An SEC of Woes

Well, at least there are no doubts anymore. For two years, we thought the Securities and Exchange Commission was simply slower and more plodding than the New York State attorney general, Eliot Spitzer, in the Big Wall Street Cleanup. Both, we thought, could work together to drain the cesspool that America’s financial markets have become.

But after the SEC’s speedy—and toothless—settlement with Putnam following that mutual-fund firm’s alleged outrageous anti-fiduciary behavior, we know better. These two are on opposite sides: Spitzer’s a true muckraker, trying to make mutual funds less expensive and more honest; the SEC desires nothing more than to maintain the status quo. The SEC’s not even a watchdog; it’s a lapdog. I wonder if, tail wagging, it brings Putnam the paper in the morning. The SEC isn’t about trying to protect individual investors; it appears the agency is trying to protect the industry from Spitzer. It isn’t about trying to rein in outrageous fees or about stopping the big skim that goes on every day at many mutual funds; it’s about ensuring that steady income stream no matter what Spitzer does.

First, let’s understand the scandals that Spitzer uncovered. Some mutual funds, having performed poorly for shareholders and under tremendous pressure from stockholders and managers to gather assets at all costs, totally sacrificed their mom-and-pop accounts to cater to larger flows from hedge funds.

I used to run a hedge fund. Spitzer was a client both before and after he became A.G. I had $450 million under management. I knew that if you could somehow take advantage of the stupid pricing of mutual funds, done at 4 p.m., even when the markets were open 24 hours, it would be like stealing candy from a baby. But that would require three things: a hedge-fund manager nefarious enough to be willing to steal money from passive mutual-fund investors; a mutual fund that cared so little about its core constituents that it would gladly journal, or transfer electronically, the profits from the mom-and-pops to the hedge funds if they placed $10 million to $20 million in “slow money” with another boring mutual-fund offering; and an SEC that wouldn’t care if it found out about it or wouldn’t understand it if it did uncover it.

Looks like we had all three. Dozens of hedge funds stole from you, the mutual funds got to keep raising assets courtesy of the hedge funds, and the SEC apparently didn’t understand what was going on and wasn’t particularly troubled when it caught a clue. Until Spitzer forced the agency to look at the scam.

“The SEC’s not even a watchdog; it’s a Lapdog. I wonder if, tail wagging, it brings putnam the paper in the morning.”

For those of you who still don’t understand what the crime is here, I want to put you at the stock racetrack to explain how you got ripped off. We are all at the races. We, the great unwashed, have to bet on the race before it starts, but some hedge-fund managers get to bet after our window closes. Those who bet after looking at the horses at the far turn (just before the official close) are guilty of “market timing.” Those who get to bet after the race is over are guilty of late trading. No racetrack would ever allow such bets (the first practice is unethical, the second is illegal), but many of your mutual funds did these kinds of trades every day. Can you imagine how lucrative that can be for the hedge-fund guys? And the assets it draws to the mutual funds? And who pays the winnings? The rest of us, not the track (the size of the pie is fixed—we get a smaller piece). It comes out of the handle!

Given that spurious legacy, the SEC had the industry over a barrel. The agency could have made real changes that would have saved the public billions, and it could have truly punished those who favored the large hedge funds over the small fry.

Instead, it sided with the industry against Spitzer, who was trying to make it so that the funds disgorged fees they took while they stole from you. It protected ineffective boards of directors and high fees, and made no criminal referrals to Justice. Small restitution of monies will be made, but no fees waived or returned despite these despicable actions. The Feds simply don’t think crimes were committed here. What has to happen, what horrible activity has to occur, before it’s considered criminal by this agency and sent to Justice?

Which makes me wonder: What exactly does the SEC do? It didn’t protect us from the zany lunacy of the bubble and a corrupt IPO process. It allowed—and still allows—ad campaigns that urge excessive margin use and no need to do homework. It failed to stop trillions of dollars in thefts from shareholders by greedy managements. And now it is protecting the mutual-fund industry from real reforms.

When I was a hedge-fund manager, I was always fearful of the SEC. The commission was consistently toughest on hedge-fund managers, even though we labored only for rich people. Funny thing, it protected the rich in hedge funds but didn’t give a hoot about the poor slobs in mutual funds. Now I am beginning to think that the SEC’s real job is to train young attorneys to go to work as general counsels to mutual funds. The SEC’s a graduate school! It’s a placement office, for heaven’s sake!

So, let’s stop kidding ourselves. There is no “rift” between the SEC and Spitzer: They have no shared goals at all. The SEC is in charge of protecting the wealthy interests, many of them corrupt, from you, while Spitzer is trying to protect you from the wealthy interests. Unless Spitzer’s Hercules, my bet says the stables stay filthy and nothing changes in the mutual-fund industry whatsoever.

The industry hates it when I use gambling analogies. It detracts from all of those years of brainwashing about the trust and skill and intelligence with which they allegedly handle your money. But it’s the gambling industry that should be insulted, not the mutual-fund mavens. The other day, I had the good fortune to interview Gary Loveman, the bright CEO of Harrah’s, one of the largest casinos in the country. He marveled at how much tougher the oversight of the casino business is than that of the mutual-fund industry by the SEC. Given the long history of mob influence at casinos, he said, it was necessary at one time. No longer, though.

I say it’s time to pass those adversarial casino regulators over to the SEC’s mutual-fund department. That’s where the real scams are today. At least when you lose at the casinos, it’s your own darned fault. I sure can’t say that about mutual funds. Not anymore.

An SEC of Woes