A quick note on the SEC cover-up

Taibbi’s article is understandably getting a lot of coverage on finance blogs – the revelation that the SEC routinely destroyed thousands of documents related to investigations of Wall Street is a bombshell, even in these cynical times.

I don’t have anything to add on the criminality aspect but I would be very curious to know more about the people involved, because the SEC that he describes in the story is a bit different from the SEC as it is normally described. I don’t say that because I question Taibbi but because it has the potential to change the conventional wisdom about why the agency has failed.

For the traditional narrative, consider this from a 2010 post by Barry Ritholtz, SEC: Defective by Design?:

Over the past 30 years, the financial world has grown exponentially in size, breadth and complexity of products, trading volume, and total assets under management.  In terms of personnel, assets under management, numbers of trader, managers, sales  people,  and mathematical PhDs., who work on the street increased dramatically.The SEC did not.

Indeed, almost by design, the SEC has done a mediocre job keeping up with the finance sector over the past few decades. Their budgeting and salary allowances was far outpaced by Wall Street. The bodies the SEC can throw at any problem are dwarfed by what Wall Street manages. Consider that there are 1,000s of quants working on Wall Street. At the SEC, there are approximately zero.

The post goes on to show the enormous gap that grew between the SEC’s staffing level and the amount of work the agency faced, and concludes:

Congress did not need to deregulate Wall Street — they only had to defund the SEC –which is what effectively happened. Hence, the chief cop on the Wall Street beat was outgunned, overmatched, undermanned and out-lawyered by the industry they were supposed to be regulating.

Ritholtz cites a 2002 GAO report that includes some damning statistics about the work/staffing gap. That report may have been part of the impetus for the agency’s significant jump in funding (the only one between 1995 and 2010, according to the SEC’s numbers) in 2003 during the heyday of Sarbanes-Oxley and the Enron scandal. Even with that increase, however, the agency’s funding has remained poor. The level actually declined from 2005 to 2008, and its 2010 funding was only 12% higher than it was in 2005.

With all of that said, it’s hard to reconcile the claim of resources as the root of the agency’s problem with statements from Taibbi’s article like this one:

As one former SEC staffer describes it, the agency is now filled with so many Wall Street hotshots from oft-investigated banks that it has been “infected with the Goldman mindset from within.”

Those are very expensive hires, even assuming they took a step down in pay from their astronomical hotshot banking salaries. They also introduce a different dynamic than the “revolving door” since those in the revolving door typically start in government and then cash in with a move into higher-paid positions in industry (for some great examples of what the revolving door looks like in action, the bios of the board members of the Defense Business Board – the charming people whose analysis was behind Panetta’s threat to scrap the military pension this week – are paragons). The SEC hiring young Wall Street hotshots, at inflated salaries, is almost the opposite of that.

The questions then would be when these people were hired, by whom, and how much of the agency’s inadequate budget they consume. That would say a lot about the new dynamics of the SEC.

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