SEC and You Shall Not Find

What is the SEC good for?

That’s what Bloomberg’s Jon Weil asks. Good question. Why did it take a court-appointed examiner to do for Lehman what the SEC should have done long ago?

Here’s what boggles the mind. Before Lehman filed for bankruptcy in September 2008, the SEC had been its primary regulator. The SEC’s enforcement division presumably has been investigating Lehman’s accounting ever since the company collapsed, or at least it should have been. Yet it wasn’t until after Valukas released his report that the SEC began showing any concern, or even awareness, that such accounting hocus-pocus may have been going on at Lehman or elsewhere.

Could it be that the SEC, led by Chairman Mary Schapiro, didn’t know the full scope of Lehman’s Repo 105 chicanery until after Valukas made his report public? The agency has said nothing to dispute such an inference. When I asked an SEC spokesman, John Heine, if this was the case, he declined to comment.

Would we have ever found out about the Repo 105 fraud if Anton Valukas hadn’t been on the case? Well, Weil again:

Even more telling was the explanation Valukas got last November when he interviewed Matthew Eichner, a former assistant director of the SEC division that supervised Lehman. Valukas said Eichner wasn’t aware of Repo 105, by name or description. Yet even if the agency had known about the volume of Lehman’s Repo 105 deals, Eichner said it wouldn’t have been a signal “that something was terribly wrong.” Eichner, now an adviser at the Federal Reserve Board, said this was because the SEC’s monitors didn’t put much stock in leverage numbers.

Amazing. I think it’s safe to say the SEC wouldn’t have dug it up.

Eliot Spitzer is on the same track over at Slate, and he zeroes in on chairwoman Mary Schapiro:

Two years after the largest financial meltdown in history, the SEC has still not brought any cases that challenge the structural flaws of the financial industry.

Spitzer’s hide is chapped by the SEC’s bizarre move to take the side of Wall Street in watering down his hard-won settlement separating analysts from bankers early last decade, and he outs Schapiro once and for all (in case it wasn’t already apparent) as an industry-captured regulator. This from discussions when he was New York attorney general and she was a top official at industry-controlled regulator NASD:

Schapiro did get active, however, during the discussion of one point critical to restoring integrity to the markets. “Spinning” was the term used to refer to the way investment banks allocated shares of a “hot” initial public offering to executives of other clients of the bank. Because IPO shares were almost always underpriced, recipients of these shares were sure to reap a huge profit when the hot stock jumped.

Our view, backed by the courts, was that this issuance of stock was a benefit to CEOs thashould have gone, if to anybody, to the shareholders of company making the IPO. It was called “spinning” on Wall Street, but in more common parlance, it is known as a bribe: Money paid to a CEO as an inducement to continue to do business with the investment bank. We therefore argued for a ban on this practice.

Schapiro took the other side, arguing that CEOs should continue to receive these benefits. Our argument prevailed, and over her objections, the final settlement banned spinning. My office later recovered significant sums from chief executives whom courts determined to have received “spinning” allocations. We claimed, successfully, that these allocations were a straightforward violation of the CEOs’ fiduciary obligation to the shareholders.

It’s worth recalling that Schapiro was hardly thought to be a fearsome watchdog when Obama was picking his industry-friendly financial appointees. Here was the headline of an excellent The Wall Street Journal story from last year:

Obama’s Pick to Head SEC Has Record Of Being a Regulator With a Light Touch

In the January 2009 WSJ piece we find one possible reason the SEC hasn’t been more aggressive on Lehman: It’ll make Schapiro’s failures at FINRA (NASD’s successor, which she headed) look even worse:

But Lehman’s problems ran far deeper: not having enough capital and apparently carrying its huge holdings of complex mortgage securities on its books at too high a value.

People close to Ms. Schapiro say the Lehman mess and the broader mortgage meltdown occurred outside of what Finra inspects: brokerage accounts. But firms were selling the mortgage securities in brokerage accounts, to investors large and small. Finra is also responsible for seeing to it that the valuations of securities sold in brokerage accounts are accurate.

Joseph Mays Jr., a consultant to small broker-dealers and a former NASD examiner, says Finra should have scrutinized the mortgage-backed securities at the root of the crisis. “If I had to assign blame, I’d blame Finra and the SEC, but I’d blame Finra first because it’s the first line of defense,” he said.

The only thing worse than having no watchdog is the false security of having one—and then finding out it gums its Kibbles ‘n Bits.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.