Corporate Governance

The SEC and the Rogue Inspector General

By J Robert Brown Jr.

We were dismayed at the leaks that revealed confidential discussions taking place at a closed Commission meeting about the Goldman case.  We are equally dismayed at the recent announcement by the SEC's Inspector General that he intends to look into allegations that the Goldman case was deliberately timed to coincide with financial reform efforts. 

The Inspector General at the SEC is supposed to be "independent."  In other words, he/she is not an agent of the Commission but is charged with conducting independent investigations and audits of the Agency.  Of course, the Inspector General reports to the Commission (or the chair, depending upon who is deemed "head of the agency") but the Commission has no authority to order the Inspector General to cease any particular investigation.  As the Inspector General Act of 1978 provides:

• Each Inspector General shall report to and be under the general supervision of the head of the designated Federal entity, but shall not report to, or be subject to supervision by, any other officer or employee of such designated Federal entity. The head of the designated Federal entity shall not prevent or prohibit the Inspector General from initiating, carrying out, or completing any audit or investigation, or from issuing any subpena during the course of any audit or investigation.

H. David Kotz, the current Inspector General, was appointed in December 2007 at a particularly tumultuous moment at the Commission.  Only the second Inspector General at the SEC, a position created in 1989 (See § 8G of the Inspector General Act of 1978), Kotz entered the Commission in the aftermath of Senate criticism of the Office. As the Report of the Senate Finance Committee (by a minority of its members) noted:

• The hallmarks of any good Inspector General are independence and integrity. However, the reputation of the Inspector General within the SEC appears to be that of an office closely aligned with management, lacking independence. In addition to the facts of the Aguirre case, we received numerous complaints about the OIG from both current and former SEC employees. The OIG should develop a plan to ensure independence from SEC management and the General Counsel's Office, and to ensure that its future investigations of allegations against management are thorough, fair, and credible.

THE FIRING OF AN SEC ATTORNEY AND THE INVESTIGATION OF PEQUOT CAPITAL MANAGEMENT, PREPARED BY THE MINORITY STAFF OF THE COMMITTEE ON FINANCE UNITED STATES SENATE, S. PRT.
2007, 110–28, 110th Cong., 1st Sess. August 2007

Kotz therefore had a mission to increase the independence of the Office of Inspector General.  He reexamined the SEC's handling of Pequot Capital and has issued reports on the SEC's handling of the ponzi schemes operated  by Madoff and Stanford.  The reports contained some sharp criticism but were necessary.  Particularly with respect to the Madoff report, the Agency had undergone some painful internal restructuring to ensure that there is no repeat of this oversight.

Having said all of that, however, the "independence" of the Solicitor General involves a high degree of discretion that must be exercised with care.  That care was absent from the decision by Kotz to investigate allegations by the Commission of the political timing of the Goldman case. 

The allegation comes from one fact:  The Commission brought the Goldman case just as financial reforms in the Senate moved towards the end game.  A letter to the Commission and signed by eight Republican Congressmen raised the issue.  The letter, however, contained little beyond reference to the timing of the case and its use by Democrats in the financial reform debate. 

The President responded by denying any efforts to coordinate ("This notion somehow that there would be any attempt to interfere with an independent agency is completely false,").  Likewise, Mary Schapiro, Chair of the Commission, was firm in her denial.  As she stated:  

• "The SEC is an independent law enforcement agency. We do not coordinate our enforcement actions with the White House, Congress or political committees. We do not time our cases around political events or the legislative calendar.

• "The fact is that regulatory reform has been pending for over a year. We have brought many cases related to the financial crisis over that period.

• "On a personal level, I am disappointed by the rhetoric.

• "In all my years as a Commissioner and Chair at the SEC and the CFTC — having been nominated to these posts by Presidents of both political parties dating back to Ronald Reagan — I cannot think of any instance where politics was a consideration in bringing an enforcement action. Nor should it ever be.

• "I started this job 15 months ago, in the wake of a serious financial crisis and with the view that the SEC must regulate Wall Street and vigorously enforce the securities laws. We will neither bring cases, nor refrain from bringing them, because of the political consequences. We will be governed always and only by the facts and the law."

Despite the emptiness of the allegations and the firm denials by the relevant participants, Kotz had opted to begin an investigation, an announcement made on Fox News.  According to Politico:

• Separately, the SEC Inspector General H. David Kotz Friday said he would investigate whether the commission had coordinated with supporters of Democratic-led financial regulatory overhaul to announce the case as the legislation was approaching the floor. That announcement came after several letters from Rep. Darrell Issa of California, the top Republican on the Oversight and Government Affairs committee, requesting an investigation of the announcement's timing.

• Kotz, speaking on Fox News, said the investigation was needed 'to understand what led to the decision to announce or bring the case on that day, to see if there was any undue influence involved.'

This is a wrongheaded move both in the ultimate decision and the unprofessional decision to announce it on Fox News.  First, one has to wonder whether decisions about internal investigations ought to be kept confidential.  Second, this decision, which will inevitably show that there was no political pressure, merely emboldens those who make those types of accusations.  It also suggests to the public that there is something to the allegations, damaging the agency's reputation even if ultimately exonerated.

There is no question that valid allegations of political influence should be examined.  Yet the threshold for investigations needs to be more than timing.  Its hard to imagine very many high profile matters brought by the Commission that couldn't be linked to some ongoing political development. 

One of the drawbacks to independence within the Commission is the absence of any check on bad judgment.  This case is an illustration of those costs.   

Full post as published by The Race to the Bottom on April 26, 2010 (boomark / email).