Today’s Economist: Simon Johnson: The S.E.C. at a Turning Point

Simon Johnson is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

The job of head of enforcement at the Securities and Exchange Commission is now open. The Obama administration should press for the appointment of Neil Barofsky, former special inspector general for the Troubled Asset Relief Program, to this position. Unfortunately, the administration has given no indication it will do so, leaving the impression that it is likely to be business as usual for the next four years, with regulators who are less than tough on the industry.

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(I have also endorsed Mr. Barofsky as a chairman of the S.E.C.; clearly, I want him at the commission one way or another.)

The departing director of the division of enforcement at the S.E.C. is Robert Khuzami, a former general counsel for the Americas at Deutsche Bank, a job he held from 2004 through early 2009. Although Mr. Khuzami was once a distinguished prosecutor, his appointment to the S.E.C. turned out to be a mistake because Deutsche Bank was so deeply involved in the securitization morass that led to the financial crisis of 2008.

(For more details, I recommend this Web page, with information collated by UniteHere, a trade union. You should also read this assessment by Yves Smith on her nakedcapitalism blog.)

Mr. Khuzami has vigorously defended his record and insisted it would have been “unwise” to press Wall Street firms and their executives for admissions of guilt. Whether the S.E.C. failed to prosecute the executives who made the key decisions because it had no case or because of Mr. Khuzami’s views, we may never know.

In addition, concerns continue to grow regarding the extent of mismanagement and illegal activity at Deutsche Bank during Mr. Khuzami’s time there; Mr. Khuzami has recused himself from the latest S.E.C. investigations.

According to Jordan Thomas, a lawyer representing one of the whistleblowers from Deutsche Bank, as quoted in the Financial Times,

During the financial crisis, many financial institutions faced an existential threat and the evidence suggests that Deutsche Bank crossed the line by substantially inflating the value of its credit derivatives portfolio – the largest risk area in its trading book.

This is precisely the kind of complex case that requires a skilled prosecutor with detailed knowledge of how the industry works. At the same time, it cannot be someone who has worked for a major financial institution either directly or as its outside counsel. The potential for a perceived conflict of interest is too great.

In the past, we would have looked to the United States Attorney’s Office for the Southern District of New York for the right kind of talent. But in the last few years this office has focused much more on insider-trading cases, with much of its evidence collected through wiretaps. The human capital that is capable of directly prosecuting and winning complicated securities fraud cases is much depleted.

Fortunately, Mr. Barofsky is at hand and is an excellent choice for head of enforcement at the S.E.C. (though surely not the only one so qualified). A career prosecutor who worked for the United States Attorney’s Office in a previous era (through 2008), Mr. Barofsky successfully pursued mortgage fraud cases and complex securities fraud and accounting fraud cases, including against the most senior executives of the former commodities giant Refco. He also worked on drug-trafficking cases, going up against some of the most dangerous criminals in the world.

In the fall of 2008, Mr. Barofsky, a Democrat, was nominated by the Bush administration to become the independent lawyer inside the Treasury Department (special inspector general, in Washington parlance) responsible for supervising the implementation of the divisive Troubled Asset Relief Program, or TARP. He was confirmed with bipartisan support and continued to enjoy such support until he stepped down in early 2011.

At TARP, Mr. Barofsky investigated and studied carefully almost every corner of the financial system, with the goal of preventing fraud and abuse in the use of taxpayer money. He prosecuted people who broke the rules and who were trying to steal from the government (and from you).

Remarkably, Mr. Barofsky had to contend with initial resistance from the Treasury team led by the secretary, Henry M. Paulson Jr. The extent and sophistication of resistance to Mr. Barofsky’s sensible compliance recommendations increased dramatically once Timothy F. Geithner was confirmed as Treasury secretary.

The Treasury philosophy was that all of its financial stability policies were intended to “foam the runway” for banks – making it easier for them to earn their way out of the crisis. The Obama administration’s much-hyped mortgage-modification program, for example, was designed and implemented in ways that were always going to be harmful to many homeowners, a point that Mr. Barofsky and his team made before, during and after this became painfully evident to the rest of us.

Mr. Barofsky understands the details and knows how to build an office that combines effectiveness and integrity with its own investigative capability. His reports will long stand out as beacons of clarity. (The TARP special inspector general reports are on the Web; the Barofsky reports are from February 2009 through January 2011.)

Another advantage to Mr. Barofsky’s appointment is that we would not have to fear that he would later rotate into a senior position on Wall Street. As he made abundantly clear in “Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street,” Mr. Barofsky has burned all those bridges already.

We need an honest and experienced prosecutor to oversee enforcement at the S.E.C. This person must be beyond reproach and able to tackle wrongdoers, no matter how powerful their political connections or how complicated their cover story.

Fortunately, we have Mr. Barofsky. It is no time for business as usual at the S.E.C.; it sorely needs an effective head of enforcement.

Article source: http://economix.blogs.nytimes.com/2012/12/27/the-s-e-c-at-a-turning-point/?partner=rss&emc=rss