SEC Chairman Bernie Madoff

“SEC Chairman Bernie Madoff”. The words just roll off the tongue, don’t they? Especially when your jaw is resting on the floor.

Investment News has posted a short article on findings of an internal SEC investigation into interactions between the SEC and Madoff’s firm, and it’s a noxious blend of surrealism, agency abuse, and wretched ethics.

The jaw dropper in the story is the possibility that, over a decade into his firm’s $50B fraud, Madoff believed himself to be outgoing chariman William Donaldson’s successor. Was he just delusional? Or was there a real possibility of such a tragic political appointment?

According to an executive summary of a report released yesterday by the Securities and Exchange Commission’s inspector general, Mr. Madoff told SEC examiners in 2005 that he was “on the short list” to become the next SEC chairman…

The following excerpts (emphases added), like the rest of the Madoff affair, will only reinforce the stubborn view that Wall Street is hopelessly stacked against the little guy:

Although the IG report summary details numerous dropped balls by SEC examiners and enforcement staff that allowed Mr. Madoff to conduct a massive Ponzi scheme over a period of years, his prominence in the securities industry may have helped him avoid scrutiny.

The report said that throughout a 2005 examination of his firm, “Bernard Madoff would drop the names of high-up people in the SEC” to SEC examiners.

When examiners in the SEC’s Northeast regional office complained to their assistant director about not getting cooperation from Mr. Madoff, “they received no support and were actively discouraged from forcing the issue,” the IG report said.

When the Northeast regional staff inquired about a similar exam that had been performed earlier by the Washington staff, a senior-level Washington examiner told junior-level examiners in the Northeast office that Mr. Madoff “was a very well-connected, powerful, person,” the report said.

When Northeast office examiners wanted to look beyond the issue of front running at Mr. Madoff’s firm, their assistant regional director denied their request, the IG report said.

A request to look into Madoff feeder funds was also denied.

Boy, with friends in high places, there’s nothing you can’t do…to other people especially!!!

Here’s the surreal part. Despite the implications of the foregoing findings, the SEC report concludes that “inexperience and poor training were key causes of the failure” of three examinations and two investigations to find any wrongdoing. Good grief…

There’s a disturbing possibility at work, which is that Madoff may have viewed an SEC chairmanship as providing some protection or cover for the criminal risks he was involved in. Had he taken over from Donaldson, the scandal could have put the SEC out of existence!

We can only hope that Madoff was a self-deluded name dropper and nothing more. Otherwise, Chairman Schapiro’s response to the Madoff scandal — “to hire new skill sets, [increase] internal training, and [seek] more resources to keep pace with financial fraudsters” — ignores the more glaring and fundamental need, which is to overhaul the culture, ethics, and agency risks inside the SEC.

We’re sure there’s more to come. Stay tuned.

URLs:

http://www.investmentnews.com/apps/pbcs.dll/article?AID=/20090903/REG/909039994/1094/INDaily01

Wage Controls on the Way?

The WSJ editorial page is decrying “The New Wage Controls” today:

The U.S. “market” economy took another hard-to-believe turn this week with the Obama Treasury appointing a “compensation czar” to dictate wage controls on private companies that take taxpayer money and offer guidelines for every other U.S. publicly traded company.” Can wage and price controls for everyone be far behind?

This is disingenuous hyperbole, for a few reasons. First, claiming that executive compensation in the ante-Obama era resembled a “market” driven system is plain wrong. Rather, it was (and still is) driven by federal rules and regulations, and fraught with agency risk and distorted incentives (much like the mortgage market, in fact). And while there is longstanding debate over whether executive compensation and corporate performance are well correlated, we know at the very least that the relationship is not a statistically powerful one, and that there have been notable instances of huge gaps between the compensation lavished on some public companies’ executives and the long term value those executives provided for their firms’ shareholders. All in all, it’s not hard to make the case that it’s a somewhat dysfunctional system, and a recent NY Times article summed it up well:

For some time now, “should” has been the operative word for investors and corporate governance groups pressing for closer links among executive pay, performance and shareholder value.

Second, the “compensation czar” is only going to oversee management compensation at the companies that are relying on direct public support. Essentially (or ostensibly), we the people, via the federal government, have become creditors and/or shareholders of certain companies, and as such, are exercising some control over how our assets are used. This simply means is that there’s finally a stakeholder at the table other than executive management and directors with some power. In a better functioning system, company directors and executives would already behave as their own ‘compensation czars’, rather than steadily enriching themselves at shareholders’ expense (a small percentage of companies have boards and management that do behave this way; perhaps not surprisingly, few if any are on public life support at the moment). In the case at hand, it sounds as though the federal government and its comp czar are simply going to act as any responsible business owner would.

