Issue of the week: Is the SEC beyond repair?

The Bernard Madoff scandal was the last straw, said Marcy Gordon in the Associated Press. Despite repeated warnings from knowledgeable investors, the Securities and Exchange Commission failed to stop the New York financier from allegedly swindling his clients out of an eye-popping $50 billion. That failure, according to congressional Democrats and Republicans alike, “reflects deep, systemic problems” at the agency responsible for protecting investors from fraud. Some members of Congress are even now suggesting that the SEC be scrapped altogether and replaced from scratch by a new market-regulation apparatus. Our regulatory system has “failed miserably,” said Rep. Paul Hodes, a Democrat from New Hampshire, “and we must rebuild it now.”

That might not be a bad idea, said Rich Lowry in National Review. In recent years, the SEC has made “a practice of being wrong.” In addition to completely missing the Madoff affair, SEC investigators also somehow overlooked the over-the-top accounting fraud at Enron and WorldCom, and they allowed Nasdaq market-makers to rip off their customers for years before finally forcing them to pay a $1 billion settlement. “Part of the problem is that the SEC has to try to outfox people” who are paid extremely well to figure out ways around SEC regulations. Does anyone really think that an agency investigator making, say, $150,000 will outsmart even a junior investment banker who can earn a seven-figure bonus for successfully gaming the system?

The pay differential is the least of it, said Michael Lewis and David Einhorn in The New York Times. The problem is far more structural. The SEC, created after the 1929 market crash to protect investors, “has somehow evolved into a mechanism for protecting financial predators with political clout.” It’s a classic—and corrupting—revolving door. Regulators who play their cards right can look forward to a lucrative job at one of those “predators” once they leave the SEC. The two most recent directors of enforcement at the SEC are now employed as general counsels at JPMorgan and Deutsche Bank. With rewards like those awaiting regulators who “keep sweet the Wall Street elite,” our market overseers have every incentive “to curry favor with the politically influential.”

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There’s an obvious remedy for the SEC’s built-in conflict of interest, said Jesse Eisinger in Portfolio.com. “First, we raze the SEC.” In its place we erect “what is known in regulatory circles as the Twin Peaks approach.” One agency would monitor “the safety and soundness” of our financial institutions. The second “would focus on business conduct and investor protection, otherwise known as lying, cheating, inadequate disclosure, and manipulation.” It’s basically a “good-cop bad-cop” approach. The safety-and-soundness regulator would make sure that companies were financially solid and honestly managed; companies that didn’t fall into line would have to face “the enforcer.” There’s no better time than now for the sweeping change that’s needed. “Wall Street is at its weakest point in decades,” while “the public temper is at its hottest.” Will the new president and Congress seize the opportunity?