S.E.C. Hurt by Disarray in Its Books

If a company’s financial reporting were so bad that its auditor had pointed out significant weaknesses in its accounting for seven years running, the Securities and Exchange Commission would most likely be all over it.

The U.S. Securities and Exchange Commission seal hangs on the facade of its building in Washington, DC.
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The U.S. Securities and Exchange Commission seal hangs on the facade of its building in Washington, DC.

But what if the company were the S.E.C. itself?

Since the commission began producing audited statements in 2004, the Government Accountability Office has faulted its reporting almost every year. Last November, the G.A.O. said that the commission’s books were in such disarray that it had failed at some of the agency’s most fundamental tasks: accurately tracking income from fines, filing fees and the return of ill-gotten profits.

“A reasonable possibility exists that a material misstatement of S.E.C.’s financial statements would not be prevented, or detected and corrected on a timely basis,” the auditor concluded.

The auditor did not accuse the S.E.C. of cooking its books, and the mistakes were corrected before its latest financial statements were completed. But the fact that basic accounting continually bedevils the agency responsible for guaranteeing the soundness of American financial markets could prove especially awkward just as the S.E.C. is saying it desperately needs money to increase its regulatory power.

Like the rest of the federal government, the S.E.C. is operating without an increase in its budget, which was $1.1 billion last year. With President Obama talking about extending the freeze and lawmakers continuing their criticism of its embarrassing performance before the financial crisis, the agency’s prospects for more money appear bleak.

That has ominous implications for investors. The S.E.C.’s technology systems, for example, lack the ability to perform sophisticated analysis of large batches of financial material. As a result, a Congressional report says, S.E.C. analysts sometimes resort to printouts, calculators and pencils. While investigating the “flash crash” of May 6, 2010, S.E.C. computers were so strained by the crush of data from just one day of trading that it took three months to figure out what had happened.

In recent weeks the commission has reduced travel to examine regulated companies, and it cannot fill many jobs vacated in the last year. Meanwhile, Mary L. Schapiro, the S.E.C. chairwoman, says that to carry out the Dodd-Frank Act, the regulatory overhaul signed by Mr. Obama last year, the commission needs 800 additional employees, more than a 20 percent increase over its 3,750-person work force.

Still, by several measures, the S.E.C. is far from starved for money. Its $1.1 billion budget in 2010 was 15 percent higher than the $960 million it received the year before — and nearly triple its $377 million budget in 2000.

Representative Spencer T. Bachus, the Alabama Republican who is chairman of the House Financial Services Committee, said last week that the tripling of the S.E.C.’s budget occurred in a period that included some of the agency’s biggest failures — the Ponzi schemes of Bernard L. Madoff and R. Allen Stanford and the collapse of Bear Stearns and Lehman Brothers.

Ms. Schapiro, an Obama appointee, came to the agency after all of those missteps. She has directed sweeping structural changes, increasing enforcement and pouring money into updating its technology infrastructure. To address the shortcomings in financial reporting described by the G.A.O., she decided to outsource those tasks to another government agency.

In an interview, Ms. Schapiro said that she understood the skepticism over her call for more resources but she noted that Dodd-Frank significantly expanded the agency’s responsibilities over hedge funds, derivatives and credit ratings agencies.

“When you look at the composite picture of how the agency has changed and I hope will continue to change,” she said, “I think we’re really poised to be that agile regulator that the country has a right to expect of us.”

Her efforts have attracted some support as well as warnings of the consequences of cutting the S.E.C.’s budget now.

“This is a serious threat to financial reform,” said Representative Barney Frank, the Massachusetts Democrat who steered Dodd-Frank through the House. “What you get is a disproportionate assault on our ability to regulate the financial industries.”

Ms. Schapiro has received plaudits for her reforms from some former S.E.C. officials, who say that the agency has for years fought battles over its budget. “She’s done an awful lot that people should be proud of and optimistic about,” said Annette L. Nazareth, a partner at Davis Polk and a former S.E.C. commissioner and division director.

At times during the debate over the Dodd-Frank legislation, it looked as if the S.E.C. was going to get a solution to its budget problems. The agency has long been a net contributor to the United States Treasury; last year it collected $300 million more in fees from Wall Street than it cost to run the agency. The difference went to the Treasury.

Efforts to allow the agency to use all of the money it collects and bypass Congressional appropriations died during the Dodd-Frank debate, despite the additional responsibilities the law gave the S.E.C.

“It’s almost as if the commission is being set up to fail,” said Harvey L. Pitt, who was S.E.C. chairman from 2001 to 2003 and who now is chief executive of Kalorama Partners.

Dodd-Frank did authorize a doubling of the commission’s budget, to $2.25 billion, over the next five years — without providing the money for it. It also authorized the commission to spend as much as $100 million beyond its operating budget for new technology systems.

Ms. Schapiro said that buying new technology was crucial because it helped to attract specialists in mathematics and financial systems that the S.E.C. needed to help police the rapidly evolving financial markets.

“It’s very hard to attract great people if they think that there’s not going to be the opportunity to use technology to get the job done, which can make us so much more efficient,” she said.

Anticipating new employees, the S.E.C. has been busily leasing more office space — an effort that has drawn the attention of the agency’s inspector general. Last week, he began investigating the S.E.C.’s decision last July to lease more than a million square feet of prime office space in Washington, one of the largest federal leases in a decade.

Within a few months of that decision, its prospects for bigger budgets fading, the S.E.C. began negotiations to return some of the leased space. The latest inquiry is the second investigation of the S.E.C.’s leasing practices in a year. Last September, H. David Kotz, the inspector general, reported that a lack of adequate policies led the agency to make lease payments that could have been avoided, including more than $15 million for space in Manhattan that no S.E.C. employees have occupied in the last five years.

Agency officials say the space was leased after 9/11, when its offices were demolished, but soon proved inadequate for the New York operations, which moved to larger offices.

Lease payments also figured in the G.A.O.’s assessment of the agency’s financial reporting. The auditor found that the agency, in a preliminary version of its annual report, had understated its lease payments by $40 million.