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Tuesday, September 30, 2014

Blame The Gatekeeper, Shoot the Messenger: Is SEC Wrong?

Recent developments out of the Securities and Exchange Commission indicate that agency is continuing its years-long trend of making selected corporate officers the intended scapegoats for management malfeasance, wrongdoing or just plain stock price underperformance.

In so doing, the SEC persists in its efforts to hold someone accountable. As in someone, anyone, anyone will do. The problem is that the SEC may not be holding the right people accountable. The bigger worry is that the SEC may not even care if it accuses or punishes the wrong people, if the goal is just to meet the low bar of holding someone accountable when it matters not whether you get the right person.

Years ago I spotted the apparent inequity in SEC enforcement policies which sought to hold two classes of corporate officers -- in-house counsel and auditors/accountants -- particularly liable for the misdeeds of others while simultaneously disqualifying these same "suspect classes" or "disfavored professions" from eligibility for the SEC's then-new whistleblower awards for detecting and reporting corporate misbehavior.

The smugly condescending (if not contemptuous) Commission attitude was that such professionals needed to "do their jobs."  Underlying that sentiment is the incorrect belief that lawyers and accountants are best positioned to uncover fraud.

Here is what is correct: Lawyers and accountants are best trained or most experienced to detect wrongdoing. But wait for the critical assumption: The assumption is that access to the needed information is equal.

This is where regulators, prosecutors and judges get it flat wrong. Lawyers and accountants are not privy to wrongdoing, not because they are "in on the secret." It's because they are both most able to detect wrongdoing and personally inclined to report it. And guess what? It's because of those factors that wrongdoers conceal their misdeeds from precisely these two categories of workers! Brilliant!

This approach is wrong on many levels and will prove to be counterproductive. The biggest problem is the encouragement of a highly risk-averse approach by lawyers and accountants who will rightfully fear how their work is judged in a de facto strict liability environment where they can fear being held liable, not only for the wrongdoing of others, but wrongdoing for which their liability will arise from their inability to detect precisely the misconduct which others conceal from them. This is a thankless and perhaps impossible job, and is also likely to be unrewarded and unrecognized. 

Another implicit message, surely not lost on lawyers and accountants, is that their non-professional colleagues have a green light to snoop around, free from the burdens of the actual responsibilities of detection, and blow the whistle. Perhaps it is even intended that other corporate workers will get to pursue the potential whistleblower rewards, because they are not doing their own jobs.

From the outside, it is crucial to see that regulators -- often overworked and inexperienced -- may be trying to show that they are "doing their own jobs" by being able to demonstrate that they are implementing and enforcing a system to hold people accountable.

It is also crucial for observers, lawyers and investors to see that the appearance of doing one's job is never the same as actual performance, nor it is the same as effectiveness in stopping fraud.

Maybe if the government really cared about stopping the next Enron or Madoff before investors lost their life savings, they would care about positively incentivizing lawyers and accountants instead of demonizing them solely on the basis of their professional achievement.

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