Edward Siedle, Contributor
Today we learned that an SEC whistleblower recently came forward to Congress with compelling evidence that the Commission over the past two decades has been systematically destroying records of its Division of Enforcement’s preliminary investigations once they are closed. Records related to past inquiries into insider trading, fraud and market manipulation against companies like Goldman Sachs, Deutsche Bank and AIG have disappeared from history.
While that tip-of-the-iceberg revelation may be upsetting, those of us who are familiar with SEC internal record policies have long known that far more information regarding investment crimes has been systematically withheld by the SEC from the public.
In 2000 I wrote an article entitled, “No Freedom of Information When It Comes to Money Managers” which addressed an issue that had bothered me since I began my career as a young staff attorney with the Securities and Exchange Commission. That is, while the SEC through its routine examinations of securities dealers and money managers and special investigations has over the decades accumulated a treasure trove of information regarding industry wrongdoing, the Commission has consistently and vigorously resisted making this damning information available to investors.
Ironically, an agency created to compel disclosure of material information to investors has morphed into the single most formidable opponent to disclosure of that information to investors.
The federal securities laws establish a two-tier disclosure system. Certain information must be disclosed by the regulated to the SEC and investors; other more sensitive information need only be disclosed or made available to the SEC. However, the SEC could, if it chose, make almost all of the information it collects from companies available to the public.
For example, investment advisers regularly, every three to five years, undergo inspection by the SEC for compliance with the federal securities laws. There are few surprises to the industry here; the inspection manual the SEC examiners use is made available to the industry and private companies offer mock SEC examinations for a fee.
Upon completion of an inspection by the SEC, the agency issues a letter detailing the firm’s deficiencies, if any. Given the complexity of the industry and its corresponding regulatory scheme, few firms are deficiency-free. The letters firms receive from the SEC upon completion of the inspection are not disclosed to the investing public. I regularly review firm deficiency letters on behalf of pensions and have rejected firms based upon revelations in these letters.
If, in the Commission’s opinion, a firm’s deficiencies are extremely serious, an “enforcement” action may be recommended against the firm. At this point, there is ample opportunity for the firm, represented by counsel, to negotiate, settle, or lobby its way out of the “enforcement” recommendation. If the matter is not resolved between the firm and the agency and an enforcement action proceeds, eventually, but not necessarily, the matter may be disclosed to the public. The SEC frequently agrees to delay damaging public disclosures. Violations the SEC uncovers in an examination but determines to be less serious are never disclosed to the public.
Thanks to the SEC, the results of SEC inspections of money managers are not available to the public under the Freedom of Information Act. In 1997, the U.S. District Court for the District of Colorado in Berliner, et al v. SEC, granted a motion by the SEC to dismiss a complaint filed requesting the production of documents related to an SEC examination of an investment adviser whose registration was revoked by the SEC and was defunct.
The plaintiff alleged that the SEC examination related to a large-scale securities fraud perpetrated by the adviser. The SEC examination produced 325 pages of documents. While the court noted that “FOIA reflects a general philosophy of full agency disclosure unless information is exempted under clearly delineated statutory language” and that “disclosure, not secrecy, was the dominant objective of FOIA,” the court nevertheless ruled that the results of inspections of investment advisors were exempt from disclosure under FOIA..
Why did the court rule that such information should be held from public scrutiny?
Here’s where our story gets weird. The court referred to testimony from the SEC that “revealing the confidential commercial and personal information contained in SEC examination reports relating to investment advisors would have a devastating effect on the SEC’s ability to regulate investment advisors and would cause embarrassment to clients whose private financial records would become subject to public scrutiny.”
That right: The Commission testified against disclosure to investors. Even the judge wrote that he wasn’t convinced revealing the information would be “devastating” to the SEC, but he did share some of the agency’s concerns. The record does not indicate any investor advocacy group testified as to the benefits investors would derive from disclosure.
The argument against disclosure that prevailed in this case is familiar and tired. That is, in order to foster an environment of “full cooperation” between the agency and the entities it regulates, sensitive details collected by the SEC should be held secret.
There are major flaws in this argument. First, there is no environment of “full cooperation” between securities dealers or money managers and the SEC today. Firms regularly withhold information from the Commission regarding illegalities under the attorney-client privilege and by other means. What exists today between the SEC and the regulated is selective or limited cooperation. Of course, brokerages and investment managers will always cooperate with regulators to a degree because if they don’t, they’ll face harsher treatment.
Second, the court, while professing to be concerned about the embarrassment of clients of managers and not managers themselves, never considered an alternative that would have required disclosure of all information but the names of clients. What was really being addressed was whether Wall Street would lose credibility if all its wrongdoing was subject to public scrutiny. What would be the effect upon the financial markets if the rules were suddenly changed? Does concealment that fosters confidence benefit or harm investors? The court didn’t want to open up a Pandora’s box.
As I said in 2000, concealment of violations, illegalities and improprieties, is misleading and harmful to investors. The odds that investors will make successful investment decisions are greatly enhanced when the regularity of improprieties is apparent. Nothing is gained by secrecy and the SEC should be the last voice supporting nondisclosure.
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