SEC lax in monitoring firms’ compliance, inspector general report says

The Securities and Exchange Commission doesn’t just enforce the rules that govern Wall Street. When asked, it often grants individual companies exemptions from the rules.

But companies that win those special breaks often fail to comply with the conditions that come with them, the SEC’s inspector general said in a report released Thursday.

What’s more, the agency has no formalized process for monitoring whether companies live up to their end of the bargain, the report said. Though the agency routinely inspects financial firms, “only in rare cases” did the examiners focus on that question, the report said.

The inspector general’s report was another in a series the office has written criticizing the SEC’s performance. Others have focused on agency spending, Ponzi scheme probes and pornography viewed on staff computers. On Thursday, the inspector general targeted the agency’s ability to keep tabs on enforcement.

The SEC both writes and polices a panoply of rules, many of them highly technical, which are meant to protect clients of investment firms and shareholders in public companies. It routinely gives companies a green light to disregard specific requirements.

For example, in May 2010, the SEC gave credit rating agencies relief from rules meant to avoid conflicts of interest in their high-stakes business, the report said. Credit rating agencies, such as Moody’s and Standard & Poor’s, rate the creditworthiness of bonds and other securities. They have been widely criticized for contributing to the housing bubble and the financial crisis that followed by assigning top ratings to investments tied to toxic mortgages.

In some cases, the SEC tells companies they don’t have to follow certain rules. In other cases, it issues “no-action” letters, in which it assures firms that they need not fear enforcement action in certain scenarios if the facts are as the companies describe.

The office of the inspector general, headed by H. David Kotz, called on the agency to do more to monitor these exemptions. When companies fail to abide by the conditions, the result could be “significant violations of the securities laws,” the report said.

Instead of treating the exemptions as risk factors worthy of heightened scrutiny, some SEC staff members take the opposite view, the report said. They assume that companies that have gone to the trouble of requesting relief from the rules “present a reduced risk,” the report said.

In a written response to the report, SEC staff members said they generally agree with the recommendations. However, some of the steps the inspector proposed would take “significant resources,” the staff said.

The agency gives companies relief from the rules for a variety of reasons, the staff said. Some rules are ambiguous, and in a rapidly changing industry some may not address current realities, the staff said. In general, firms that seek relief “do so because they are attuned to compliance issues,” the staff said.

In routine examinations, SEC inspectors have found cases in which companies failed to meet conditions of their exemptions or no-action letters.

The agency staff gave the inspector general 477 examination reports on firms’ compliance with conditions. The inspector general’s office reviewed 72 of those and found that examiners noted compliance problems in 44 of those.

The inspector general’s report described some examples in general terms.

In one case, the SEC had issued a no-action letter warning a firm that if it released “performance data” it should make certain additional disclosures to avoid misleading prospective clients. But the firm published the performance data without the additional disclosures, the report said.

In a case that showed seeking exemption isn’t necessarily proof that a firm is attuned to the rules, a company was operating as if had been granted an exemption even though the SEC had not yet approved its request.

The other inspector general reports have addressed the agency’s purchase of useless information technology, its leasing of downtown Washington offices it did not need and could not afford, and its failure to stop Ponzi schemes by Bernard Madoff and R. Allen Stanford.

The SEC’s critics in Congress have invoked the inspector general’s work in arguing that the agency should not receive the budget increase it says it needs to meet its greatly expanded responsibilities.

David S. Hilzenrath, The Washington Post, June 30, 2011

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