September 11, 2009
Preventing the Next Madoff
Posted by David Zaring

As the government begins to wind down its bailout, and stalls on putting new anti-crisis policies into place, it is worth parsing the SEC's handwringing over its failure to catch Ponzi-schemer Bernard Madoff.  The BLT has the overview of the agency's Inspector General report on what went wrong, which was paired with a suitably shouty congressional hearing. 

As friend of the Glom Miriam Baer noticed, the SEC's plans for the future would - in theory - punish agency employees for failing to catch the next big fraud:

[Enforcement chief Robert] Khuzami, who was the general counsel for the Americas at Deutsche Bank prior to joining the SEC in March of 2009, testified that the division of enforcement is now “undergoing a fundamental restructuring.”

Among the new initiatives: creating five specialized investigative groups of in-house experts and newly-hired staff; cutting management by 40 percent and reassigning those personnel to front-line investigations; hiring the division’s first-ever chief operating officer, and implementing a new system for handling complaints and tips. He also promised better training and more rigorous performance reviews.

It all sounds fine in theory.  But in practice, it is very difficult to punish civil service employees, including those at the SEC, because they essentially have tenure.  Like academia, you can reward stars, but you can't dock the deadwood, and so "more rigorous performance reviews" are unlikely to come with much consequence. Moreover, one of the ways you reward stars is by giving them a supervisory position, and Khuzami wants to get rid of most of those.  One of the great things about being a government lawyer (and the SEC is almost entirely made up of lawyers) is the massive responsibility you get on day 1 of the job.  One downside is that for most lawyers, the responsibilities are similar in year 30.

So oddly enough, although we do not have all the details, Khuzami's reorg might flatten the incentives for SEC investigators, rather than enhance them. 

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