Are We Really Getting Tough on Financial Fraud?

Consumer outrage about “bailout madness” and the proliferation of Ponzi schemes and investment fraud is fueling a push for greater oversight and regulation. The government is talking tough, saying that there will be more prosecutions for financial fraud forthcoming..

That sounds good, doesn’t it? Of course we’re all in favor for more aggressively pursuing those who swindle others out of their savings or cheat the system. But while more prosecutions make good headlines, how realistic is this goal?

Currently, the rate of investigation and prosecution is very low. There simply aren’t enough resources to investigate all allegations of fraud. Even cases with all the proof ready for prosecutors often don’t make it into court for a variety of reasons.

The Securities and Exchange Commission (SEC) is one barometer for how serious our government is about pursuing fraud, waste, and abuse.  There are more than 12,000 public companies in the United States, all bound by the rules and regulations of the SEC. In 2008, the SEC almost hit a record with enforcement actions, bringing 671 actions against public companies and individuals involved in them.

Unfortunately, the number of actions is very small when compared to the number of fraud tips the SEC receives each year. A recent hearing before the House of Representatives included testimony from the head of the SEC, who reported that over 700,000 tips are received by the SEC each year. And while common sense tells you that some of those tips are meritless, it’s hard to imagine that only 671 of those (the number of actions brought by the SEC last year) were worthy of investigating.

The SEC has about 3,600 employees, down from about 4,000 just a few years ago. The agency plans to spend $943 million this year, or roughly $262,000 per employee. For 2010, the agency wants a 9 percent increase in the budget to allow more employees to be hired.

Let’s do the math on this. With 3,600 employees and 671 enforcement actions, we’re talking over 5 employees for every one action. With a budget of $943 million and only 671 actions, that’s $1.4 million spent by the agency for every one enforcement action. Of course, the money is not just spent on enforcement. There are plenty of regulatory duties and administrative functions the SEC must do as well, but doing the math makes it interesting.

Is the Securities and Exchange Commission really in need of more money? Or do they really need to find a way to make better use of the money? It seems that underfunding of the agency isn’t really the only problem. It also seems like the time has come for the agency to change how it is run. Business has changed since the agency was created in the 1930s.

But even if the SEC was to become more aggressive and try to bring more enforcement actions, it’s not likely to make a dent in the instance of financial fraud. It is clear that there is more fraud than our government can handle, and making statements that enforcement actions will be increased doesn’t really help much. The bottom line is that people and companies who want to do the right thing will, regardless of the enforcement activities. Those who are intent on committing fraud will find ways to do it no matter what the laws say or how tough the enforcers are.

As we have seen recently, even some cases that appear to have had compelling evidence were never seriously investigated by the SEC. Fraud schemes perpetrated by the likes of Bernie Madoff were brought to the attention of the SEC multiple times, but apparently never examined in detail.

Consumers have a right to be dismayed at the apparent lack of devotion to finding and fighting financial fraud. Yet what can really be done? Even this public show of support for more enforcement actions isn’t likely to scare off the bad actors. They realize that their chances of being caught are slim, so they often don’t worry about being one of the 671 cases prosecuted in a year.

What can really be done about corporate fraud? Government oversight only goes so far.

Companies need to establish a corporate culture that does not tolerate dishonesty, and that rewards honesty and transparency. Investors need to seek out companies that are committed to resisting the temptation to participate in financial fraud, and reward those companies and executives by investing in them.

When companies are found to be unethical, they need to be punished by investors and avoided at all cost. The government wants to create disincentives for fraud. We’ll have better success by creating incentives for ethical behavior.

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