Teeth for the Watchdogs

I’ve been a fan of Inspectors General for decades – even though I was once the subject of an IG report. The 30 most senior Federal Inspectors General are appointed by the President and confirmed by the Senate, and can only be fired by the President. They report both to the Senate and to the head of their department or agency. Their job is to find and bring to light mismanagement and (the iconic) “fraud, waste, and abuse.” Interestingly, the US Air Force Inspector General also runs a Complaints Program.

 You don’t have to be a fan of Stafford Beer or grok his Viable System Model and “System Three” to grasp the value of an individual or office whose mission is taking problems directly to the head of a large organization. It does help, though, to have spent time in the innards of a large organization wondering whether the bosses really understand what’s happening down below. Information doesn’t flow upwards very easily “through channels.”

Of course, if your IG reports to the folks who fund your agency, it’s not difficult for him to get your attention: “If you have them by the budget, their hearts and minds will follow.” But what if an office is supposed to bring problems to light but can’t get anyone’s attention?

A recent WaPo story, Subway Safety Panel Foiled by Constraints, highlights this problem. The Tri-State Oversight Committee is responsible for safety on the DC area’s subway system (Metro), but has “no employees of its own and no dedicated office, phone or Web site. It borrows space for its monthly meetings, which officials said no member of the public has ever attended.”

In June, 2009 a subway accident killed nine and injured 80. The previous April the TSOC (“Tea-Sock”) sent Metro a nice letter describing a similar incident and asked for a report, but the Post article continues that “The committee has no power to demand a response and, to date, the committee says Metro has made no formal report to it on the incident.”

Hold your breath and turn blue, Tea-Sock!

Driven by the publicity surrounding the fatalities, the Congress is now considering shifting safety regulation to the Federal Transit Administration, which funds American subway systems. That should do the trick. But it is “a day late and a dollar short.”

According to the Post, “Some state-level regulators have far more authority. For instance, the subway system in San Francisco, which is subject to muscular oversight by state regulators, discovered problems with flickering circuits and was directed to install a collision-avoidance backup system decades ago.” Decades ago…

A recent Bloomberg News story, Pequot Trading in Google, Cox, Premcor Sparked Warnings to SEC, highlights a different watchdog problem. Rather than being a toothless watchdog like Tea-Sock, the Securities and Exchange Commission was (charitably) “distracted.” The SEC received at least 44 reports of possible insider trading by a hedge fund, Pequot Capital Management Inc. These reports weren’t from disgruntled individuals: “The spreadsheet shows that the SEC received alerts from the New York Stock Exchange, the American Stock Exchange, the Chicago Board Options Exchange and the NASD, the brokerage regulator now known as the Financial Industry Regulatory Authority, or Finra.” That’s some list of watchpuppies.

“Systems problems” abound here, but there’s also a technology problem or two. According to the article, the market surveillance analysts use computer software to spot suspicious trades. Their reports, however, average 123 days to prepare and forward to the SEC. Since I learned years ago that only 5% of “report languishing time” involves actual work, the watchpuppies need to learn to move their work from desk to desk a bit faster – possibly electronically?

There is also an apparent technology imbalance. According to a National Public Radio story, the trading firms are using supercomputers and “flash trading” to place orders in split seconds. Split seconds vs 123 days: it’s hard to see how the watchpuppies can keep up!

The same Bloomberg story says that in 2006 the SEC received 514 surveillance tips but brought only 29 cases forward. A 2007 report by the General Accountability Office faulted SEC for its oversight of referrals. There is also widespread concern that the SEC has been too cozy with its regulated industry; a former SEC attorney has claimed that his supervisors blocked him from investigating Pequod. Does the name Bernie Madoff ring a bell?

Since the SEC is certainly subject to corruption (where do the SEC’s staff go after working there?), and the SEC doesn’t report to anyone who funds the stock exchanges, we need a better feedback mechanism to control insider trading.

I’d like to suggest the following:

(1) The referrals from the watchpuppies shall be made public.

(2) If a lawsuit is brought alleging an instance of insider trading, a published relevant referral shall be a rebuttable presumption of guilt.

That shifts the burden of proof to the companies doing the trading. Given their profits, I think they can handle it.

F’rinstance: In December, Bank of America okayed paying Merrill Lynch executives $5.83 billion in bonuses after they’d driven Merrill into the ditch. That’s almost twice what it would cost to pay off $200,000 in loans for each of America’s graduating medical students last year.

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