Wall Street's Watchdog: Too Many Responsibilities, Too Little Capacity

The Securities and Exchange Commission has problems. Big problems. It polices a vast array of actors with huge incentives for cheating -- corporations, investment advisors, and securities firms -- and yet lacks the capacity to effectively do this job. To boot, it has the same problems of many federal agencies: poor management, duplicative functions, underpaid professionals, and so on.

That is the finding of a big new study of the SEC just finished by the Boston Consulting Group.

One chilling statistic in the BCG study on the SEC is buried in a table on page 251. It is this: Last year the SEC did examinations of just 9 percent of the 11,888 investment advisors registered with the agency. To put it another way, each investment advisor is examined on average every 11 years.

Why is that stat chilling? Because Bernard Madoff's Ponzi scheme is an example of what happens when investment advisers don't get enough scrutiny. And, of course, it's not just Madoff. Ponzi schemes have been rampant in the U.S. in recent years. Now we know why, in part: Examinations of investment advisers are so infrequent that it is easy for many schemes to go undetected.

And here's the really scary thing: Examinations have actually become less frequent since the Madoff scheme was uncovered. In 2008, 13 percent of advisers were examined, as opposed to 9 percent in 2010. One reason for this backsliding is that the number of registered investment advisers keeps growing every year. Today there are 1,200 more investment advisers registered with the SEC than in 2006.

Therein lies the story of the SEC's woes -- not just today, but over the past few decades. Yes, the agency's budget has grown, as its critics like to note, but these increases have not been enough to keep up with the exploding size of the financial sector and the number of publicly held companies filing earnings reports. There is no better evidence of the SEC's shortcomings than the fact that we have had two major waves of financial scandals in just the past 15 years.

Among other things, the study notes that the SEC needs to make a much larger investment in technological systems that can engage in automated "market surveillance." The study notes that the "agency's technology needs today are greater and more urgent than ever before." For instance, the SEC needs to make a new push to monitor growing high-frequency trading for securities violations.

Streamlining the agency can save some money, the study suggests, but it concludes that if the SEC is going to swing its highest priority oversight functions, and also cope with Dodd-Frank, it will need to spend an extra $200 million to $300 million a year. That figure is comparable to the SEC budget increase of $264 million that the agency's chair, Mary Shapiro, is asking Congress for. Her request hasn't gone down so well given the drive of the Republican leadership to roll back all domestic discretionary spending to 2008 levels -- cuts that would be catastrophic to the agency.

(Fortunately not all Republicans are on board with the tone deaf goal of slashing the SEC's budget when Wall Street's orgy of bad behavior is still fresh in the collective memory. "My recommendation would be to probably not take them back to 2008 levels," said Republican congresswoman Jo Ann Emerson after a hearing Tuesday. "They've got a big mission and they need the tools to do their job.")

The Boston Study Group is one of the most sophisticated consulting firms around. Its team spent months delving into the SEC's challenges, interviewing 425 people both inside and outside the agency.

Who should we believe about the budgetary needs of the SEC: BCG or a bunch of Tea Party types who are taking a blunt ax to the federal budget?