The "Swindlers' Encouragement Commission" Strikes Again

Today brought a warm rush of joy to my heart when I read Jonathan Macey's commentary in the Wall Street Journal about the "SEC's Facebook Fiasco."

This government agency has been on my mind quite a bit recently, because I'm writing the biography of my father, economist and investment adviser Edward C. Harwood, who spent five of the last seven years of his life fighting the Commission back in the 1970s.

Harwood gave this grave-faced government body the nickname "Swindler's Encouragement Commission," due to the fact that the public thinks the SEC is protecting them from evil people but in reality, as we have seen most recently from the Madoff case, it is not.

My Dad won, in effect, his case against the Commission. In the end, the SEC had to back down from its claims. This is rare: usually the very rumor of the agency's presence in the room is enough to cause most investment advisers to turn to dust. The business is built, after all, upon reputation. Once that's gone, it's over, at least for most people.

Not for my Dad. He stood up to the SEC challenges, and alongside him, believe it or not, were his very courageous investors. Together, with Judge Gerhard Gesell's help, they proved that a contract is worth more than the paper it's written on--at least back then.

My version of the story will come out, for those who are interested, within the next few months. I'll keep you posted. Meantime, may the gods smile upon brave souls like Jonathan Macey who have the courage to tell the SEC like it is.

Here are a few excerpts:

"...[T]he commission's rules regarding stock sales are crippling for U.S. investors."

"Thank to SEC regulation and the litigious atmosphere it fosters--not to mention Sarbanes-Oxley's onerous burdens on corporate executives--the whole capital formation process is moving offshore."

"The SEC's fundamental approach to regulation involves depriving investors of opportunities in order to protect them." [Oh, how this rings true. But it lost one of those battles in 1978.]

"... [A]ccording to the SEC, all investors large and small must be protected against the danger that they will succumb to a feeding frenzy of enthusiasm when given the opportunity to invest in a new deal. For example, the SEC rules governing the Facebook offering until Goldman pulled the plug include the requirement that the stock being sold 'cannot be the subject of advertising, general promotional seminars or public meetings in connection with the offering.' The concern here is that publicity about a deal might, heaven forbid, create interest among investors."

Read the whole commentary (subscription required). It's really a hoot, and right on target.

My father would be pleased to see that there are those who follow in his faded but indelible footsteps.

Government Intervention Run Amuck No. 19: the SEC vs. Madoff

The Madoff scandal has the damaged investors looking for scapegoats--other than their own cupidity and Mr. Madoff himself, of course. Sooner or later the question had to be asked: Where was the SEC?


[Thanks to Ca.uky.edu for the image.]

Now, goodness knows I am the last person in the world to defend the Securities and Exchange Commission. I don't know what there record is today, but in the 1980s one would have been hard-pressed to find a case where the SEC saved an investor a penny.

This may not be true today, I don't know. But what is certain is that they didn't do their job in the Madoff case, as Christopher Cox seems to be admitting publicly.

But is this really the SEC's fault? Yes of course it is; but it is also the fault of voters who elected the legislators who created the SEC in the first place.

Just like the FDIC, the SIPC, the PBGC, and (hiccup) now even the Federal Reserve, federal guarantee agencies can be grouped under the common heading "Lenders of Last Resort," a kind of national insurance policy for each risk involved (banks, brokerages, pension funds, and ... well, everything else).

The problem with national insurance policies is that, unlike private entities entering into any other venture, the government has no bottom line to manage.

A private insurance company would only insure risks it felt certain it could insure and survive. The government, on the other hand, insures whatever risks it thinks it must to protect the electorate, whether or not the government budget exists to pay for it.

This leads us to what economists call "Moral Hazard," where market players--who are not stupid--take into account the fact that what they are about to do is insured by the government, which allows them to take on more risk than they ordinarily would.

This backfiring of intent is a well-known phenomenon in economic research. For example, wearing seat belts actually causes more accidents because people feel safer and take more risks while driving. It distorts the incentives, as economists say.

Thus the government that started out to be the protector of the consumer becomes a kind of Risk Devil, encouraging more risk-taking than is healthy, eventually guaranteeing havoc in the marketplace, creating its own program's ultimate failure, and harming the very constituents it intended to protect.

Government oversight may sound like a good thing; but it often ricochets. We might do well to abolish these entities and create in their stead citizen watch-dog groups that will use current legislation to police the bad guys but guarantee nothing and no one.

Read more about the hubris of the financiers who were hit by Mr. Madoff's game in this great piece by John Kay in the Financial Times today. Also, read how Madoff investors are looking for people to sue. It'll just be a matter of time before they decide to sue the SEC--which is us, by the way; and instead of abolishing the SEC, just watch: Legislators, responding to your demands, will strengthen it.

Good grief. We'll never learn.