Published May 17, 2013
Between hedge fund moguls Steven A. Cohen and Raj Rajaratnam, and banking giants Goldman Sachs (GS), Citigroup (C) and JPMorgan Chase (JPM), the Securities and Exchange Commission could raise enough money in fines to fund itself for a full year.
The question is ... why doesn’t it?
In March, CR Intrinsic Investors, an affiliate of Cohen’s massive SAC Capital Advisors hedge fund, agreed to pay more than $600 million to settle insider trading charges filed against it by the SEC. The deal requires CR Intrinsic to pay $275 million in disgorgement to be returned to investors hurt by the schemes alleged, another $275 million in penalties that will go straight to the U.S. Treasury, and another $52 million in interest. The deal is awaiting final approval by a judge who has questioned its propriety.
Either way, whether the deal is approved or not, the SEC, which is charged with regulating the vast U.S. securities markets, will get nothing. Not a dime.
Other eye-opening SEC settlements in recent years include: a 2009 deal worth $92.8 million that settled insider-trading charges against now-jailed Galleon Group founder Rajaratnam; a $550 million deal reached by Goldman related to allegations the bank defrauded investors, and a JPMorgan settlement worth $154 million tied to similar charges, both reached in 2010; and a Citigroup deal in 2011 in which the bank agreed to pay $285 million, also related to fraud allegations.
All told those five settlements come to $1.683 billion, slightly more than the $1.674 billion the SEC recently requested for its 2014 budget.
And Nasdaq OMX Group (NYSE: NDAQ), parent company of the Nasdaq stock market, may be next in line for a hefty fine. The electronic stock market is reportedly eyeing a $10 million settlement with the SEC in connection with Nasdaq's botched handling of the Facebook (NASDAQ: FB) initial public offering a year ago, according to a Wall Street Journal report.
Those settlements are merely the most high-profile of scores of deals reached each year by the SEC. Consider that since 2009, according to the SEC, the agency has collected $2.68 billion in “total penalties, disgorgement and other monetary relief” from firms whose alleged wrong-doings contributed in one way or another to the financial crisis.
Again, none of that money stayed at the SEC.
Each year the SEC tends to collect more money for the federal government than it gets back in funding. 2011 was a particularly busy 12 months for the agency: regulators filed 735 enforcement actions – a record year – while obtaining more than $2.8 billion in penalties and disgorgement. All with a 2011 budget of just under $1.2 billion.
Self-Funding Vs. Congressional Appropriations
In the wake of the financial crisis of 2008-2009 and the Dodd-Frank banking reform bill that arose from that crisis, the SEC has seen its responsibilities greatly enhanced. Not least, Congress wants the agency (along with its futures counterpart, the Commodities Futures Trading Commission) to keep a closer eye on the massive derivatives markets where much of the trouble started back in 2008.
To cover the costs of their new broadened responsibilities many market participants have sought to have funding for the SEC shifted away from an annual Congressional appropriation to something called self-funding, which means the agency would pay for itself using the myriad administrative and transaction fees paid to the SEC each year by members of the securities industry.
Indeed, the SEC could potentially fund itself each year using just those fees and without ever using the fines and penalties it assesses to various miscreants.
Among the influential groups in favor of self-funding for the SEC is the Systemic Risk Council, whose members include former SEC Chairman William Donaldson and former CFTC Chair Brooksley Born. In a recent open letter, the two argued that the difference between self-funding and the Congressional appropriations process is “enormous.”
“Self-funding helps agencies hire and retain good staff and insulates them from political pressure exerted by the deep-pocketed institutions they regulate. It also allows them to make and implement strategic decisions to adapt to changing markets and build needed information technology to become more effective and efficient, all which require multiyear budget certainty. The SEC and CFTC have none of these advantages,” the two former regulators wrote.
Also on board for self-funding is the American Bar Association: “In light of the dramatically expanded responsibilities and mandates that the Dodd-Frank Act has imposed on the SEC and CFTC … we consider it urgent and crucially important for Congress to further re-examine its approach to funding these agencies in order to provide them with stable and more predictable sources of revenue. Therefore the ABA strongly favors authorizing self-funding of these agencies to achieve these objectives,” the group wrote in a 2012 letter to Congressional lawmakers.
The ABA noted that other primary U.S. regulatory agencies, including the Federal Reserve, the Federal Deposit Insurance Corp. and the Office of the Comptroller of Currency, cover their own budgets through self-funding.
SEC Fines Should Be Returned to Harmed Investors
The ABA collected some stats of its own: from 2005 to 2009, the SEC took in about $7.4 billion is transaction and registration fees that went directly to the U.S. Treasury. Meanwhile, Congress appropriated just $4.5 billion for the SEC’s budgets during that period.
“Notably, these amounts are wholly apart from the enormous sums of money that (the SEC) collects in its enforcement cases – which we do not believe should be included in any self-funding mechanism,” the ABA wrote.
The argument against the SEC using penalties and fines to cover its budget is that it would create an obvious and potentially frightening conflict of interest: in theory in order to increase its budget, SEC regulators could aggressively ramp up their caseloads for no other reason than to stuff their coffers.
That hypothetical doesn’t bother Andrew Stoltmann, a Chicago attorney who often represents investors in securities cases involving allegations of fraud.
“I’m a fan of self-funding,” Stoltmann said. “I think it really provides a great incentive for a government agency to be aggressive in pursuing wrongdoers. And this is exactly the sort of shot in the arm the SEC needs.”
That said, Stoltmann believes fines and penalties, whenever possible, should be repaid to investors hurt by the schemes investigated by the SEC.
“The sole purpose of this money needs to be compensation of the victims,” he said. “Securing large fines makes for great headlines but failing to give the money back to those who have been negatively impacted is simply backwards.”