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ETHICS at the SEC: An Oxymoron

SEC Has Lost its Moral Authority to Regulate Securities Markets

Perhaps you heard that a not-for-profit group co-founded by a Securities and Exchange Commission lawyer used his name to raise thousands of dollars from law firms that represent clients before the agency. According to an article by Jessica Holzer posted online at the Wall Street Journal, four law firms, including Winston & Strawn LLP and WilmerHale LLP, paid the Electronic Discovery Institute $4,500 each to sponsor a conference the group hosted last week at the Ritz Carlton resort in Amelia Island, Florida. The conference was attended by officials from dozens of large corporations.

Patrick Oot, the SEC's special counsel for electronic discovery, co-founded the Electronic Discovery Institute in 2006 before coming to the SEC in the fall of 2010 to develop the agency's procedures for handling outside requests for its emails and other electronic documents in lawsuits and investigations. Oot, who also is a top official at EDI, is quoted promoting the Amelia Island event in a document that details what law firms get in return for the $4,500 sponsorship fee, including having their logo placed on all event marketing materials and the chance to speak on a panel or moderate a lunchtime discussion. EDI said the firms could count $3,700 of their $4,500 sponsorship payment as a charitable contribution to EDI.

Federal regulations bar government employees from knowingly soliciting funds from certain "prohibited sources," which include "someone who conducts activities regulated by the employee's agency." For the SEC, such sources would include securities firms or publicly traded companies, the very entities they are sworn to regulate. Asked whether a law firm representing clients before the SEC is a prohibited source, a spokesman for the Office of Government Ethics, an agency charged with writing federal ethics regulations, said, "A company that does business with an agency is a prohibited source for the employee of that agency."

This isn’t the first time the SEC got caught with its (ethical) pants down. Last March SEC chair, Mary Schapiro, came under Congressional fire for hiring as the SEC’s general counsel someone with a Madoff financial interest — David M. Becker, who participated in matters involving how the scheme’s victims would be compensated.

The revelations about Mr. Becker’s role have raised fresh questions about ethical standards and practices at the agency, where Schapiro was brought in with a mandate to strengthen its enforcement unit. Louise Story and Gretchen Morgenson point out in a NY Times story that questions about Becker arose after Irving H. Picard, the trustee overseeing the Madoff case, sued him and two of his brothers to recover $1.5 million of the $2 million they had inherited in 2004 from a Madoff investment by their late mother. Becker’s financial ties to Madoff had not been publicly disclosed until that suit.

 “One of the things the S.E.C. does is hold companies to a very high standard with regards to transparency and disclosure,” said Representative Randy Neugebauer, Republican of Texas. “We think it’s important that the same integrity exists within the SEC, ensuring that people working there do not have conflicts of interest and that here is a process to vet those issues and make sure they are taken care of in a way that gives confidence.”

Perhaps the most significant Madoff matter involving Becker is a proposed reversal of the agency’s recommendation on how to compensate victims of the scheme. While the SEC had agreed on a deal that would return to investors only the money they had put into their Madoff accounts, Becker argued that the commission should change its stance to allow victims to keep some of the gains their investments had generated, since the investment would have grown somewhat over time even in a low-interest account. The Becker family would benefit from this approach.

In correspondence with lawmakers late last month, Becker said that he alerted the ethics office about his family’s Madoff investment again that May after he received a letter from a number of law firms representing Madoff victims asking that the commission change its proposed compensation formula. Among the issues are whether Madoff investors who withdrew money before the fraud was exposed must return some of their proceeds — and if so, how much — to other investors. “I recognized that it was conceivable that this issue could affect my financial interests because the issue could affect the trustee’s decision to bring clawback actions against persons like me,” Becker wrote in response to lawmakers. The ethics officer approved his participation, he said.

The mission of the SEC Securities is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. It’s difficult to do that when questions arise about the credibility of the SEC’s own actions. The Commission has compromised its integrity and has a black eye from the Madoff affair. It has lost its moral authority to ensure that public companies act in accordance with ethical standards. Congressional investigations will do no good other than to impose an additional layer of requirements on the SEC. Like most regulatory efforts where ethics is the underlying issue, the effort is doomed to fail because you can’t legislate ethics.

Blog posted by Steven Mintz, aka Ethics Sage, on September 16, 2011