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A Failure of Funding

After the 9-11 attacks exposed faults in terrorism detection–overlooked clues, ignored tips, bureaucratic quagmire — Republicans joined with Democrats to supercharge homeland security.  American should not suffer another 9-11.

Yet illogically and hypocritically, Republicans now use failure by Wall Street police to detect and shut down the Madoff Ponzi scheme as an argument to gut funding for the Securities and Exchange Commission.  At three hearings on March 10, Republicans invoked this Madoff rational.

The Republican case is illogical because Americans, of course, must not be forced to suffer due to inadequate Wall Street police. Our current recession, with nine million unemployed and thousands evicted from their homes, stems from woefully deficient supervision.

The Republican case is hypocritical because the SEC’s Madoff failure came largely on the Republican watch.

But Republican’s have apparently advanced the Madoff argument because their first rhetorical efforts to defund the SEC didn’t play with America. Republicans first claimed they weren’t picking on the SEC in particular, but simply exercising general fiscal responsibility. They’re cutting everything. But that’s a specious argument at the SEC, which is self-funded through fees. Congress limits the fees it can then spend for operations. In fact, the SEC recoups investor funds from fraud. Last year, that figure topped $2.2 billion, twice the SEC’s annual budget.

Then, apparently, some Republicans bragged they could stop implementation of the Dodd-Frank Wall Street Reform Act by starving the agencies of the funds needed for implementation. In the first hearing of the Senate Banking Committee, ranking Republican Sen.  Richard Shelby explained. “A lot of us voted against and oppose Dodd-Frank. Obviously, we’d repeal it. So I certainly don’t think we should rush to implement it.”

But America desperately needs Wall Street reform.

Even sober private sector attorneys who represent corporate clients before the SEC understand the need for full funding. Forty such attorneys recently appealed for sanity to congressional leaders in a letter. “In an economy desperately needing investor confidence to promote capital formation and economic growth, the regulator of our capital markets is running almost on empty,” penned the counselors, led by K&L Gates partner Stephen J. Crimmins.

No one denies that the SEC missed the colossal Madoff fraud that ripped some $18 billion out of the some of the nation’s most worthy charities.

However, it is clear that an already under-resourced SEC figured prominently.

Madoff said he could have been caught in 2003. “I was astonished. They never even looked at my stock records.” According to an Inspector General’s report, the SEC lacked experienced staff for a rigorous review. And it was a Bush-appointed commission that missed, ignored or simply misdeployed junior staff to examine what turned out to be the biggest illegal scam (not a redundancy) in Wall Street history.

True, at least some of the Madoff failure spills on Democrat doors. Current Chair Mary Shapiro acknowledges that David Becker, who served as general counsel, should have recused himself from the case because his mother invested with the Madoff fund.

Examination of the SEC’s Madoff failures can and must help sharpen the teeth of our Wall Street watchdogs. But with the nation digging out from an entire recession borne of financial fraud, we need to confront the real and daunting budget obligations of responsible supervision. At a Senate hearing Sen. Jack Reed (D-R.I.) note that “Between 2005 and 2007, just as the markets were reaching a critical stage, the SEC’s budget was frozen or cut. … The SEC lost ten percent of its staff, which severely hampered its enforcement and examination programs, effectively taking cops off the streets just when they were most needed. Even now, frozen at its 2010 funding levels, the number of SEC staff is only just returning to where it was prior to 2005.”

At a House hearing Rep. Maxine Waters (D-Calif.), also shared her concerns about congressional Republicans basing their funding levels on 2008, as that was, “the year the nation’s financial markets collapsed and … when lawmakers realized that the resources we had provided to the regulators of those markets had been sadly lacking.”

At a Senate hearing, SEC Chair Mary Shapiro lamented her agency’s information resources. “Our market analysts continue to use decades-old technology to recreate market events or to monitor trading that occurs at the speed of light.”

Dodd-Frank adds to the SEC’s responsibilities, requiring it to oversee an additional 30,000 institutions with its 3,800 staff. For context, the New York City police number  34,500. Already, the SEC must oversee some 6,400 public companies.

Defunding the SEC threatens to exacerbate the asymmetry that already challenges SEC cops chasing especially fleet thieves. Consider: Veteran staff enforcement attorneys at the SEC may earn $125,000, whereas first year attorneys at elite private firms begin at $160,000.

Compensation—greed, many say–is central to Wall Street. The best paid hedge fund manager in 2010 received $5 billion, or about $2.5 million an hour. The lure of such huge compensation apparently drives some to illegal activity, such as exploiting insider information. (The SEC doesn’t just police Ponzi scheme fraud) For example, the SEC recently accused a Procter & Gamble board director of tipping a friend at a hedge fund with insider information. That 2 minute phone call allegedly allowed the hedge fund to profit a half million dollars.

P&G naturally says it is cooperating fully with the SEC’s investigation, but one suspects that company officials don’t exactly find this a happy experience. P&G is the largest employer in the 8th district of Ohio, home of House Speaker John Boehner. A happy time or not, Public Citizen calls on the Speaker to award the SEC the budget necessary to complete this and all the other investigations necessary to keep our financial markets the jewel of the American capitalist crown.

Taxpayers can’t be asked to attract the brightest sleuths to the SEC with money. But we shouldn’t insult and undermine the public-spirited servants that have eschewed the high pay of Wall Street to work at the SEC by emasculating what budget they have.

A briefer version of this blog post appeared in The Hill.

Bartlett Naylor is the financial policy advocate for Public Citizen’s Congress Watch.