Implementing the "internal controls" provisions of Sarbanes-Oxley has been immensely costly for publicly held businesses in the United States while the concrete evidence of it's benefits has been scant. By some estimates, the direct costs of implementation are as high as $35 billion each year. And the real costs might be even higher. Nonetheless, because non-compliance with Section 404 can be disastrous for a public company due to regulatory sanctions and massive stock declines, companies continue to spend and spend to implement Section 404.

It's clear the regulation is broken but we're unlikely to be rid of it any time soon. The regulation's defenders insist the regulation is helping us avoid the kind of accounting scandals we saw in the late nineties, and that government enforcement of the regulation is necessary because the market can't be trusted to regulate itself. There's some truth in this argument: the market won't necessarily price internal controls over financial accounting at the price regulators think is appropriate, much less at some level that optimizes efficiency over the long term.

But it's a half truth because it rests on a double standard. It insists we focus on the reality of imperfect markets but not notice the reality of imperfect government. There's no evidence that the government has arrived at the right level of internal controls, or that it can efficiently police this regulation.

Yesterday we got a reminder of the reality of imperfect government when the General Accounting Office declared that the Securities and Exchange Commission had a material weakness in the internal controls over its own financial reporting. This is a serious blow to the SEC's credibility, which avoided getting tagged with the "material weakness" finding last year only by promising to improve things. But things haven't improved. Indeed, they may now be worse.

Fortunately for the SEC, there is no market accountability for government agencies. You can't short the SEC, and lawmakers are unlikely to penalize the commission by denying it authority or funds. Indeed, we expect that this GAO finding will somehow become an argument for the SEC to get more funding. That's the way it works in our nation's capital: failure is only evidence of the need to get more of the people's treasure.

And for those of you who miss the irony of this we'll make it clear: the SEC is the agency charged with enforcing Section 404 on public companies. Of course, no government agency has ever let the glass facades of its own house prevent it from throwing stones.

SEC Flunks Internal Controls Audit [CFO.com]

Sometime in the next few weeks, Securities and Exchange Commission chairman Chris Cox will likely have to decide how he will vote on a pair of competing rules on shareholder access. One “proxy access” rule would shift power from boards of directors to cliques of outside shareholders by permitting certain shareholders and groups of shareholders to include in company proxy materials proposals for amendments to bylaws that would mandate procedures to allow shareholders to nominate board of director candidates. The other preserves longstanding rules that make it difficult and costly to for dissidents to mount proxy fights.

The SEC’s commissioners are evenly divided along partisan lines on the question. The Democratic commissioners favor increased proxy access. The Republicans favor the status quo. Cox holds the deciding vote. Which way will Cox vote? We’re not in the predictions game. But if we take Cox at his word about his own agenda at the SEC, it seems clear that he should vote against the new proxy access rules.

After the jump, we look at how the new proxy access rule hurts ordinary investors.

It is apparently still news to some that the Securities and Exchange commission is very deferential to the securities industry. This morning the Wall Street Journal reported that “the agency has been publicly and noisily pressured by a congressman, a union leader and a Democratic presidential candidate, amid increasing consternation the agency is favoring business interests in its decision making.”

The focal point for the attention is a Supreme Court case that will decide on whether shareholders can sue investment banks for the fraudulent activities of their clients. The question is whether the SEC will file a brief with the court supporting the plaintiffs position that investment banks can be held liable. Prominent (some would say, notorious) plaintiff’s lawyer Bill Lerach is lobbying the SEC to take the side arguing that banks can be sued. Merrill Lynch, which is a defendant in a class-action lawsuit filed by lawyers representing former Enron shareholders, asked the SEC to take the opposite side.

Both sides, of course, claim that their position best protects investors. The plaintiff bar claims that holding banks liable will make banks better police their clients and avoid aiding or even looking the other way when companies engage in fraud. The banks see this opening the flood gates to a torrent of lawsuits.

Who’s right? That’s probably entirely besides the point. These things are rarely, if ever, decided on the basis of wise policy.

[After the jump, we pull back the curtains on what really decides these kind of public policy issues. Hint: it's not a great and all-knowing wizard.]

There were 116 financial restatements in corporate public filings in 1997. Almost ten years later (2006), that number has grown over 15 fold to 1,876. Hank Paulson wants to know why. Paulson has ordered a Treasury study of restatements, their predominant causes, and effect on investors that will be headed by former SEC chairman Arthur Levitt and former SEC chief accountant Donald Nicolaisen.

The main reason restatements are thought to have increased so dramatically in number is because of tougher accounting oversight, and the fact that accounting firms have become increasingly aggressive in the face of so much exposure to litigation. Projected recommendations of the study include reducing the liability of public accountants and diluting the auditing industry so that it isn't as dominated by the same few firms.

