The SEC Fiddles While the System Burns: Insider Trading Enforcement As Securities Law Theater

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By Jerri-Lynn Scofield, who has worked as a securities lawyer and a derivatives trader. She now spends most of her time in India and other parts of Asia researching a book about textile artisans. She also writes regularly about legal, political economy, and regulatory topics for various consulting clients and publications, as well as writes occasional travel pieces for The National.

Bloomberg yesterday reported in the the Securities and Exchange Commission’s (SEC) demands in its investigation of alleged insider trading by noted hedge fund manager and former Goldman Sachs head of research Leon Cooperman.

According to Bloomberg:

Wall Street’s top cop demanded that a resolution of its insider-trading case against Leon Cooperman include the billionaire investor accepting a temporary suspension from the hedge fund industry, according to people familiar with the matter.

Before suing Cooperman last month, the U.S. Securities and Exchange Commission pushed the outspoken trader to agree to a settlement that would have required him to pay about $8 million in penalties and prevented him for some period of time from managing money for clients, said the people who asked not to be named because the meetings were private. Cooperman has shown no signs of wanting to negotiate, as he’s repeatedly denied wrongdoing and said his firm met with the SEC before it filed the lawsuit to explain why its allegations were “totally unwarranted.”

Cooperman and SEC spokeswoman Judy Burns declined to comment.

Cooperman, 73, has described his fight against the regulator as a battle for his legacy, arguing that any fine is irrelevant because it would be far less than he annually donates to charity. But an industry suspension could have significant consequences, potentially affecting his role at Omega Advisors Inc., the New York hedge fund he’s built over more than two decades through savvy stock picks.

The SEC is taking an aggressive line against Cooperman at the same time it is also announced that hedge fund advisory firm Artis Capital Management and a senior research analyst have agreed to settle charges related to their failures to detect insider trading by one of their employees.

I should make it clear that I’m taking no position on whether the allegations against Cooperman are true. Nor do I particularly care.

What does concern me is the phenomenon of securities law theater. The SEC’s almost exclusive focus on alleged insider trading at the exclusion of far more important systemic abuses is part of the theatrical spectacle that substitutes for effective regulation and coincides with the rot that has overtaken so many aspects of our wider regulatory systems. The following observations may seem to be a bit ad hoc and anecdotal, but that doesn’t mean they don’t contain some kernels of truth. And these musings are no doubt inspired by having spent too many hours in the air earlier this week, travelling from JFK to Kolkata, so the related phenomena of air safety theater, and customs theater, are at the top of mind.

Why Has the SEC Focussed On Alleged Insider Trading?

Is it just pour encourager les autres? Perhaps in part.  And also, because I suspect, insider trading, in one form or another, is widespread enough (if not ubiquitous)– and so notoriously difficult to define, that there are  plenty of alleged violations to occupy the SEC. But the most important reason is that insider trading prosecutions really don’t address what’s most broken about the system– nor do they attract the sort of pushback that might accompany more aggressive enforcement actions that target more serious, systemic abuses.

Theatrical Gestures Substitute For Effective Regulation

To expand on my earlier point, securities law enforcement has gone the way of other areas of regulation, away from substance and toward the theatrical. Anyone who’s flown in the not-so-halcyon days since 9/11 has experienced air safety theater, a ritualized series of mandatory actions that don’t, in fact, I’ll wager, make us all that much safer. Every time I’m forced to pass through JFK, I’m reminded of these thoughts. Why the whole removing of shoes, decoupling the belt, removing jackets, taking out the laptop, etc., performance? Asian airports such as Hong Kong and Bangkok are not only clean, pleasant, and relatively quiet– no CNN shouting at you from everywhere– but have also have figured out ways to use scanners that don’t require the strip tease that always makes me anxious I’m going to leave something important behind.

