Sometimes it takes a meltdown to force regulators into action.
"The primary mission of the US Securities and Exchange Commission is to protect investors and maintain the integrity of the securities markets."
There, that was easy. Rare is the organization that can state its mission so succinctly. And the SEC's motto, "the investor's advocate," is even clearer. Having said all that, what's unclear is which investors the SEC was protecting, and on whose behalf it was advocating, when some $60 billion of Enron shareholders' money went poof! late last year.
Why didn't anyone see it coming? The short answer: because Enron fell between the cracks in the government's regulation scheme. Indeed, the firm's collapse represents a regulatory failure of unprecedented scale.
Enron had transformed itself so thoroughly - from natural-gas pipeline operator to commodities trader and market maker - that watchdogs simply didn't understand what it had become: a large, bank-like financial services company. That transformation put Enron under the purview of no one.
The Federal Energy Regulatory Commission handles only physical energy "deliverables" - not the futures contracts in which Enron traffics. The Treasury Department and the Fed mind the banks, but Enron isn't a bank. The SEC proactively inspects broker-dealers, but Enron doesn't trade securities.
Similarly, if a holding company owns numerous public utilities, it is prevented by law (enforced by the SEC) from getting into noncore businesses; Enron, with ownership of one electric utility, doesn't fall under that restriction. Congressionally approved exemptions keep Enron's nonexchange energy contracts away from the Commodities Futures Trading Commission, another potential regulator.
So, while each agency was doing its narrowly defined job, nobody was protecting shareholders.
That's why Enron's fall ultimately needs to be a wake-up call for the SEC. It was watching Enron, but only as it watches any public company - by waiting for filings and investigating alleged wrongdoings after the fact. And even if the SEC had poked around, it might not have known what to look for. "The SEC reviewers can compute receivables or cash flows," says Howard Schilit, a forensic accountant who analyzes public filings in search of funny business for investor clients. "But they haven't been trained to analyze a trading company." That needs to change, because as it is now, investors in companies that skirt disclosure rules are simply out of luck.
This is, after all, how policy shifts happen. The Great Depression begat the SEC - when Congress decided the nation needed a watchdog to prevent stock manipulation and other chicanery - as well as Glass-Steagall banking reform, which separated banks and investment brokerages. The oil shock of the early 1970s produced federal fuel-efficiency measures regulating the automakers. And the savings and loan debacle of the 1980s forced Congress to tighten rules on what thrifts and other financial institutions could and couldn't own.
It's too easy to argue that the onus must be on the companies to make fair and accurate disclosures. And the SEC's frequent sermonizing - la its recent investor warning to beware of pro forma financial reports - isn't good enough. The fact is, the economy and the companies in it are morphing too rapidly for passive regulation.
So, what should the SEC do? For starters, it has to get out of the office more. It needs to visit public companies the way banking regulators inspect financial institutions. The Federal Deposit Insurance Corporation started that practice, in part, reacting to the phenomenon of Depression-era bank runs. What happened to Enron, of course, was not unlike a 21st-century version of the same - and demands an equally vigilant oversight structure. Of course there's no way the SEC could inspect every public firm, but it could proactively and routinely investigate linchpin companies that affect the entire economy - much the way the Internal Revenue Service currently sets up shop inside important giants like GE.
Lynn Turner, director of Colorado State University's Center for Quality Financial Reporting and former chief accountant of the SEC, has called for a quasi-governmental oversight board to monitor the accounting industry. That's a good start - make it part of the SEC. But after all the hand-wringing is done, one truth remains: Where the public's investments are involved, the SEC must assume leadership - not unlike the role President Bush wants the Office of Homeland Security to play in the war on terrorism.
The chief cop for the securities markets can't just sit back and wait for criminals to be brought to the station house. It needs to get to know the neighborhood - confusing though it may be.
