments, essentially outsourcing the job of monitoring risk to the banks themselves." As part of the rule change, the SEC had created a supervisory program, but this program became low on the SEC's priority list.

Bear Stearns took full advantage of the looser net capital rule and borrowed more money. Its leverage ratio rose sharply to 33 to 1; in other words, for every $1 in equity, the bank borrowed $33 of debt. Other banks also followed similar steps as Bear Stearns.

New York Times reported on the possibility of the SEC averting Bear Stearns complete failure: "The commission’s division of trading and markets “became aware of numerous potential red flags prior to Bear Stearns’s collapse, regarding its concentration of mortgage securities, high leverage, shortcomings of risk management in mortgage-backed securities and lack of compliance with the spirit of certain” capital standards, said an inspector general’s report issued last Friday. But the division “did not take actions to limit these risk factors.”" Other banks also followed similar steps as Bear Stearns. The article goes on to further discuss the way in which the SEC outsourced its oversight to the very firms that they were supposed to police.

In recent months, the public media has heavily criticized the SEC for not moving fast enough with reforms regarding tougher financial regulations. As NPR has stated, "almost three years since banks started taking losses that led to the worst financial crisis since the Great Depression, the Securities and Exchange Commission is still asking basic questions about what happened." The NPR further reports that the SEC sent a questionaire to collateral managers in October of 2009, asking information on "trading, allocation and valuations and advisers' disclosure," as well as other details on business management. As Lynn Turner, SEC's chief accountant in the late 1990s comments, "one wonders why this letter, especially given the general nature of it, is just now being sent. And why wasn't it sent several years ago, as the CDO market was exploding? "It makes it look like the SEC is several years behind the markets."

"To date, the agency has little to show for its probes into the causes of the crisis that engulfed global financial markets just over a year ago. In June 2007, Christopher Cox, then the SEC chairman, testified before Congress that the agency had "about 12 investigations" under way concerning CDOs and collateralized loan obligations and similar products. A little more than a year later, Cox told Congress that the number of investigations into the financial industry, including the subprime mortgage origination business, had ballooned to more than 50 separate inquiries."

Reforms Proposed and Shapiro's efforts to Improve SEC's image

In the face of criticism, the SEC has announced a series of reforms seeking to tighten financial regulation. Some proposed reforms include: new limits on short selling, new rules making it easier for shareholders to impact corporate management, curbing corruption in state pension plans, and overhaul of the credit-rating industry. SEC Chair, Mary Shapiro, faces pressure from Obama Administration to act quicker in terms of passing financial reforms. The SEC may find some of its powers in the future limited as the Obama Administration has been pushing the creation of a Consumer Financial Protection Agency as the center of its financial regulation reform. This Consumer Financial Protection Agency would attempt to look out for the financial interests of ordinary American consumers.

The most discussed recent reform proposal focuses on a rule regulating brokers and increasing their accountability to the public. The proposal seeks to create a fiduciary duty between brokers and their customers. With a fiduciary duty to customers, Brokers would have to act in the best interests' of their clients, specifically when recommending investments. Currently, only investment advisors owe a fiduciary duty to their clients while brokers are held a lesser standard, only needing to recommend "suitable" investments to their clients. Connecticut Senator, Christopher Dodd has proposed a bill that eliminates brokers' exemption from the Investment Advisors Act and require brokers to register as advisors, making them fiduciaries. "The Dodd bill is broader and stronger,” said John C. Coffee, a professor of securities law at Columbia Law School. “In the full-scale House bill, you see how limited it is. The House makes a new limited fiduciary standard to broker dealers, but only when they are giving personalized investment advice” about securities to a retail customer."

In late February, the SEC passed a reform limiting short selling, which has been considered by some a cause of the 2008 financial crisis. The measure curbing short selling passed narrowly with a 3-2 vote. As the Wall Street Journal article goes on to describe, "In short selling, investors try to profit by borrowing shares and selling them. If the shares fall, the investors can buy them back at a lower price and pocket the difference. When financial stocks were diving during 2008, critics said speculators were abusing the tactic to artificially drive down the price of certain stocks." The new rule on short selling applies to stocks that decline at least 10% in a single day. For these stocks, SEC will allow short selling "only if the price of the sale is above the highest bid price nationally." Some Congressman have supported the SEC measure. "Rep. Gary Ackerman (D., N.Y.) applauded the SEC's action, saying it is a "vital step toward combating the artificial manipulation of stocks." Sens. Ted Kaufman (D., Del.) and Johnny Isakson (R., Ga.) called for even tougher action. They said in a joint statement that the rule will be of "limited use, helping only in the worst-case scenarios that could occur during a terrorist attack or financial crisis."