Those lucky enough to pass through JFK also experience customs theater. Australian customs and immigration officials manage the difficult feat of letting visitors know they’re dead serious about customs regulations. The reason for this is that the unique, isolated Australian ecosystem has been seriously compromised by the introduction of foreign flora and fauna. But that they also welcome visitors to their country and don’t seem to wish we’d just all go away. Think about that the next time you’re facing the typical grilling upon arrival back in the US of A– a grilling that’s simultaneously offensively intrusive and likely pointless.

If you think it’s bad for American citizens, it’s far worse for visitors. Over and over during my encounters with non-Americans in foreign places, they’ll confess that although they like Americans, and have enjoyed previous visits to the US, fewer and fewer of them want to make return visits. Why? The entire experience of entering the country has become so unpleasant, and in some cases uncertain and arbitrary, that they avoid even transiting through the country. And then the other thing people almost inevitably mention is personal safety: Almost no non-American comprehends our gun control policies.  And not surprisingly, when the see constant reports of such violence, they often elect to spend their holidays elsewhere.

Just think of the forms  of contempt toward  various people the powers that be demonstrate by moving to using entry scanners. At the onset, there’s the contempt inherent in replacing skilled immigration officials, replacing the knowledge they’ve built up with that of a machine– at a time when the economy is failing to create enough well-paid jobs. then,  they create a class of elites that get the benefit of expedited procedures. The Global Entry system is an explicit trade-off between allowing the government greater scope to examine aspects of your life in exchange for quick, efficient passage through immigration screening.

For the rest of the hoi polloi, however, the alternative is other sets of automated screeners.  To these people,  there’s also an expression of contempt– or perhaps indifference is a better word. No one knows how to use the machines, and there aren’t enough people to provide advice. Often, someone often has to help complete the processing anyway, so what’s the point? So the irony is that amongst all the countries I’ve recently visited, the installation of scanners means line for returning citizens is far longer than that for non-citizens who are accorded the dignity of having customs officials efficiently process their entry in far less time than it takes a returning citizen who has not submitted to the time, expense and surrender of privacy in applying for  Global Entry membership.

But I digress.

SEC’s Enforcement and Regulatory Prowess

There’s been a serious slide in the SEC’s reputation within my living memory from a time when, as under its second head of enforcement Stanley Sporkin, the SEC was widely feared and respected– as Yves has written on more than one occasion. My favourite Sporkin anecdote, which Yves repeated here picks up on some comments made by a reader:

I was an SEC enforcement attrorney during the generally-regarded halcyon days of the Sporkin era, and I can tell you, we kicked ass and took names. I myself was involved in many cases involving some of the biggest names on Wall Street, and was instrumental in several cases that eventually resulted in the enactment of the Foreign Corrupt Practices Act. We had a trial unit back then that was quite busy actually trying, and, more often than not, winning cases. We referred many cases for criminal prosecution (including for perjury), not having prosecutorial authority ourselves.

Back then, the industry quaked in its boots when we came calling. The only partially apocryphal story about Stanley is that, during an investigation he was leading (before he became the head of enforcement), he had a group of witnesses waiting to give on-the-record testimony. When the witness he had been deposing had a heart attack during the deposition (a not-infrequent occurrence), the ambulance attendants wheeled the stricken witness out of Stan’s office on a gurney, with Stan close behind, announcing to the waiting group of witnesses, “alright, who’s next.”

Given the current state of play, this anecdote appears almost quaint (albeit a touch macabre).

On the regulatory side, things have been at times a wee bit better, albeit not recently. The tenures of chairs Harvey Pitt, Christopher Cox, Mary Schapiro, and Mary Jo White range on a spectrum of disappointment to outright failure. Interestingly, Arthur Levitt and William Donaldson are a bit better regarded, the former for his efforts to protect the interests of retail investors, and the latter for his implementation of necessary regulation to enforce the 2002 Sarbanes-Oxley reforms.

Why is this, I note that both Levitt and Donaldson came from the business rather than legal backgrounds. This presents a bit of a paradox: Those who come from the business side have tended to be tougher SEC commissioners. (This started with Joseph P. Kennedy, first head of the SEC, a notorious stock manipulator who was appointed precisely because he’d exploited what he knew about how markets then worked to make a fortune. Think of a fox guarding the henhouse).

