Obama's challenge: sorry record of Democratic deregulators
President Obama’s pledge to bring back some meaningful regulation of the financial markets may be more difficult than he imagines. The reason: Senate Democratic leaders not only enabled the deregulation, they were cheerleaders.
In America, unlike other nations, the structure of investor protections against securities fraud stands on two separate legs: Government regulators and private lawsuits. Senator Chris Dodd, Chairman of the Senate Banking Committee, and other Democrats, worked diligently to saw off both legs.
Here is how the people’s representatives took the side of fraud defendants over the fraud victims.
STEP ONE: CURTAIL PRIVATE INVESTOR LAWSUITS
When in the mid 1990’s Dodd and fellow Democrats Charles Schumer, Patty Murray, and Harry Reid worked to curtail private lawsuits by investors who were victims of securities fraud, they weakened what has traditionally been the most effective deterrent to securities fraud.
Their actions represent the result of a determined effort by giant corporations seeking to do away with accountability in the financial markets because they felt it got in the way of their profits. In 1992 these companies spent millions of dollars on lobbying to get Congress to enact a law to shield them from private lawsuits. (Siconolfi, Michael, and Anita Raghavan. “Securities Firms Make Large Gifts to Congressmen.” Wall Street Journal 22 Aug. 1995: C1+.)
The Coalition to End Abusive Securities Suits, or CEASS as it was known, included some large accounting firms caught in fraud scandals of the 1980’s and 90’s, such as Arthur Anderson, Coopers and Lybrand, Ernst and Young, Deloitte Touché. Other CEASS members included securities firms and insurance companies, such as Prudential Securities, Chubb insurance, Morgan Stanley, and Amdahl corp. It was the beginning of a massive, costly, and successful lobbying effort.
The CEASS lobby in the early 1990’s pushed hard for Congress to approve a new law that would make it more difficult for people to bring class action lawsuits in federal courts against companies allegedly involved in securities fraud. The legislation was called the Private Securities Litigation Reform Act of 1995 (PSLRA), and it changed the rules to require that investors prove intentional lying by company executives in order to get into court. This standard is so high that investors now practically need to have an executive make a videotape and say he lied before investors can challenge suspicious behavior.
Making these lawsuits harder to bring to court diminishes the main deterrent to securities fraud in the U.S., since federal and state government regulators are notoriously understaffed. Most of the big cases, such as the billion dollar scandal of Charles Keating’s Lincoln Savings and Loan selling worthless bonds to elderly retirees in the late 1980’s, were uncovered by private lawsuits which then led to SEC investigations. Under the new standards in the PSLRA of 1995, the Keating fraud and others like it would not have been uncovered. We now know the sleepy state of federal watchdogs is one reason why Bernie Madoff was able to operate for decades without getting caught.
Two members of Congress championed the Private Securities Litigation Reform Act of 1995, and took credit for its enactment over President Clinton’s veto:
Republican Christopher Cox, then a Congressman from Orange County, California. Cox collected campaign contributions from high tech executives who also happened to be fraud defendants.
Democratic Senator Chris Dodd, Chairman of the Senate Banking Committee, who became very popular among banks and securities companies who were fraud defendants and among insurance companies who pay the investor settlements in financial fraud cases.
Dodd enjoyed the eager support of many top Democrats in favor of restricting investors’ access to the courts.
Not everyone thought this was a keen idea, however. Consumer groups, states attorneys general who enforce the securities laws, the AARP, and the securities regulators in all 50 states sent messages to Cox and Dodd that the bill was a bad idea that would weaken safeguards against fraud. (”Less protection for investors.” Consumer Reports Sept. 1995.)
Rick Roberts, a former Securities and Exchange Commissioner under the first President Bush, warned in September 1995, “if you look at the whole picture, congress is taking away the right to bring an action if there is a fraud; it’s cutting the level of information investors receive; and third it will try to slash the SEC budget so there are no public remedies. If I was an investor, I would be getting very queasy about plugging my money into the securities market.”
STEP TWO: LETTING THE FOX GUARD THE HENHOUSE AT SEC
In 2004, President Bush appointed Chris Cox to be Chairman of the SEC and the Senate, with the approval of Dodd and the other Democrats, voted unanimously to confirm Cox. In so doing, Dodd and the Democrats agreed to place the protection of investors in the hands of a man who had already made it his cause to shred the most potent deterrent to securities fraud.
As chairman, Cox allowed securities firms to avoid legal requirements to be audited by accounting firms that were registered with the government. The result was that firms like Bernie Madoff’s used their own accountants to do friendly audits and fraud can remain undetected for years. Also, under Cox, the SEC’s budget declined in 2006, and 07.
Why bring up all of this recent history? Because when Sens. Dodd and Schumer cried out this week about how the SEC “missed Madoff,” it is hard to remain silent.
President Obama and Treasury Secretary Geithner should know the sorry record of the Congressional team it has inherited, before they suit up to pitch for stronger protections for investors. And voters should know when their Senators talk like Teddy Roosevelt and act like Jay Gould.