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SEC Has Finally Gone Too Far

Stocks in this article: BACDBCSMSJPM

NEW YORK ( TheStreet) -- The Securities and Exchange Commission has long been accused of "regulatory capture" -- being deeply in hock to the industry it is supposed to be regulating -- and yet the agency remains woefully toothless.

So maybe the latest accusations against the agency, first reported in Rolling Stone magazine will be enough to finally bring about some long-needed changes.

The SEC has been accused of destroying files in preliminary investigations it has closed in defiance of an agreement with the National Archives that such case files would be preserved for 25 years. If they were to be destroyed after that time, it would be up to the National Archives to do the destroying, according to Rolling Stone.

But the SEC somehow saw its way around that deal, and has destroyed at least 9,000 case files since 1993, according to the Rolling Stone report, which cites evidence an SEC whistle-blower named Darcy Flynn presented to the SEC's inspector general and to three Congressional committees.

"It shows really poor judgment--probably at some mid-level bureaucratic level," says Columbia University law school professor John Coffee. "I suspect that its root cause is the SEC's almost neurotic sensitivity to criticism, which the Madoff affair has aggravated. But the real danger here is that it could disguise serious conflicts of interest associated with the SEC's rapidly revolving door."

The revolving door at the SEC is well known. Heads of enforcement at the SEC regularly show up at big Wall Street banks after they leave the commission. Examples include Gary Lynch , who, after leaving the SEC's top enforcement job, worked for Credit Suisse (CS), and Morgan Stanley (MS), and will soon join Bank of America (BAC).

Other former SEC enforcement chiefs currently working on Wall Street include JPMorgan Chase (JPM) general counsel Stephen Cutler and his counterpart at Deutsche Bank (DB), Richard Walker.

The allegations of file destruction make Walker's trip through the revolving door look especially troubling, since Walker joined Deutsche Bank from the SEC in 2001, just three months after a potentially major case against the bank was dropped. Which outside attorney defended Deutsche Bank in that case? Gary Lynch. Who is the SEC's top enforcer today? Robert Khuzami, who in his last job worked for Walker at Deutsche Bank.

While files from that case do not appear to have been destroyed, one wonders how many of equal important were. Finding out may be difficult, but if this episode inspires enough outrage, maybe the wholesale changes needed at the SEC will finally occur.

On the other hand, it would be easy to see how the opposite could result: a further weakening of the agency. One of its toughest critics is Rep. Darryl Issa (R., Calif.), head of the House Committee on Oversight and Government Reform. On Friday, The New York Times columnist Floyd Norris makes the case that Issa should himself be investigated by the SEC.

So if you hear Issa start seizing on the file destruction as a reason to cut the SEC's funding, read Norris's article and make up your own mind. Reform is surely needed at the SEC, and additional funds wouldn't hurt. The regulator has failed repeatedly, but the alternative is worse.

-- Written by Dan Freed in New York.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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