I’m not suggesting that the fox/henhouse metaphor still applies. But why is it so that the lawyers who’ve headed the agency have failed to be effective?  I think the answer, in part has to do with business types not needing to worry they’ll have access  to the revolving door in the way many of the SEC’s lawyer-commissioners do.  One secret they don’t tell you is that even though many senior attorneys in major firms earn incomes that far exceed the national average, they don’t pull down the stupendous amounts that allow those on the revenue-generating side to cash out at an early age when they get tired of playing the game. Given the high costs of funding the type of high-expense lifestyle typical of senior Acela corridor professionals– expensive real estate, weekend places, private school fees– continuing to be “well-regarded” is necessary to retain one’s status and ensuring a continued place on the gravy train.

I know, I know, cry me a river and before I get killed in the comments, please understand that I’m just trying to explain how the system works, and am by no means defending nor justifying it.

You can look at this in two ways. The first, more cynical view, is that it’s necessary for lawyers not to rock the boat too much and make major cases against household name firms– especially in the financial sector– that just might, and I repeat just might– have some systemic consequences and restore a greater respect for at least the illusion of probity that seems to be so lacking now, lest they lock themselves out of future lucrative employment opportunities. The second, more charitable view is that no one likes a loser, and that given how seriously the SEC is outgunned and even outlawyered (due to deliberate under-funding on the part of Congress), the agency is risk averse and its leaders don’t want to get a reputation for failure if they bring cases and don’t prevail. Take your pick. Either explanation works.

Business types by contrast have made their pile and can step back and have more financial independence to act on their insights on what’s actually in the public interest.

And finally, I should mention that there’s also an element of community corruption, with lawyers not necessarily recognizing they or their friends or colleagues are biased or ideologically compromised (in a non quid pro quo kind of way). It’s natural that they might think that. But this needs to change, and it’s necessary to shift the bounds of discourse to understand that the current system is neither natural nor inevitable but is deeply compromised. The SEC needs to return to being regarded as a tough cop on the beat.

Insider Trading Redux

One alleged bright spot in the DoJ’s corporate enforcement record had been current US Attorney for the Southern Sistrict of New York Preet Bharara’s record of more than 80 insider trading convictions or guilty pleas. This legacy has been compromised in part by the United States Supreme Court’s refusal to hear an appeal of a United States Court of Appeals for the Second Circuit decision overturning one such conviction– opening the door to contesting other such convictions.

Yet we shouldn’t shed too many tears to see these insider trading convictions overturned. And such a development might not even be  a source of consolation to Leon Cooperman at this time, since he seems determined to clear his name and might not be content to slide by another basis. These prosecutions  are of little systemic significance and clearly reflect a misplaced sense of enforcement priorities when so many other issues cry out for investigation. Fruitful areas for serious examination might include flouting Sarbanes-Oxley internal control certification requirements and committing accounting control fraud. And more recently I should add, examining aggressively allegations by Wells Fargo and other whistleblowers).

Regular readers of Naked Capitalism know this. Now, we need to spread the word.

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  1. EoH

    Slight quibble: “the hoi polloi” doubles the article, “the the many”. Rather like saying, “Sierra Nevada mountains” (snow covered mountains mountains).

    1. Yves Smith

      I know you are technically correct, but “the hoi polloi” is standard American usage. “Hoi polloi” without the “the” comes off as awkward.

      1. Bill

        another quibble: encourager les autres, not encourager les actress. Someone’s software intended to correct errors is creating them instead.

        1. Jerri-Lynn Scofield Post author

          Fixed it! And you are correct, I didn’t type any line about the actress– although as it came out, it did make me smile. Autocorrections are generally not so amusing as this one was.

  2. Norb

    One of the problems facing spreading the word, involves overcoming the acceptance of crime in normal society. Yes, people are angry and upset about the criminality taking place, but they have been conditioned to accept it. They live their lives by avoiding it as much as possible.

