Back before most people never thought about mortgage-backed securities, troubled assets or credit default swaps, we weathered a technology bust in 2001, peppered with various scandals from accounting to analyst conflicts.  A guy we don't hear from much now, Eliot Spitzer, was the AG of New York, and he went after 10 entities we used to call investment banks for issuing research telling the public to "buy" the stocks of their investment bank clients, even though those clients were tanking.  Spitzer also accused some of the banks of spinning shares of hot IPOs (something else we haven't seen in awhile) to their investment banking clients.  The result was a Global Settlement of Analyst Conflicts in which the banks neither confirmed nor denied issuing improper research or spinning hot IPO shares but agreed to settle with Spitzer, the DOJ and the SEC and cough up $1.5 billion collectively to be used for a variety of purposes, including restitution ($432.75M) and investor research ($80M).  The year was 2003.  Now, six years later, federal district judge William Pauley has issued a scathing rebuke of the SEC as he returns unused portions of funds that were to be used for restitution to the federal treasury.

I have blogged about the disgraceful nonuse of the investor education funds before (three years ago!), and will update that with a different post.  However, the $432.75M for restitution is the main target of Judge Pauley's concern, and it deserves its own post. 

According to Judge Pauley's intutition, the SEC basically came up with a settlement number for the banks to pay as penalties and for disgorgement without any consideration or analysis of the investor losses.  Here, the court was charged with identifying a plan of disbursement without any input from the SEC, who had not done the work, the defendants, who had no incentive to identify investor losses as they had not admitted to any, or the adversarial process.  Without anyone advocating for investors who felt they were aggrieved, it fell to the court to come up with a workable solution.  Because no investors were in front of the court, the court attempted to send claim forms to investors twice, receiving return rates of less than half each time, and granting more than half of those claim forms some relief.  The court only had broad criteria to go from that the SEC had provided.  As a result, monies provided by some banks were inadequate to compensate investors who tied their losses to those banks, but monies provided by other banks were barely touched (including Bear Stearns, J.P. Morgan, and Merrill Lynch/Henry Blodget, who was barred from the securities industry).  The court now declares that it has met its limits of reaching investor losses and will return the surplus (almost $80M) to the federal treasury.  One highlight:

This Court believed the SEC had brought its expertise to bear on the issue at the time the settlements were submitted for approval in October 2003. But three years elapsed before the SEC acknowledged that the amounts the Defendant paid, representing both disgorgement and penalties, were not necessarily connected to any measure of investor losses. (citation omitted). Had the SEC realized that earlier, several exercises in futility could have been obviated and the current predicament -- $75 million accumulating interest at the Federal Reserve Bank of New York with no payees -- avoided.

And finally,

In the final analysis, this Court does not question the SEC's interest in bringing to an end improper conduct. Nor does it question the SEC's interest in recompensing investor victims and deterring future violations. However, whether the SEC has the institutional resolve and commits adequate resources to reach these goals is an open question.

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