Another slant, SEC Will Be Investigated in Probe Sought by Senate's Grassley
By Otis Bilodeau
Oct. 26 (Bloomberg) -- The U.S. Securities and Exchange Commission,
already under scrutiny for its handling of a trading probe that
entangled Morgan Stanley Chief Executive Officer John Mack, now faces
a broad review by government auditors of its management and methods
for policing the financial markets.
The Government Accountability Office agreed last week to investigate
the SEC's enforcement division and compliance department after
requests by Senator Charles Grassley, an Iowa Republican who
questioned whether the agency gave Mack special treatment. Grassley
asked the GAO to examine the SEC's ``planning, oversight, control and
other management processes'' and gauge whether the agency does enough
to oversee regulators at the New York Stock Exchange and NASD.
``Based upon allegations I have received over the past few months, I
have become increasingly concerned regarding the operations of the
SEC, and whether the SEC is faithfully adhering to its mission'' to
protect investors, Grassley, the chairman of the Senate Finance
Committee, wrote in one of two Sept. 19 letters to GAO Comptroller
General David Walker.
The review ratchets up the heaviest political pressure the SEC has
faced since Christopher Cox, a California Republican, took over as
its chairman in August 2005. Grassley's requests target units run by
SEC enforcement chief Linda Thomsen and Lori Richards, head of the
Office of Compliance, Inspections and Examinations.
Senators including Grassley are concerned that the SEC shielded Mack
from a probe of insider trading at Pequot Capital Management Inc.,
which runs $7 billion in hedge funds. Gary Aguirre, a former SEC
investigator, told the Senate Judiciary Committee in June that he was
blocked from questioning Mack because of the Morgan Stanley CEO's
political clout. New York- based Morgan Stanley is one of Wall
Street's two biggest securities firms.
`Coating of Dirt'
The SEC eventually interviewed Mack in July and notified him and
Westport, Connecticut-based Pequot earlier this month that it won't
pursue a case against them. The SEC repeatedly has denied Aguirre's
claims and Mack and Pequot denied any wrongdoing.
``This Aguirre story will leave a coating of dirt unless it is probed
and washed away,'' said Edward Fleischman, a former SEC commissioner
now in private practice at Linklaters in New York. ``It will benefit
us all, and it will ultimately benefit the SEC, to have the GAO go
through all of this as an outside observer.''
Thomsen declined to comment. Walter Ricciardi, a deputy enforcement
director at the SEC, said the agency has no objection to the GAO
inquiry.
``We welcome the review and look forward to any recommendations that
might follow,'' Ricciardi said in an interview.
Donaldson Appointee
Thomsen is the only division director at the SEC not appointed by
Cox. She was promoted in May 2005 by Cox's predecessor, William
Donaldson, after then-Enforcement Director Stephen Cutler returned to
private practice.
Cox said Oct. 18 that members of Congress have ``legitimate concerns
and I share those concerns'' when asked about Aguirre's allegations.
Grassley asked the GAO, Congress's investigative arm, to report its
findings by June. The GAO said in an Oct. 16 letter to Grassley that
it ``accepts these requests as work that is within the scope of its
authority.''
The inner workings of the SEC's enforcement division are rarely
exposed to public view. As a matter of policy, the agency doesn't say
when it opens or closes investigations and officials won't discuss
their progress in building a case.
NYSE, NASD Oversight
Grassley asked the GAO to assess how the SEC tracks investigations,
the amount of time the agency takes to complete them and its
``reported success rate.'' He also requested that the auditors
determine how many referrals of potentially illegal trading activity
from U.S. exchanges ``actually become part of a regulatory action.''
SEC enforcers rely on the self-regulatory organizations, or SROs,
that police the exchanges, including NYSE Regulation and the NASD, to
report signs of suspicious trading for further investigation.
The SEC must ``detect and deter potential abuses of SRO authority
arising from inherent conflicts of interest,'' Grassley wrote to the
GAO. ``How does the SEC ensure that the SROs vigorously oversee their
own members?''
An analysis of stock-trading data by Toronto-based Measuredmarkets
Inc. showed in August there may have been insider trading in advance
of 41 percent of the largest U.S. takeover announcements in the
preceding year. Derivatives traders also made perfectly timed bets
before public announcements of recent deals such as the $33 billion
leveraged buyout of hospital operator HCA Inc.
Hedge Funds
About 20 percent of the new investigations opened at the SEC in the
past year focused on insider trading and slightly less than half of
those probes led to enforcement cases, according to Ricciardi.
``We often see suspicious trading, but in some cases it's hard to
find the evidence,'' he said in an Aug. 27 interview.
Cox said Oct. 18 that the SEC is ramping up its scrutiny of potential
insider trading by hedge funds ahead of company mergers. Thomsen, the
enforcement chief, told Congress last month that cases of insider
trading by hedge funds have become a ``significant concern.'' Hedge
funds are private pools of capital that allow managers to participate
substantially in the gains they make for investors.