A restatement explosion seems an odd justification for a major deregulatory push. This would assume that companies are not using dodgy accounting tricks to mask true performance and that financial restatements are somehow onerous to companies that misstate financials in the first place. One would think that tougher accounting rigor in audits followed by a spike in restatements is a sign that a lot of violations were going unnoticed, not that accouting firms are creating unnecessary restatements through nit-picking.

Treasury Targets Financial Fixes [Wall Street Journal]

In the movie Office Space, Initech employees decide to enrich themselves by skimming fractional amounts off transactions and pocketing it. Yesterday Morgan Stanley agreed to pay nearly $8 million to settle charges brought by the SEC that it had captured gains that rightfully belonged to customers by failing to offer them the best price available for stock they were purchasing. The official term for this is “failing to provide best execution” to customers. But we prefer to call it “The Office Space Trick.”

Here’s how the Wall Street Journal describes the skimming.

Morgan Stanley's automated system allowed the company to profit when it was able to obtain better prices than the best-publicized prices at the time, the SEC said. For instance, the complaint said, when the brokerage firm was able to buy a stock quoted at $10.01 for $10, it would charge the customer $10.01 and pocket the difference.

The SEC calculated that Morgan Stanley failed to provide the best execution on trades accounting for 3.7% of the OTC orders it executed for customers of Morgan Stanley's Private Wealth Management unit, Morgan Stanley Dean Witter Reynolds and third-party brokers working through Morgan Stanley. .

To Morgan Stanley’s credit, the problem with was with an automated trading program, and not fraudulent, skimming Initech-type employees. And, also to the bank’s credit, the problem was discovered by a trader who was amazed that he was making so much money.

The Journal again:

A Morgan Stanley trader uncovered the programming bias when he made nearly $400,000 of profit in a single stock in a few minutes of volatile trading one day in December 2004, the SEC said.

Morgan Stanley Set To Reimburse Clients [Wall Street Journal]

That was fast! The Securities and Exchange Commission didn’t waste much time going after investors who bought shares of Dow Jones & Co in the weeks prior leading up to the public revelations that News Corp had offered to buy the company at a steep premium. Yesterday, the SEC filed a lawsuit against a Hong Kong couple, Kan King Wong and Charlotte Ka On Wong Leung, accusing them of insider trading. The couple had purchased $15 million of Dow Jones shares prior to the May 1st announcement.

“It was their first purchase of Dow Jones shares -- and a profitable one,” the Wall Street Journal reports today. “After the unsolicited offer was disclosed May 1, Dow Jones shares rose more than 50%. Three days later, the couple had their broker sell their entire position in the stock for a profit of $8.2 million.”

The close timing of the purchases with the announcement make it highly unlikely that this was simply a case of lucky timing on the part of the Wongs. Adding to the suspicion that the couple had insider information is the risk they took on buying the $15 million of stock. Prior to the transactions, the Wongs reportedly had only $433,000 in their Merrill Lynch account available for purchasing equities. They borrowed money from Ms. Wong’s father and used margin loans to buy the stock. Another stock purchase was funded by a money transfer from an unknown person using a JP Morgan Chase account in Brussels. The stock purchases—the couple accumulated the stock over the course of a couple of weeks beginning April 13—were also a stark departure from the usual investment pattern of the Wongs. “The SEC said that prior to their Dow Jones stock purchases, the Wongs owned mostly fixed-income securities, as well as equities valued at $606,600,” the Journal writes.

The questions everyone is asking is: what did the Wongs know and how did they know it?

Yesterday federal prosecutors charged Hafiz Muhammad Zubair Naseem, a Credit Suisse investment banker, with insider trading. He is accused of tipping off a banker in Pakistan with information about nine corporate acquisitions, including the TXU buyout.

It appears that Naseem was more or less a full-time insider trading professional, using his position—as well as his office phone—at Credit Suisse to obtain information about deals and leak them to his foreign contact from the very start. The SEC says he began his lawbreaking “[i]immediately upon obtaining employment at Credit Suisse in March 2006.”

But he doesn’t seem to have been especially clever about it. This wasn’t an elaborate system of dead-drops, or tips passed along through cut-outs. Naseem was simply calling his banker-buddy in Pakistan with the information. Did he really think he’d get away with that for very long? Apparently the answer is yes.

The good news is that Credit Suisse seems to have played a role in catching him. “We immediately brought the activities of this employee to the attention of the relevant authorities,” the Swiss bank said in a statement. Since this type of insider trading is basically theft from his employers and clients, it is good to see that Credit Suisse apparently helped uncover his alleged activities.

