Who, exactly, does the Securities and Exchange Commission represent?   When it brings a suit against a company such as it recently did against Citi accusing it of fraud, whom is the SEC trying to protect?  It can’t be the shareholders, because any fines meted out against Citi will be paid by them.   That leaves only the officers and managers of the enterprise being sued, or the SEC itself.  I’d say it’s a little of both, which effectively results in a collusive effort to defraud shareholders.  Unless a judge steps in.  Which she did, in the SEC case against Citi.

When presented with a settlement offer of a $75 million fine against Citi for the “negligent fraud” of two of its managers concerning the firm’s subprime exposure, U.S. District Court Judge Ellen S Huvelle turned it away, seeking answers to a litany of questions, many of them posed by a shareholder activist, Stanley Lerner.   The two executives involved were fined, each not more than $100,000 and allowed to “neither admit nor deny” the accusations of fraud. 

Judges are beginning to push back.  District Court Judge Jed Rakoff got the ball rolling last year when he refused to accept the offered $33 million settlement fine jointly proposed by the SEC and Bank of America over allegations that BofA lied about Merrill Lynch to its investors prior to its purchase. 

Again I ask:  Who is the SEC’s client in these cases?  Is it the public?  The non-shareholding public has only an attenuated, derivative interest in generally seeing public company fraud being prosecuted. 

These cases always begin with great momentousness, and end with a whimper.  Which is telling.  The beginning of the case is when the SEC gets to do its political preening.  By the end (w/ the possible exception of Goldman’s case), nobody’s paying attention.  Except the judges.  Sometimes.

In my view, the SEC exists solely to represent itself.  It operates a gatekeeper function, allowing managements that want to exploit the agency costs of owning shares in public corporations to do so with a wink and a nod and a few million dollars from the very shareholders the management seeks to defraud.  The SEC looks good, and gets a bit richer, but not so much as to materially affect the manager’s stock options.

In fact, there is no one protecting the shareholders.  They can bring a shareholder’s derivative suit, but that too, is effectively the company suing itself.  If the SEC were interested in protecting the shareholders, it would drop the organizations from its suits, and prosecute only the officers and managers of the organization that perpetuated the fraud.    As it stands, the litigants to an SEC fraud case collude against the shareholders, both in the conduct of the case, and in the repercussions lax consequences for misbehavior has on the officers and managers going forward.

Thankfully, federal judges like Rakoff and Huvelle are beginning to see through this veneer and get at the heart of the matter–that the SEC and the officers and managers of the corporations it is suing are hardly antagonistic litigants.  There are some rare occasions when the legal system actually operates to aid in the dispensation of justice.