Why The SEC Should Finally Be Scrapped

In the midst of the tranquil, pre-earthquake, pre-hurricane dog days of summer, Darcy Flynn, a longtime attorney at the SEC, dropped an under-the-radar bombshell. Flynn testified to Congress that the watchdog had systematically destroyed thousands of records about preliminary investigations - in what could well be a strict violation of federal law.

The whistleblower charged that since at least 1993, the SEC had destroyed at least 9,000 "Matters Under Inquiry" that have been closed - including cases relating to Bernie Madoff's humongous fraud, Goldman Sachs's dealings in credit default swaps, alleged financial fraud at Wells Fargo and Bank of America, and alleged insider trading at Deutsche Bank, SAC Capital Advisors and Lehman Brothers. The allegations were first reported by Rolling Stone magazine.

The SEC has been plagued for years by charges that it is an ineffective body. But the latest insider criticism levied at the watchdog should signal an end to its "loose rule" over the financial industry, some say.

In a Bloomberg column, William D. Cohan, a former investment banker and author of "Money and Power: How Goldman Sachs Came to Rule the World", charges that former SEC commissioners Christopher Cox and his predecessor, William H. Donaldson, allowed the financial industry to get away with "an excess of abuses, the extent of which may never be fully known, thanks partly to the SEC's alleged document destruction."

He claims the SEC has had a much too close relationship with Wall Street for too long to make it effective.

From Bloomberg:

"Witness Robert Khuzami, the SEC's director of enforcement, who used to be the general counsel for the Americas at Deutsche Bank in New York, a firm that issued one fatally flawed mortgage-backed security and collateralized-debt obligation after another during the early part of the last decade. (A Senate subcommittee report on the financial crisis devotes 45 pages to Deutsche Bank's squirrelly securities business and the role it played in fomenting the meltdown.)

Is it any surprise that Khuzami set his sights on Goldman Sachs, rather than on his old company, in trying to create some accountability for the mortgage mess? Deutsche Bank was a bigger player in the mortgage-securitization and CDO markets than Goldman Sachs was, yet it was Goldman that the SEC ended up going after in April 2010 when the agency filed -- to great fanfare -- a politically useful civil suit related to a synthetic CDO that Goldman created and sold in April 2007. (Deutsche Bank did many similar deals.) Goldman Sachs settled the accusations in July 2010 for $550 million, more to make the bad publicity go away than because it did anything different from any other Wall Street firm.

There's no evidence of impropriety on Khuzami's part, but it should hardly give investors confidence that someone with such an obvious conflict of interest could bring a suit against a competitor of his old employer. (Schapiro, meanwhile, was previously head of the Financial Industry Regulatory Authority, and was paid almost $9 million when she left to join the SEC.) It goes both ways: For years, top SEC officials have been turning in their regulatory credentials for compensation bonanzas at the very companies they were once charged with overseeing."

Cohan also decries the SEC's "ongoing obfuscation" when it comes to Freedom of Information Act requests.

"The SEC is the black hole of such applications, hanging them up for years and ultimately ignoring them. This is a violation of trust that threatens our democracy and makes it difficult for journalists and historians to figure out what went wrong. Maybe that's the point," he writes.

Ok, so the SEC has a boatload of problems, some of which have just recently come to light, others well-known to industry insiders for years.

But what could the SEC be replaced with?

Cohan says any new regulatory body should pay its employees much higher salaries (which begs the question of whether SEC funding could ever match up salaries paid to private-sector attorneys). But it should not allow any of them to have previously worked on Wall Street.

That might not be as easy as it sounds though. After the whole credit default swap debacle, critics of the SEC charged that regulators didn't actually understand complex financial instruments, and that only those who have actually worked in the financial industry and directly dealt with them can truly grasp their complexity.

Still, Cohan's view that a new regulatory body should have "genuine law-enforcement power, as opposed to the SEC's civil-suit-only mandate, and be able to indict a firm and its top executives for wrongdoing," is spot on.

The new agency should "have the chops to regulate a powerful industry badly in need of it, free of conflicts of interest," he says.

"It's now crystal clear -- and beyond unconscionable -- that the SEC stopped doing its job long ago. We need to rebuild it on a more secure foundation," Cohan writes.