Adding Ineffective Regulation

The new SEC chairman, Mary Schapiro, announced changes supposedly to bolster detection and prosecution of stock fraud. But, as the Wall Street Journal observes, increased enforcement regulation isn't likely to help:

Unveiling her enforcement agenda, Ms. Schapiro proposed to let the staff negotiate fines of publicly traded firms without the approval of SEC commissioners. Some of our readers will note that since Bernard L. Madoff Investment Securities was not a public company, such a change will have zero impact on cases like his.

What we have here is a campaign to restore confidence in the SEC without addressing the true causes of its failures. The news last night that Ms. Schapiro will name a new head of the enforcement division must be paired with a recognition of why the last one failed. At her recent Senate confirmation hearing, Ms. Schapiro pledged that "one of the first things I will do will be to try to take the handcuffs off the enforcement division." As if. The staff conducted its various half-hearted inquiries of Bernard Madoff over the years without ever consulting the Presidentially appointed commissioners.

Staff decisions not to inform their superiors of credible evidence provided by investors like Harry Markopolos didn't simply keep the five commissioners out of the loop. They also meant that the investigations never had a real chance to succeed, because only a majority vote of commissioners can trigger a subpoena. The failure of the staff to request a subpoena was critical. Even if the SEC staff was inclined to believe the information presented by Mr. Madoff, subpoena power would have allowed them to check his books against those of his claimed trading partners and other third parties who might have provided a reality check. . .

If Ms. Schapiro seeks to learn from the SEC's recent history, she might start by considering the most basic lesson from the Madoff incident. Private market participants spotted the fraud, while SEC lawyers couldn't seem to grasp it. Rather than giving her staff lawyers still more autonomy, she should instead be supervising them more closely, while trying to harness the intelligence of the marketplace. Meantime, investors should remember that their own skepticism and diversified investing remain their best defenses against fraudsters.