Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Markopolos on the SEC

Last year, I blogged
about the Markopolos submission to the SEC (way back in 2005) in which
he argued that the Madoff fund was a Ponzi scheme. I wrote then that
the Markopolos submission was extremely persuasive and well argued and
was a good example of forensic economics. His prepared testimony
to the US Congressional hearings is even better at explaining his
deductions. He talks about how his army special operations background
trained him “to build intelligence networks, collect
intelligence reports from field operatives, devise lists of additional
questions to fill in the blanks, analyse the data and send draft
reports for review and correction before submission.”

The entire 65 page document is worth reading in full. What I found
most interesting (after having read the 2005 submission) is what he
has to say about the SEC. What happens when he turns his forensic mind
at the SEC itself is really fascinating. He pulls no punches either in
his diagnosis or in his recommendations:

  • Unfortunately, as bad a regulator as the SEC currently is, and the
    SEC certainly is a bad regulator, it is the best of a very sorry
  • …the SEC is a group of 3,500 chicken tasked to chase down and
    catch foxes which are faster, stronger and smarter than they are.
  • Amazingly, the SEC does not give its employees a simple entrance
    exam to test their knowledge of capital markets! … Talented CPAs,
    CFAs, CFPs, CFEs, CIAs, CAIAs, MBAs, finance PhDs and others with
    finance backgrounds need to be recruited to replace current
    staffers. … I caution the SEC to avoid focusing on any one of the
    above professional certifications at the expense of the rest because
    all are relevant and necessary. … Diversity will ensure that group
    think is kept at bay. … Right now the SEC is overlawyered. Hopefully
    it can transition away from this toxic mix as quickly as possible.
  • SEC staffers need to be encouraged to attend industry conferences
    … [and] … educational meetings. … Either the SEC is
    anti-intellectual and intentionally maintaining staff uneducated about
    the capital markets or it is ignorant.
  • SEC staffers … with industry credentials [like CPA, CFA etc]
    … are not allowed to have their designations printed on their
    business cards … if the SEC allowed its few credentialled staff to
    put these credentials on their business cards, it would expose the
    overall lack of talent within the SEC.
  • But if you walk into an SEC regional office, you won’t see
    any of these journals [Journal of Accounting, Journal of Portfolio
    Management, Financial Analysts Journal, Journal of Investing, Journal
    of Indexing, Journal of Financial Economics and so on]. … Apparently
    all the SEC uses is Google and Wikipedia because both are free.
  • If an SEC staffer doesn’t know derivative math, portfolio
    construction math, arbitrage pricing theory, the capital asset pricing
    model, both normal and non-normal statistics, financial statement
    analysis, balance sheet metrics or performance presentation formulas
    then they shouldn’t be hired other than to fill administrative
    or clerical positions.
  • … the SEC needs to recruit foxes in senior, very high paying
    positions that offer lucrative incentive pay for catching foxes and
    bringing them to justice. … highly successful industry
    practitioners who have succeeded financially during their long careers.
  • Compensation at the SEC needs to be both increased and expanded to
    include incentive compensation tied to … enforcement revenues.
  • It is my belief that SEC examiners are so inexperienced and
    unfamiliar with financial concepts that they are literally afraid to
    interact with real finance industry professionals and choose to remain
    isolated in conference rooms inspecting pieces of paper.
  • … most SEC Regional Offices are lucky to have even one Bloomberg
    terminal for the entire region’s use. Whereas your typical
    investment firm would have one Bloomberg per analyst, trader and
    portfolio manager.
  • Fortunately, the US has two very competent securities’
    regulators who do a truly fantastic job and at an unbelievably low
    cost. Unfortunately, they are the New York Attorney General’s
    office (NYAG) and the Massachusetts Securities Division (MSD). … one
    alternative solution is to disband the SEC and give its budget to the
    NYAG and the MSD.
  • … consider moving the SEC out of Washington because Washington is a
    political centre and not a financial centre

I think that by and large Markopolos is on the right track though I
disagree with a few of his recommendations. The question is whether
any of this is likely to happen. Unfortunately, state failure is as
endemic as market failure (if not more).


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