There’s a bitter irony in all of this though, as the executive self-enrichment of recent decades was enabled to a significant extent by public policies and regulations at the federal level, including: ownership discloure rules that have made it easier for bloated managements and boards to defend entrenched positions; caps on the tax deductibility of executive compensation that have led to over reliance on generous short term option grants and a short term focus on stock performance; and minimal disclosure of executive perqs (though the SEC improved that last one slightly in recent years). And that’s just a small sampling. We can only hope, when this episode is over, that the men and women in Congress don’t forget what it feels like to be an equity holder. Unfortunately, we suspect that those expensive plates at future campaign events will come with more than a healthy dollop of amnesia. Thus,  if the office of the comp czar were truly put to good use, it would seek to dismantle and redesign the regulations and tax rules that continue to work against the interests of ‘regular’ shareholders.

URLs:

http://online.wsj.com/article/SB124476565985708427.html

http://www.nytimes.com/2009/04/05/business/05comp.html

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1014281

More Industry Black Eyes

The SEC believes it’s uncovered another case of wrongdoing, this time at a firm headed by a “prominent member” of the National Association of Financial Planners, or NAPFA. The bitter irony for NAPFA members is that the organization is very vocal about working in clients’ best interests, rather than following Wall Street business-as-usual.

Here’s an interesting editorial take on the story and what it means for the industry:

The allegations of wrongdoing against a former NAPFA president could not have come at a worse time for the group, which is part of a troika with FPA and the Certified Financial Planner^® Board of Standards lobbying Congress for creation of a new Self Regulatory Organization to oversee financial planners. Last month, another NAPFA member, Matthew Weitzman of AFW Wealth Advisors in New York City, was caught up in scandal and was reportedly the target of an SEC probe, according to a story by New York Times personal finance columnist Ron Lieber, who was one of Weitzman’s clients.

In a post here just yesterday, I mentioned that the continuing string of scandals involving RIAs make it unlikely that any effort to further regulate RIAs could be thwarted by NAPFA, FPA and the CFP Board. But revelations about Putman are particularly sad because he held himself out as a leader of NAPFA, an organization that is dominated by members with great integrity, advisors who have always been at the forefront in campaigning for issues in the interest of consumers. To see NAPFA’s reputation stained by a few bad members is heartbreaking…

While NAPFA has remained a beacon of light in the sometimes shrouded world of financial advisors by supporting a fiduciary standard, it also increasingly became a marketing machine for advisors who used the referral network and favorable press garnered by NAPFA to grow their businesses and who were little interested in the high ideals of many the group’s members. Perhaps the news about Putman’s troubles will cause an introspective discussion among NAPFA members and help the group reclaim its high moral ground.

Gluck concludes by calling the financial media to task:

One other good thing that may come of this is that maybe—just maybe—a reporter in the consumer press will write about the idiocy of these “top financial advisor” lists, which sell magazines but stink at figuring out which advisors are really the best. There is no substitute for real research, which these magazine stories always fail to do. While the articles in Worth and Medical Economics were great marketing for Putman’s firm, these publications can’t possibly research all of the nation’s advisors and find the best ones without a massive effort, an undertaking they are unlikely to know how to effecutate [sic] or finance.

Our editorial slant: Unfortunately, these kinds of episodes seem likely to increase the probability of excessive and/or poorly designed regulations, which will limit consumers’ choice and industry dynamism over the long run. We do accept that regulations can and should be improved when appropriate, but we don’t see how regulations will ever prevent human beings from being human beings (consider that despite the rule of law, societies still need prisons), however badly we want to reduce the risk of malfeasance in financial services to zero. There appear to be some common threads to most of the fraud cases brought by securities regulators, which leads us to believe that one of the most powerful tools for creating a better regulated industry is education. Not the kind of financial education we’re used to, like consumer pamphlets from public agencies and glossy marketing pieces from private organizations, but actual education, starting sometime in the K-12 years. There are few aspects of life more important or more prevalent than finance, and while almost everyone has the opportunity to use financial technologies (and potentially bring ruin upon themselves), far fewer have the opportunity to learn what it’s all about.

Fortunately, American civil life is still alive and well, despite occasional hysteria about its demise. We know of charter schools in our area dedicated to finance, business, and entrepreneurship, and other organizations have sprung up to fill the gap. We just came across this one in Colorado (thanks Google), which offers some some statistical data in support of its mission and our editorial above.

URLs:

http://www.investmentnews.com/apps/pbcs.dll/article?AID=/20090608/REG/906079995/1094/INDaily01

http://www.napfa.org/

http://gluck.advisorblogcentral.com/post/2009/05/Former-NAPFA-President-Faces-SEC-Fraud-Charges.aspx

http://www.yacenter.org/index.cfm?fuseAction=financialLiteracyStatistics.financialLiteracyStatistics