Another reform many financial experts have called for involves curbing or banning speculative trading, especially in Credit Default Swap Markets. George Soros and Senator Maria Cantwell have supported this measure to curb speculative trading. However, Duffie, a finance professor at Stanford University's Graduate School of Business, argues that speculative trading is not harmful to the market and that the reform should really focus on market manipulation. As Duffie explains in the Wall Street Journal, "Those who call for stamping out speculation may be confused between speculation and market manipulation. Manipulation occurs when investors "attack a financial market in order to profit by changing the value of an investment. Profitable speculation occurs when investors accurately forecast an investment's fundamental strength or weakness."

Commissioners

• Mary L. Schapiro Chairman since 2009
• Kathleen L. Casey Commissioner since 2006
• Elisse B. Walter Commissioner since 2008
• Luis A. Aguilar Commissioner since 2008
• Troy A. Paredes Commissioner since 2008

Past commissions

Under president Bill Clinton:

• Arthur Levitt, Jr. - 1993-2001 (Chair: 1993-2001)
• Steven Wallman - 1994-97
• Norman S. Johnson - 1996-2000
• Isaac C. Hunt, Jr. - 1996-2002
• Paul R. Carey - 1997-2001
• Laura S. Unger - 1997-2002

Under president George Walker Bush:

• Harvey L. Pitt - 2001-03 (Chair: 2001-03)
• Cynthia Glassman - 2002-present
• Paul Atkins - 2002-present
• Roel Campos - 2002-present
• Harvey Goldschmid - 2002-present
• William H. Donaldson - 2003-present (Chair: 2003-present)
• Kathleen L. Casey (nominee 2006)

Source: SEC History.

Articles and resources

Related SourceWatch Resources

• American Stock Exchange
• London Stock Exchange
• New York Stock Exchange
• Pacific Stock Exchange
• Philadelphia Stock Exchange
• securities and commodities violations
• Stephen M. Cutler
• Arunma Oteh

External links

• Securities and Exchange Commission, Washington Post, December 18, 2002.

External articles

• Dina ElBoghdady, "SEC’s turf threatened, Commissioner Michael Piwowar says", The Washington Post, January 27, 2014.

• Dina ElBoghdady, "Congress slashes SEC’s funding for technology upgrades", The Washington Post, January 16, 2014.

• Eric Zuesse, "SEC Prosecutor Says SEC Top Brass Are Corrupt", Alternet, April 11, 2014.

• Susan Pulliam and Evan Perez, "Criminal Probe Looks Into Goldman Trading," Wall Street Journal, April 30, 2010.

• Louise Story and Sewell Chan, "Goldman Sachs Messages Showed It Thrived as Economy Fell,"," New York Times, April 24, 2010.

• Daniel Wagner, "SEC Staff Watched Porn as Economy Crashed,", Times Magazine, April 22, 2010.

• Matt Miller, "Goldman Sachs and the Revolt of the Lower Upper Class,, Washington Post, April 21, 2010.

• Sebastian Malleby, "In Sec vs. Goldman, who's really at fault,", Washington Post, April 21, 2010.

• Peter Baker, "Former White House Advisor is a Lawyer for Goldman,", New York Times, April 20, 2010.

• Binyamin Appelbaum, "A Difficult Path in Goldman Case,", New York Times, April 20, 2010.

• Nelson D. Schwartz, "Goldman's Revenue and Earnings Top Forecast,",New York Times, April 20, 2010.

• Economist Online, "Goldman Sachs Charged by the Sec: A Volcanic Cloud Over Wall Street,", The Economist, April 16, 2010.

• Theresa Barraclough, "Treasury 10-Year Yields Near 3-Week Low After SEC Sues Goldman,", Business Week, April 18, 2010.

• Gretchen Morgenson and Landon Thomas Jr., "Glare on Goldman From U.S. and Beyond,", New York Times, April 18, 2010.

• Louise Story and Gretchen Morgenson, "For Goldman Sachs, a Deal's Stakes Keep Growing,", New York Times, April 17, 2010.

• Editorial,"Watch the Goldman Case,", New York Times, April 16, 2010.

• Louise Story,"Top Goldman Leaders Said to Have Overseen Mortgage Unit,", New York Times, April 18, 2010.

• Joel Seligman,"Letting the SEC self-finance would Improve Securities Regulation,", New York Times, February 25, 2010.

• Deborah Solomon,"Questions for Harry Markopolos",New York Times, February 25, 2010.

• Sewell Chan,"New Effort for More Regulation of Wall Street",New York Times, February 23, 2010.

• Damian Paletta,"Volcker Rule Stalls in Senate",Wall Street Journal, February 24, 2010.

• "Over the Years, the Rules Have Changed",New York Times, February 15, 2010.

• Jenny Anderson and Zachery Kouwe,"Robert Khuzami-SEC's Enforcer on the Beat",New York Times, February 8, 2010.

• Robert Smith,"In Recordings, Madoff Offers Tips to Evade SEC",NPR, September 10, 2009.

• Mary Bottari,"Federal Judge Issues Blistering Decision on Failure of SEC to Police Banksters: Oscar Wilde Weighs In",Bankster USA, September 15, 2009.

• Matt Renner,"Financiers Used 'Hotline' to SEC Examiners",Truthout, February 24, 2009.