You can't fine someone unless you catch them. And most securities fraud goes undetected.
THE BILL INTRODUCED By Sen. Jack Reed, D-R.I., and Sen. Charles Grassley, R-Iowa, that would give the SEC the power to levy heavier penalties for violating securities law is a step in the right direction.
But the legislation is unlikely to substantially deter fraud in the financial services industry, because — like most criminals — people who break securities law don't expect to get caught. In fact, most violations are probably never discovered and those committing them are never punished.
The Securities and Exchange Commission doesn't have enough investigators or intellectual firepower to uncover more than a fraction of violations that occur each year.
For example, Bernard Madoff's Ponzi scheme went on for more than 20 years, even though Harry Markopolos, a financial analyst, warned the SEC in 1999 that Mr. Madoff's reported investment returns were mathematically impossible.
SEC inspector general H. David Kotz has reported that six investigations of Mr. Madoff between 1992 and 2008 failed because of incompetent staff work or neglected alerts from financial experts and whistle-blowers.
WRONG QUESTIONS
Mr. Madoff himself said that he should have been caught during an SEC inquiry in 2003, but the examiners didn't ask the right questions or look at his stock records.
The Reed-Grassley bill would increase fines to as much as $1 million for individuals and as much as $10 million for institutions. These amounts may deter some people and spur a number of smaller firms to strengthen internal controls.
They will have little effect on those who don't expect to be caught, however, and the remote possibility of a $10 million fine may have a present expected value less than the cost of enhancing those controls for some larger firms.
STRESS ETHICS, COMPLIANCE
Eric Feldman, president of the Core Integrity Group LLC, told the annual conference of the Association of Certified Fraud Examiners last year: “Laws and law enforcement are more successful in deterring certain types of corporate fraud and corruption [such as bribery to foreign officials] than others [such as false claims, defective products and many types of accounting violations].”
The best way to enhance ethical behavior is to encourage the development of comprehensive, multifaceted business ethics and compliance programs, Mr. Feldman said.
Unfortunately, surveys show that patterns of unethical behavior emerge as early as high school. In a 2008 survey, 78% of high school students admitted to having cheated the previous year, and 38% said they had cheated on tests two or more times.
According to a Rutgers University survey of college students nationwide, 43% of liberal arts students, 52% of education students, 63% of law and medical students, and 75% of MBA students admitted they cheated to get into graduate school.
The reasons given: Everyone does it, and in a highly competitive world, cheating is necessary to succeed.
Reducing the level of misconduct in the financial services industry will involve more than increasing the fines that the SEC can impose.
It will require beefing up the SEC's enforcement staff, not just in numbers but in brainpower. That will cost more, but perhaps those higher fines can finance it.
It will also involve emphasizing an ethical culture within financial firms. That will mean more than handing new employees a handbook spelling out the company's core values and code of conduct.
In addition, it will require regular reminders to all employees that the firm expects and values ethical behavior, and that they should report any suspect actions. It will require that unethical behavior, no matter how minor, be punished and that those who bend the rules in an attempt to get ahead are not rewarded.
Finally, top managerial staff members must lead by example in both their business and personal lives, and suffer financially — forgoing bonuses and perhaps even salaries — when a major ethical breach occurs on their watch.
