SEC Fines: The Cost of Doing Business?

I’ve long argued that SEC fines have become simply the cost of doing business on Wall Street.  The benefits of violating rules outweighed the paltry sums firms had to pay when they were found to be engaged in wrongdoing.  This is why I was not surprised to read today’s article from The New York Times entitled “SEC Fines Didn’t Avert Stanford Group Case.”  The article details how the SEC charged Stanford Financial Group with allegations that among other violations, the firm:

• did not have adequate capital to meet the requirements of being a broker-dealer;

• provided misleading, unfair and unbalanced information about its certificates of deposit;

• failed in its research reports to adequately disclose a variety of research methods and the way it was valuing certain securities;

• distributed sales literature that did not disclose the affiliations between the company and a related bank; and

• failed to present fair and balanced treatment of the risks and potential benefits of instruments it was marketing as C.D.’s.

As a penalty, Stanford Financial Group reportedly paid fines of ten, twenty, and thirty thousand dollars.  You cannot even compare this to a wrist slap.  These fines wouldn’t even cover the dry cleaning bill of Stanford Financial Group CEO Robert Allen Stanford.  The SEC’s previous charges certainly seem credible now that Stanford Financial allegedly cannot account for nearly $8 billion in deposits and its mutual fund is accused of overstating historical performance.

This is a stark example of how meaningless fines in no way acted as a deterrent to institutional wrongdoing and, once again, the average Joe is left holding the bag.  By no means is this the only example.

As readers of this blog are no doubt aware, on May 31, 2006, the SEC’s Division of Enforcement issued a news release trumpeting that it had settled with 15 broker-dealer firms, including Merrill Lynch for what essentially amounted to rigging the auction rate securities market between January 2003 and June 2004. The penalty: a paltry fine totaling $13 million, of which Merrill Lynch’s piece was an insignificant $1.5 million.

According to the complaint filed last year by the State of Massachusetts, Merrill is accused of being badly conflicted when selling auction rate securities to its retail customers, some of whom I represent. The firm reaped a hefty $90 million in profits in 2006 and 2007 underwriting these securities for their corporate customers and priced them at interest rates ultimately advantageous to them.

Even Eliot Spitzer’s much heralded “Global Settlement” did little to deter conflicts of interest on Wall Street.  The settlement was reached in 2001, but in 2004 the SEC found several large broker/dealers failed to disclose payment relationships they had with companies their research departments covered.  The result was that seven firms split a fine of $3.65 million.  Wall Street research hasn’t improved one iota since.

Research is still openly conflicted with investment banking (a “Chinese Wall” does NOT constitute a solution in my opinion) and as the economy soured in 2007, brokers continued to peddle financial services stocks armed with buy ratings from the research departments…earning commissions all the way.

High on the agenda of the SEC’s new regime is enforcement.  In fact today, Chairwoman Schaprio announced that former U.S. Prosecutor Robert Khuzami will lead the agency’s enforcement division.  Rest assured many will be watching to ensure that the “fine fits the crime,” because otherwise investors aren’t on a level playing field.