Last year, I blogged about the Markopolos submission to the SEC (way back in 2005) in which he argued that the Madoff fund was a Ponzi scheme. I wrote then that the Markopolos submission was extremely persuasive and well argued and was a good example of forensic economics. His prepared testimony to the US Congressional hearings is even better at explaining his deductions. He talks about how his army special operations background trained him “to build intelligence networks, collect intelligence reports from field operatives, devise lists of additional questions to fill in the blanks, analyse the data and send draft reports for review and correction before submission.”
The entire 65 page document is worth reading in full. What I found most interesting (after having read the 2005 submission) is what he has to say about the SEC. What happens when he turns his forensic mind at the SEC itself is really fascinating. He pulls no punches either in his diagnosis or in his recommendations:
- Unfortunately, as bad a regulator as the SEC currently is, and the SEC certainly is a bad regulator, it is the best of a very sorry lot.
- ...the SEC is a group of 3,500 chicken tasked to chase down and catch foxes which are faster, stronger and smarter than they are.
- Amazingly, the SEC does not give its employees a simple entrance exam to test their knowledge of capital markets! ... Talented CPAs, CFAs, CFPs, CFEs, CIAs, CAIAs, MBAs, finance PhDs and others with finance backgrounds need to be recruited to replace current staffers. ... I caution the SEC to avoid focusing on any one of the above professional certifications at the expense of the rest because all are relevant and necessary. ... Diversity will ensure that group think is kept at bay. ... Right now the SEC is overlawyered. Hopefully it can transition away from this toxic mix as quickly as possible.
- SEC staffers need to be encouraged to attend industry conferences ... [and] ... educational meetings. ... Either the SEC is anti-intellectual and intentionally maintaining staff uneducated about the capital markets or it is ignorant.
- SEC staffers ... with industry credentials [like CPA, CFA etc] ... are not allowed to have their designations printed on their business cards ... if the SEC allowed its few credentialled staff to put these credentials on their business cards, it would expose the overall lack of talent within the SEC.
- But if you walk into an SEC regional office, you won’t see any of these journals [Journal of Accounting, Journal of Portfolio Management, Financial Analysts Journal, Journal of Investing, Journal of Indexing, Journal of Financial Economics and so on]. ... Apparently all the SEC uses is Google and Wikipedia because both are free.
- If an SEC staffer doesn’t know derivative math, portfolio construction math, arbitrage pricing theory, the capital asset pricing model, both normal and non-normal statistics, financial statement analysis, balance sheet metrics or performance presentation formulas then they shouldn’t be hired other than to fill administrative or clerical positions.
- ... the SEC needs to recruit foxes in senior, very high paying positions that offer lucrative incentive pay for catching foxes and bringing them to justice. ... highly successful industry practitioners who have succeeded financially during their long careers.
- Compensation at the SEC needs to be both increased and expanded to include incentive compensation tied to ... enforcement revenues.
- It is my belief that SEC examiners are so inexperienced and unfamiliar with financial concepts that they are literally afraid to interact with real finance industry professionals and choose to remain isolated in conference rooms inspecting pieces of paper.
- ... most SEC Regional Offices are lucky to have even one Bloomberg terminal for the entire region’s use. Whereas your typical investment firm would have one Bloomberg per analyst, trader and portfolio manager.
- Fortunately, the US has two very competent securities’ regulators who do a truly fantastic job and at an unbelievably low cost. Unfortunately, they are the New York Attorney General’s office (NYAG) and the Massachusetts Securities Division (MSD). ... one alternative solution is to disband the SEC and give its budget to the NYAG and the MSD.
- ... consider moving the SEC out of Washington because Washington is a political centre and not a financial centre
I think that by and large Markopolos is on the right track though I disagree with a few of his recommendations. The question is whether any of this is likely to happen. Unfortunately, state failure is as endemic as market failure (if not more).