We’re sympathetic to the idea that it would be really terrific if we could have a securities regulator that would be good at catching frauds. The Securities and Exchange Commission actually has a division that is supposed to perform this task but you’d never know it from their record. Most frauds are actually detected by investors, short-sellers or whistle-blowers rather than regulators. Isn’t there some way to get a better regulator?
Randy Shain, vice president of First Advantage Investigative Services, a due-diligence investigative firm, today argues that the SEC should hire investigative journalists to detect fraud. He argues that journalists would be much better at discovering fraud than the lawyers, often fresh out of lawschool, typically hired by the SEC.
So, why journalists? Simple: journalists are sceptical by nature and are taught to keep asking questions until something makes sense. They are also the types of people who do what they do to benefit others. (They clearly don’t work for the money.) Journalists question authority, and often are suspicious about things they are told; given this, they are not likely to think of, and be scared by, picayune legal issues when asking hedge fund managers questions.
Journalists, regardless of where they work, are comfortable questioning people in power. While a first-year lawyer hoping eventually to land a job at Morgan Stanley might be put off asking for explanations from a hedge fund manager with billions of dollars under management, most journalists would be excited by the idea of doing so. Journalists will continue to look for the story until they get it, not stopping when confronted by a manager hostile to their review.
Finally, journalists are adept at developing sources of information, something that would allow them, as examiners, to be able to speak as easily to back-office personnel or computer programmers as they would to the lead portfolio manager or principal of a fund. Moreover, journalists are trained to identify, locate and contact former employees, who often have incredible insight without the restrictions of a current worker.
We’d love to give our whole hearted support to that proposal. In fact, our anecdotal evidence suggests that the SEC already relies heavily on journalists in its enforcement activities. When I was a lawyer, I once interviewed for a position with the enforcement division of the SEC. I asked them how they found their cases. The response was that most of the cases were referred to them by the stock exchanges. The rest were discovered by reading the newspapers. Shain’s proposal would cut out the middle man, the lawyer at the SEC.
Unfortunately, journalists have a major handicap when it comes to enforcement. They often lack the required perspective that leads to good judgment about which cases are worth pursuing. Shortly before the credit crisis struck, many journalists were going absolutely crazy about a phony scandal called backdating. They obsessed about a minor accounting fraud while truly major frauds were occuring and huge risks were being created by investment banks leveraging real estate investments. Journalists also remained focussed on hedge funds while much greater risks were being created by well regulated banks.
The record of journalists as psuedo-regulators is actually quite poor, and its possible that a fraud detection unit staffed by journalists would actually be worse than one staffed by lawyers.
Not surprisingly, the market actually has a solution for the poor record of securities regulators. We’ve created a breed of men called short-sellers who are highly incentivized to detect frauds and uncover hidden risks on the balance sheets of public companies. Their collective record is quite good in this regard. Oddly, however, those men and women have been demonized all through this crisis. If we were hopeful types, we’d hope that this demonization would stop. People who want timely messages about markets shouldn’t shoot the messengers.
(And, yes, I know its probably a heresy for a journalist to say journalism isn’t the answer. If it helps, I’m also a lawyer and don’t think lawyers are the answer either.)