    The media plays a major role in this conditioning. Endless daily news loops highlighting petty crimes from the lower classes, popular television shows subtlety and not so subtlety glorifying criminal life, and many forms wrongly illustrating successful law enforcement. In the end, a completely false impression is maintained in the minds of the citizenry.

    How does one break the conditioning? You would need to change people’s media consumption habits. When considering financial matters, effective action is hampered because working people are tied directly into the system through 401K programs. They don’t want to rock the boat, or wholeheartedly believe the marketing used to sell the corrupt programs. If government officials refuse to prosecute, or will endlessly use the successful strategy of enforcement theater, what immediate workable options are left, pulling your money out of a 401K? As more and more people are driven to low wage jobs, even this point becomes moot due to no retirement fund to loot.

    Gridlock indeed. Without an awareness of the importance of managing the commons, we are lost. When considering financial matters, it seems we need to begin setting up neighborhood watch groups for our own protection. Instead of reforming wall street, more fruitful effort can be taken by thinking about how to replace it.

    Protecting the commons is the word that needs to be spread, and expressed in those simple terms. If that theme is successful, all else will follow. The success of neoliberalism depends on the destruction of the common good. They are mutually exclusive ideologies.

  3. lyman alpha blob

    Theater indeed. If they really wanted to crack down on this practice they’d have to shut down Wall Street and throw most of Congress in the big house (although didn’t Congress pass a law exempting themselves from insider trading a few years back?).

    On the not quite bright side, at least they’re going after an actual Wall Street type rather than Martha Stewart this time.

  4. Neil Pyper

    Thanks – useful piece. Does the impending presidential election have any implications for this?

    1. Jerri-Lynn Scofield Post author

      It does. No more than three SEC commissioners can be members of the same political party. Currently, chair Mary Jo White is an Independent (term expires in 2019), while Kara Stein is a Democrat (term expires in 2017), and Michael Piwowar a Republican (term expires 2018).

      Commissioners can only be removed for cause, but the President has the power to name the chair, and can change that decision, as this WSJ article describes.

      So Obama could demote MJW from the chair position but not fire her outright. The structure of the SEC’s commissioners is part of what makes the SEC an independent agency.

      The next President can nominate two members of his/her party to the open seats; the Senate must then confirm the nominations. The President also designates the chair. With two open seats and only 1 Dem, 1 Rep, and 1 Ind currently serving, the incoming President will effectively be able to shape future SEC policies by his/her choice of commissioners (provided these nominations can be confirmed).

  5. Chauncey Gardiner

    Re: …“But the most important reason is that insider trading prosecutions really don’t address what’s most broken about the system– nor do they attract the sort of pushback that might accompany more aggressive enforcement actions that target more serious, systemic abuses.”

    IMO one systemic elephant in the room that is being studiously ignored is that these financial markets are heavily controlled and manipulated as an unstated policy. IMO a special investigator should be appointed and given adequate funding to investigate the markets policies, funding and activities of the Fed, and particularly the Federal Reserve Bank of New York’s Markets Group, including their daily interactions with the primary dealers; their coordination of market interventions with foreign central banks, large HFT firms and other entities; the structures and role of financial futures and ETF derivatives; and those findings should be made public.

    Perhaps manipulated financial markets are preferred public policy. If so, that should be publicly discussed, acknowledged, and passed into law, as I don’t believe this is presently in the Fed’s so called “dual mandate”. However, before doing so it might be wise to consider that capital formation – a cornerstone of capitalism – appears to have been seriously impaired under the current regime.

  6. RBHoughton

    What NC is asking for is in everyone’s interest. The difficulty is in getting regulators to routinely do their job.

    When the regulator goes and interviews a baddy and is told that the bad guys want to support him he gets amotivated and flexible when he should be upright and resolute.

    The revolving door is incompatible with propriety. Commerce should be considered a battlefield. Your either an enforcer of the rules or a bender of them. No changing sides.

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