VideoIt's not that the Securities and Exchange Commission wasn't working hard during the years that Enron, WorldCom, and others were allegedly submitting fictional financials. In many instances, the agency, overburdened and lacking strategy, was simply working wrong.
Consider the case of Ants Software Inc., a software company trading over-the-counter that has not yet booked revenue. For nearly two years, starting in January 2000, the SEC tried its hardest to document suspected wrongdoings ranging from incorrectly identifying a director in a filing to failing to file periodic reports from 1988 to 1999.
Meanwhile, Ants CFO Ken Ruotolo spent hours with company attorneys and more than $150,000 in legal fees trying to convince the agency it was on the wrong track. "We had very reasonable explanations for all four elements of their inquiry," he says. SEC investigators wouldn't budge, even when the company agreed to settle by promising to cease and desist without admitting or denying guilt. "We implored them to come forward with some kind of official pronouncement about what they found in the investigation. They never would, but they wouldn't close the case either," says Ruotolo.
Ultimately, he says, the SEC dropped the case, with no material modifications, charges, sanctions, or fines involved. The real victory, as he sees it, was getting the case officially closed last January (two months after the SEC decided not to bring action). "We understand that that is very rare," says Ruotolo. "A lot of times they just leave these open on the books and never give issuers a final resolution."
Indeed, such tenacious butterfly-chasing has not been uncommon at the agency. Given increased filings and an infamous lack of resources, "simple multiplication would tell one very clearly that the odds are good to excellent that the SEC will not be able to successfully investigate many of the financial fraud cases in front of it," former SEC chief accountant Lynn Turner told Congress in April. "It was not unusual at all that a case would become stale and grow old and the staff assigned to the case would pursue other job opportunities...and the case would never be completed, because of this lack of resources," he said. Greg Bruch, an assistant director in the SEC's enforcement division until last October and now a partner at law firm Foley & Lardner, agrees, adding: "People don't understand what a remarkable achievement it is that the SEC brings any cases."
Since 1996, the SEC's aggregate workload has grown about four times as much as its staff resources--because of both increased volume and problems with staff turnover. Lingering low-priority cases such as Ants have created a crushing backlog--more than 2,400 investigations were still ongoing at the beginning of fiscal year 2002, about four times the number opened during the year. Meanwhile, some 40 percent of the agency's staff left between 1998 and 2001, with average tenures in some departments shorter than standard training periods.
On top of this shaky structure comes the Sarbanes-Oxley Act of 2002, with its laundry list of responsibilities. During the next year, the SEC is expected to devise 24 sets of new rules, launch and complete six major studies, shepherd the formation of the new public accounting oversight board, hire 200 new employees, and review one out of three filings. To smooth the way, Congress promised $776 million (sliced to $750 million in the current Senate appropriations bill), which amounts to a 77 percent year-over-year budget increase.
Whether the money and power are enough to create an agency that can sniff out the next Enron before the stock collapses is uncertain. But what no one disputes is that digesting the new resources could be as difficult as winning them from Congress. "You have to realize there will be about a two-year time lag between passing this bill and having troops in the field," says Richard C. Breeden, who chaired the SEC from 1989 to 1993. Turner says it may take three to five years to see any impact from those changes. "Any organization, be it government or be it business, has to have a process in place for managing change," he says. "As with almost all government agencies, the SEC hasn't had that in the past."
Human-Resource Woes
A key step in making the SEC more effective is improving staff recruitment and retention. But even with the additional $76 million earmarked for pay increases and $97 million for new hires, accomplishing those goals won't be easy. For starters, the SEC must deal with a federal hiring system that gives insiders little discretion over the speed or integrity of the process. Second, there are signs that the pay increases (known as "pay parity" because they put SEC salaries on par with those at other federal financial regulatory agencies) aren't buying the agency the love it needs from employees.
"Employee morale is at an all-time low," said one SEC attorney as the raises hit paychecks in August. Managers received double the 6 percent raise that union employees got, he says, so employees "feel like the agency basically hijacked pay parity for the managers."
That sentiment is shared by many in the National Treasury Employees Union (NTEU), which represents about two-thirds of the SEC's approximately 3,000 employees, says union president Colleen Kelley. "As far as we can tell, about 60 percent of salaries today are paid to front-line [nonmanagement] employees represented by the NTEU," she says, "but it appears the SEC has allocated only 40 percent [of the money for raises] to those employees." In addition, Kelley maintains that employees are not satisfied with a new system for promotions that makes advancement criteria more subjective and caps pay raises at half the annual percentage increase previously attainable. "So far, we don't believe that what they have created is going to solve turnover and retention problems; we think it's going to exacerbate them, actually," she says.
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