SEC Staff Cuts Are Penny-Wise but Pound-Foolish
Mercer Bullard
05/08/01 - 02:44 PM EDT
Imagine you're in charge of the federal budget. In 2000, investors poured $388 billion into mutual funds and the number of Americans owning mutual fund shares swelled from 82 million to 88 million. Over the past two years, the
Securities and Exchange Commission has lost 30% of its professional staff to private industry, and the federal government is running a huge surplus.
Do you (1) increase or (2) reduce the number of SEC mutual fund examiners? If you answered No. 2, you and Dubya think alike.
President Bush proposes to cut 57 SEC staffers, with 13 coming from the ranks of mutual fund examiners. With the SEC currently inspecting funds only once every five years, these staff cuts are reason to celebrate if you're a fund manager who makes money by playing fast and loose with your shareholders' money.
The Unexamined Fund
Why should you care whether the SEC gets around to checking out your fund? After all, the mutual fund industry has a squeaky clean reputation and seems not to warrant a closer look.
However, it's strong legal protections to which the industry owes its reputation. Mutual funds have been relatively scandal-free, not because fund managers are inherently superior human beings compared with brokers, but because they operate under a more effective regulatory structure. And this structure would be worthless without vigorous SEC oversight.
Investors' first line of defense is the SEC's examinations staff members who go on site, poring over fund managers' trading documents, personal accounts, accounting records and advertisements.
The inspections result in more than 90% of managers receiving deficiency letters citing securities law violations and requiring corrective action. Many of these are minor, but many are not. The serious violations are referred to the SEC enforcement division, which decides whether it has the facts and the resources to make a case stick.
Last year, the SEC charged
Dreyfus manager Michael Schonberg with fraud for putting most of his hot IPO
allocations into a single fund to boost its performance, leaving only scraps for three others he managed. The SEC also sued Dreyfus for advertising the fund's top-ranked performance without disclosing that it was largely attributable to the IPOs, the same charge it made against the
Van Kampen fund family in 1999. (For more, see
TSC's stories on
Dreyfus and
Van Kampen. The SEC also recently won a case against directors of the
Monetta funds, who accepted allocations of hot IPO shares from the funds' manager. And it sued
Shawmut Investment Advisers for sending fund trades to brokers in return for referring clients to Shawmut's advisory business.
And in 1999, the SEC
sued Scudder Kemper for allowing a trader who forged his name on order tickets to conduct illegal derivatives trades that cost the
Scudder Short-Term Bond Fund $13 million.
These frauds can't be discovered in public filings. They can only be brought to light -- and deterred -- by an active examination program, and even then, major problems can escape undetected.
For example, a timely SEC examination might have saved shareholders of two
Heartland municipal bond funds a harsh lesson in the elasticity of fund net asset values
. The funds lost 70% and 44% in a single day due to alleged mispricing. The SEC recently
froze the funds' assets and appointed a receiver to manage it.
The Heartland funds' combined, single-day loss of $62 million is not much less than the SEC's annual budget for its entire funds division. If reducing staff leads to more fiascos like Heartland,
Congress' cost-cutting may backfire in a very public way.
The Pay's the Thing
If staff cuts weren't enough, Congress apparently plans to add insult to injury by nixing plans to pay remaining SEC staff as much as other federal regulators receive.
Annual attrition at the SEC is twice the overall government rate and more than twice the 5% rate experienced at the
Federal Reserve Board. Acting
SEC Chairman Laura Unger
testified yesterday before a
House Committee that banking agency attorneys, accountants and examiners made 24% to 39% more then their SEC counterparts, with this disparity causing "a significant drain on morale."
In March, the
Senate passed a bill that would reduce securities registration fees by about $14 billion (much of which is paid by mutual funds) and increase SEC salaries to match those of federal banking regulators. But the pay parity bill is now hung up in the
House Government Reform Committee. Committee Chairman Rep. Dan Burton is concerned that other government agencies, such as the tiny
Commodity Futures Trading Commission, will argue for pay parity as well, according to industry newsletter
Fund Action.
If the CFTC, which is made up principally of securities lawyers and accountants, has lost 30% of its most highly skilled personnel over the past two years, as has the SEC, then it should get pay parity with banking regulators as well. But there's no reason to hold up pay parity for the SEC while we wait for other agencies to make their cases.
Would you stay in your job if you could double your salary elsewhere? The best staff members at the SEC could command three or four times their government salaries in the private sector, and senior staff do even better. Perhaps Burton should consider how he'd feel making $86,000 rather than $141,000 -- about 39% less than other members of Congress -- before he further cripples the SEC's ability to protect investors by opposing pay parity. If you agree, please
let him know. Mixed Signals
To get the respect it deserves, what the SEC may need most is a more effective leader.
The New York Times reported today that President Bush has selected securities lawyer
Harvey Pitt to replace
Arthur Levitt, who resigned as chairman in February. Pitt's nomination and approval cannot come too soon, as acting SEC Chairman Laura Unger's views on pay parity may not carry much weight.
Consider Unger's tone toward
Regulation FD, a groundbreaking rule that requires companies to release "public" information to the public at the same time as insider Wall Street analysts.
Unger, who at a public SEC meeting suggested that Regulation FD should have been called "BFD," was recently asked at a conference whether FD actually stands for "frequently disregarded," "fully dysfunctional" or "fundamentally dumb."
Unger responded, "I think it stands for all of the above,"
Dow Jones newswire reported. At a recent public roundtable on Regulation FD, Unger described it as "rule-making run amok," according to
The Wall Street Journal.
When the acting SEC chairman publicly disparages the SEC staff's work, why should Congress take seriously her pleas that it pay SEC staff as much as banking regulators?
One of the new SEC chairman's first real tests will be convincing Congress that it is compromising investor protection in the name of cutting costs that would be "fully dysfunctional" and "fundamentally dumb."
