SEC Details Its Post-Madoff Reforms

By James Eccleston

he Securities and Exchange Commission (SEC) recently highlighted what it has been doing to avoid another Bernard Madoff fraudulent scheme. While the public awaits a report from the SEC's Office of the Inspector General, determining why the SEC failed to detect the Madoff scheme, the SEC is taking the opportunity to explain its "decisive and comprehensive steps to reduce the chances that such frauds will occur or be undetected in the future." Let's examine the SEC's publication, "The Securities and Exchange Commission Post-Madoff Reforms" (available on its website).

The SEC details ten categories of reforms. The first, "Safeguarding Investors' Assets", relates to two pending proposals aimed at investment advisers. The annual surprise examination requirement would subject investment advisers, who control or have custody of their client assets, to another set of eyes to verify that client assets actually exist. The second proposal would apply to investment advisers who do not use an independent firm to maintain their client assets. Those advisers would be required to obtain a third party written report assessing the safeguards that protect the clients' assets.

The second category, "Revitalizing the Enforcement Division", relates to a restructuring of the division to "reduce bureaucracy and speed up the enforcement process by removing a layer of management." The reform also includes forming "special units" and "streamlining internal processes to make investigative procedures more efficient."

The third category, "Revamping the Handling of Complaints and Tips", concerns improving intake procedures, so that the "processes for collecting, recording, investigating, referring and tracking" information is improved. The SEC also is creating a centralized system for handling the information.

Fourth, the SEC has sent to Congress proposed legislation that would establish a funding mechanism to pay whistleblowers. Those who bring forward substantial evidence of significant securities law violations would be compensated using money collected from wrongdoers which otherwise is not distributed to investors.

The fifth category, "Conducting Risk-Based Examinations of Financial Firms", relates to "sweep" examinations of higher risk activities. The SEC lists such risks as: advisers whose client assets are held with an affiliated, not independent, entity; firms that use an unknown auditor or no auditor at all; and firms with a disciplinary history.

The sixth category, "Increasing Focus on Agency-Wide Risk Assessment", involves better risk assessment techniques. It also addresses increased collaboration with third parties and other government agencies.

Seventh, the SEC highlights how it is improving fraud detection techniques for examiners. The SEC has instituted measures to detect fraud and other violations, including "more rigorous reviews of firms before the examiners enter the premises, and a more complete exam guide that focuses not only on obvious signs of fraud but also more subtle signals that deserve closer inspection, such as a firm using an unknown accountant."

The eighth category relates to the SEC's recruiting staff with specialized experience. The agency lists two examples. The first, Senior Specialized Examiners, are those with specialized experience in areas such as trading, operations, portfolio management, options, valuation, new instruments and portfolio strategies. The second, the Industry and Market Fellows Program, are "highly-seasoned financial experts to keep pace with the practices of Wall Street and protect investors."

Ninth, the SEC details how it has expanded and targeted training of staff. Hundreds of staffers are being trained to become Certified Fraud Examiners and Certified Financial Analysts. In addition, there is targeted training related to such areas as hedge funds, specialized products, derivatives and options.

Tenth and finally, the SEC highlights that it is seeking more resources to fund all of this! The request is understandable. Currently, the SEC has just over 400 staffers in its examination program to examine more than 11,000 regulated investment advisers and 8,000 mutual funds. That's a Herculean task of which fraudsters like Bernard Madoff are well aware. Investors deserve better protection and the resources to fund it!

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About the Author:
James J. Eccleston is the president of Eccleston Law Offices, P.C. The Chicago-based firm represents investors and advisers nationwide in securities and employment matters. 312-332-0000 www.EcclestonLaw.com.