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The SEC's latest whitewash -- of its own investigations

Securities and Exchange Commission seal, generic

Last Updated Aug 19, 2011 8:36 AM EDT

(MoneyWatch) It wasn't only corrupt lawmakers and "evil bankers" who deregulated the financial industry in the years leading up the housing crash -- government watchdogs also deregulated themselves. Kid-glove audits. Flaccid enforcement. An institutional deference to CEOs. Entire federal agencies charged with preventing fraud and guarding the banking system abetted the nation's largest financial companies in doing precisely the opposite.

Of these regulators, arguably none has a worse record in recent years than the SEC. Over the last decade, it whiffed on corporate implosions including Enron, WorldCom and Bear Stearns; allowed investment banks to engage in wild and destructive market speculation; and let convicted fraudster Bernie Madoff perpetrate the biggest Ponzi scheme of all time. So what does the agency do for an encore? It violates federal law by systematically disposing of 20 years' worth of its own records of investigations into Wall Street, insider trading and other allegations of law-breaking.

Appetite for destruction
Reports investigative journalist Matt Taibbi:

For the past two decades, according to a whistle-blower at the SEC who recently came forward to Congress, the agency has been systematically destroying records of its preliminary investigations once they are closed. By whitewashing the files of some of the nation's worst financial criminals, the SEC has kept an entire generation of federal investigators in the dark about past inquiries into insider trading, fraud and market manipulation against companies like Goldman Sachs, Deutsche Bank and AIG. With a few strokes of the keyboard, the evidence gathered during thousands of investigations â€"- "18,000 ... including Madoff," as one high-ranking SEC official put it during a panicked meeting about the destruction â€"- has apparently disappeared forever into the wormhole of history.

According to the whistle-blower, Darcy Flynn, a long-time SEC lawyer who helped manage the agency's records, the SEC destroyed documents related to so-called "matters under investigation" from at least 1993 to 2010. MUIs are preliminary inquiries into possible breaches of securities law. Among that material were records pertaining to the SEC's Madoff probe and to possible fraud at a number of Wall Street firms and hedge funds.

Sen. Charles Grassley is pressing SEC chairman Mary Schapiro to explain the SEC's document-destruction practices. Among other things, the Iowa Republican wants to know why the SEC is destroying MUIs and whether that policy has harmed agency investigations.

The SEC acknowledges it dumped the documents, and the agency's inspector general has opened a probe into the matter. But for now, predictably, the agency isn't admitting it did anything wrong. Taibbi notes that an SEC spokesman suggested that the documents in question technically aren't federal records, which means they wouldn't have to be retained.

That doesn't seem to square with the expressed concerns of the government's official record keeper, the National Archives and Records Administration. After Flynn notified the agency of what the SEC was doing, NARA ordered the agency to stop destroying records and asked it to explain its actions. Securities regulators are supposed to keep all federal records for at least 25 years. According to Taibbi, Flynn claims that SEC enforcement officials themselves expressed concern that it might be criminal to destroy MUIs.

Criminal stupidity?
Even if the practice wasn't illegal, it was, to use the term of art, dumb. Fine, government agencies generate mountains of data. Storing and managing it is undoubtedly a pain (although I hear they have these things called "computers" that can help). When it comes to regulating an industry, however, such information is vital. Financial fraud is hard to prove. It typically requires a painstaking accumulation of facts that, properly assembled, may indicate a pattern of wrongdoing. As one expert told Taibbi:

"Street-level law enforcement is increasingly data-driven," says Bill Laufer, a criminology professor at the University of Pennsylvania. "For a host of reasons, though, we are starved for good data on both white-collar and corporate crime. So the idea that we would take the little data we do have and shred it, without a legal requirement to do so, calls for a very creative explanation."

In wiping out what sounds like important investigative records, in other words, the SEC was effectively erasing the agency's collective memory. As Taibbi notes, it's as if the cops on the beat were throwing out evidence of a possible crime.

If we needed more evidence that the SEC is overdue for a top-to-bottom overhaul, this latest episode should do it. Despite its poor regulatory record, the agency is more vital than ever. Under the Dodd-Frank financial reform law, it will play a critical role in ensuring that financial firms obey the law. The SEC needs to give Congress some answers fast.

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    Alain Sherter covers business and economic affairs for