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Pity the toothless terriers of the SEC

Mary Schapiro, chairman of the U.S. Securities and Exchange Commission, speaks during a Financial Stability Oversight Council meeting in Washington late last year. Bloomberg News file photo

The initial one-sentence dispatch that Bloomberg News published last week, about the latest courtroom twist in the Galleon Management insider-trading saga, was as strange as it was intriguing.

In its entirety, it read: “Raj Rajaratnam and his co-defendant Danielle Chiesi were ordered by a federal judge in New York to turn over wiretaps the government made of their conversations to the U.S. Securities and Exchange Commission.”

Naturally my first reaction was incredulity. There must be an error in the story, I thought. Maybe the reporter switched around the names of who was ordered to turn over what to whom? My gut instinct was wrong. The article was correct.

Here we have two defendants: Rajaratnam, the former Galleon hedge fund chief whose criminal trial is scheduled to begin Feb. 28, and Chiesi, who pleaded guilty last month to three counts of conspiracy to commit securities fraud after fighting the government’s charges for more than a year. The SEC is suing both in a separate civil proceeding. The U.S. Justice Department and SEC are cooperating with each other. And you mean to tell me that the only way the SEC could lay its hands on the government’s wiretaps was to get them from the defendants? The prosecutors couldn’t give the SEC copies?

It’s sad but true, as I confirmed when I read the court papers in the SEC’s case. I then realized that, up until that moment, I had no idea just how weak the SEC really is. If these are the handcuffs the SEC has to deal with on a big case like this, then it’s no wonder its enforcement division’s performance over the years has been so feeble.

No sharing

It turns out the 1968 statute that authorized the government’s wiretaps doesn’t allow the government to share them with the SEC. Or at least that’s the position taken by prosecutors in the criminal case. So, to get around this, the Justice Department first had to turn the wiretaps over to the defendants. That way, the SEC could get them later on during discovery for its own lawsuit.

After the SEC requested the evidence from Rajaratnam and Chiesi, their lawyers complained that giving the wiretaps to the commission’s attorneys would violate the defendants’ privacy. The judge presiding over the SEC’s suit, Jed Rakoff, rejected that argument this week and ordered the defendants to produce all the relevant communications in their possession. So it looks as if the SEC finally will get hold of the same information the FBI has had since 2008.

It’s anyone’s guess how much money had to be spent paying government lawyers so that one twig of the executive branch could hand information over to another one. These are your tax dollars at work, as the saying goes. The SEC, which last year had a budget of about $1 billion, has complained for ages that it’s underfunded. As this episode shows, though, its problems aren’t just about money.

Often it has lacked the will or competence necessary to fulfill its basic duties, like investigating the many early warnings it received about Bernard Madoff’s Ponzi scheme. The fines it can impose tend to be meager. Somehow it hasn’t been able to find anyone at Lehman Brothers, Fannie Mae, Freddie Mac or AIG who committed any wrongdoing during the financial crisis, as if those companies’ claims of solvency and robust financial health were all true.

Yet we probably can’t expect much better, as long as the U.S. vests the primary authority to enforce its securities laws and regulate capital markets with an agency that lacks the power to conduct criminal investigations. Eliot Spitzer, during his tenure as New York’s attorney general, brought more landmark cases on the SEC’s turf than the commission did, with a much smaller staff. He probably couldn’t have, were it not for his office’s power to threaten defendants with criminal charges under the 1921 Martin Act, New York’s state securities-fraud statute.

Little appetite

The Justice Department has shown little appetite for investigating securities and accounting fraud by executives at the country’s most important banks. (Targeting hedge-fund managers for insider trading seems a higher priority at the moment.) Even if the Justice Department were inclined to probe the conduct of senior officers at too-big-to-fail financial institutions, it might not always be able to share the evidence it gathers with the SEC directly, as the Galleon case shows.

So here’s an idea for Congress to consider the next time the SEC comes begging for a budget increase. Don’t just throw money at it. Give it more power. Or even disband it — dozens of SEC staffers and contractors were caught last year watching porn on their work computers, after all — and start fresh by creating a new agency with teeth to replace it.

We already entrust the Environmental Protection Agency and the Food and Drug Administration, for example, with criminal authority. EPA and FDA special agents are sworn federal law enforcement officers empowered to conduct investigations, carry firearms, make arrests, and execute and serve warrants. Prosecutions still must be carried out by Justice Department lawyers, such as local U.S. attorneys’ offices. At least the EPA and FDA have a full arsenal of investigative tools, though. The SEC (or its successor) should, too.

The alternative is the SEC we have now: A toothless terrier that’s weak by design. Perhaps it would do better if we gave it the means to try.

Jonathan Weil is a Bloomberg News columnist.