SEC blamed for failing to spot Madoff fraud

Harvey Pitt, the former head of the US Securities and Exchange Commission, on Thursday delivered a measured, but trenchant indictment of his former employer over its “terrible failure” to spot the Ponzi fraud of Bernard Madoff, who on Monday was sentenced to 150 years in jail.

Mr Pitt, who was SEC chairman for 15 months between 2001 and 2002, confirmed that the regulator had been given evidence of alleged wrongdoing by Mr Madoff’s business at various points – in 1992, 1999, 2005 and 2006. “But during [my tenure], there was no indication whatsoever that Madoff was doing something wrong,” he said.

Staff at the regulator, he said, had always “lacked the sophistication and skillset” necessary to do their jobs effectively. The SEC was staffed with too many lawyers and not enough economists and market practioners, said Mr Pitt, himself a former lawyer.

Commenting on the SEC’s future, Mr Pitt said he admired the calibre of US president Barack Obama’s team and was broadly supportive of its desire to reform the regulatory environment. But he said political expediency meant grand plans for new structures – for example to speadhead consumer protection – would crash into existing bodies. “Rather than eliminating the SEC now, there is an effort to make it even less relevant than some think it’s already become,” Mr Pitt said. The result was an “emasculated” SEC.

Mr Pitt resigned from the SEC in November 2002, after a difficult period during which Enron and Worldcom both collapsed. He was seen by critics as having been slow to address the problems of biased equity research on Wall Street.

Speaking on Thursday at the offices of CQS, a London-based hedge fund on whose advisory board he sits, Mr Pitt also laid out his blueprint for the direction he thought regulatory reform should take.

Having spent recent months advising governments on both sides of the Atlantic, in his capacity as chief executive of regulatory consultancy Kalorama Partners, he said current ideas for “extensive and, I believe, invasive regulation” seemed to be directed at “fighting yesterday’s crisis”. “The next crisis, we can be pretty sure, won’t look anything like the last one,” he said.

The answer, Mr Pitt said in a familiar refrain, was to adopt the more principles-based approach that the UK’s Financial Services Authority has traditionally used. “The FSA model is a good model and one that the US would do well to follow,” he said, though the FSA has recently redefined itself, under chairman Lord Turner, as an “outcomes-based” regulator and has moved away from its former “light-touch” style.

Mr Pitt said there were two key principles vital to ensure effective financial regulation. The first was a need for more data to be disclosed by banks and hedge funds to government, though that information should only come back to the markets in aggregate form. In particular, hedge funds should be obliged to disclose potential conflicts of interest, for example if they were simultaneously invested in a company’s equity and debt.

The second was a need for government to have a “residual regulatory authority”, allowing it emergency powers to intervene in the financial system if it saw that by certain measures, such as leverage, the economy was overheating.