No One Told You?

“’We're not sitting around waiting for people to call us,’ says Norm Champ, deputy director of the SEC's compliance office. ‘But one of the problems we have is when people spot things but don't tell us. If people think they have something, they should let us know.’”

The Intelligent Investor, Why Regulators Can’t Keep ‘Safe’ Bond Funds From Sinking, Wall St. J., Jan. 15, 2011, at C1.

Last week the SEC charged Charles Schwab with misleading investors about the safety of a short-term bond portfolio.  The Intelligent Investor used this as a jumping point to highlight the limits of regulation.  As the article points out, the SEC struggles to keep up with individuals in the financial industry for a variety of reasons.  One key reason being that the SEC is understaffed.  The commission has 460 examiners that monitor 7,500 mutual funds, 1,000 exchange-traded funds and 11,000+ investment advisors.

Despite being over matched, the SEC does not seem to be getting any help from outsiders.  Or does it?  Harry Markopolos is one example.  Markopolos is a former securities industry executive best known for blowing the whistle on Bernie Madoff.  He was asked to look into the Madoff Fund to see how his firm could match Madoff’s double-digit returns.  He quickly realized that the fund was a fraud and reported it to the SEC.  As he chronicles in his book, No One Would Listen, the SEC ignored numerous warnings about Madoff for a period of fifteen years.

Back in March, Markopolos was on the Daily Show and, while ranting about the SEC, brought up an interesting point.  He argued that one of the principle problems with the SEC is that it is staffed with lawyers.  While intelligent people, they do not possess the level of financial sophistication required to keep up with constantly evolving financial markets.  While I do not know how the SEC is staffed, I agree: lawyers can not keep up with financial innovators.  Financial innovation is not the specialty of lawyers and it is too complex to understand it at the same level as hedge fund managers.

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For more on the need to better train lawyers in financial matters, see Robert J. Rhee, The Madoff Schandal, Market Regulatory Failure and the Business Education of Lawyers, 35 J. Corp. L. 363 (2010).

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