Naseem is 37 years old, and a Pakistani national. He worked for the Global Energy Group at Credit Suisse. In addition to TXU, Naseem is accused of passing along tips involving Hydril Co., Trammell Crow Co., John H. Harland Co., Energy Partners Ltd., Veritas DGC Inc., Jacuzzi Brands Inc., Caremark Rx Inc. and NorthWestern Corp. He is charged with one count of conspiracy and 25 counts of securities fraud.

Credit Suisse Employee Arrested, Charged With Insider Trading [Bloomberg]

The New York Stock Exchange is still not in compliance with government regulations meant secure the best price available for stock traders, a source familiar with the SEC’s regulatory work says. The National Market System regulation—known as “Reg NMS” to regulators and securities industry insiders—requires stock exchanges to provide smaller traders and individuals with access to the same price quotes offered to institutional traders, and to execute trades at the exchange where the best price is available. Compliance requires a heavy reliance on electronic trading.

Shortly after the stock markets plunged in late February, the NYSE requested a second extension of its NMS compliance deadline from the SEC. In January the deadline had been pushed back from February to March. The NYSE gave scant explanation for its failure to meet the March deadline, and the SEC denied the request for the extension.

The NYSE still is not meeting the Reg NMS requirements, the source says. Neither the NYSE nor the SEC could be reached for comment. Our source says the next step may be an SEC investigation or enforcement action against the NYSE.

Earlier: REG NMS: Time Is A Luxury The NYSE Does Not Have [DealBreaker]

Apparently no one at the SEC tipped off John Thain that they are looking into the alleged problems with the hybrid trading system.

John Thain, head of the New York Stock Exchange, told CNBC's Bob Pisani that there is no investigation by the Securities and Exchange Commission of trading problems at the the Big Board during Tuesday's market selloff.

The comment, which Pisani mentioned on air, appeared to contradict a Wall Street Journal report earlier Thursday that the SEC is looking into whether the NYSE's shift toward electronic trading affected its ability to handle a surge in trading volume.

Citing a person familiar with the matter, the paper said the regulators are concerned that capacity issues may have exacerbated the Big Board's woes this week.

We assume that what Thain means is that the SEC has not launched a formal "enforcement action" against the NYSE. But it stretches credibility to say that the SEC is not at least looking into the alleged problems with the hybrid system, especially since those problems have received so much media attention in the last couple of days.

And that should just about conclude our "All Thain, All The Time" coverage. No one should really have to read that much about John Thain this early in the day.

CNBC's Pisani: Thain Says No SEC Probe of NYSE Trading [CNBC.com]

Federal authorities are looking into the Glitch, the Wall Street Journal's "Heard on the Street" column reported this morning. Or at least one of the glitches. It seems that lawmakers and investigators at the SEC are wondering whether the New York Stock Exchange's move to a hybrid system combining specialists on the trading floors with electronic trading may have contributed to Tuesday's market downturn.

The New York Stock Exchange's move into the electronic age happened almost overnight. Now the Securities and Exchange Commission is looking into whether it happened too fast and contributed to this week's trading troubles.

Over the past year or so, the Big Board has shifted much of its trading away from its floor and onto an electronic platform, a move that many investors have embraced because it promises faster execution times in a business where time is money. In November, the NYSE announced it would close one of its five trading rooms, citing the potential to cut costs and because electronic trading requires fewer floor traders.

The SEC is examining whether the NYSE's shrinking of the floor affected the NYSE's ability to handle a surge in trading volume such as occurred during Tuesday's market slide, according to a person familiar with the matter. The regulators are concerned that capacity issues may have exacerbated the Big Board's woes this week.

[Editor's Note: There's no graphic attached to this item because we couldn't find any pictures of electronic trading enthusiast Dunan Niederauer holding his head in is hands while being laughed at by men in funny jackets. And our graphics department doesn't like to use photoshop before noon.]

NYSE's Trading Overload Draws Attention of the SEC [$$] [Wall Street Journal]

Hey. Wait a minute! Aren't we the same folks who spilled all those pints of digital ink on Friday bemoaning the corporate crime reporting of business journalists? How dare we start promoting that old Aguirre story again?

Well, you see, there are actually two Aguirre stories. One over-reported, smear-filled and not very helpful to the public understanding of some real problems with American business and finance. And the other? You guessed, under-reported, helpful and not anywhere near as full of name-through-the-mud hotness.

Aguirre's charges garnered a lot of attention from the press. Far more than you might expect for a bureaucrat blowing the whistle on his superiors, charging them with cravenness before the powerful and politically connected. You can get that story at any happy hour on Capitol Hill. What attracted attention to this story was that the executive Aguirre had been investigating, John Mack, was running Morgan Stanley. According to Aguirre's theory, Mack could have leaked information to Arthur Samberg, the head of the hedge fund Pequot Capital Management Pequot about a coming takeover bid of Heller Financial by General Electric. Pequot is said to have made around $18 million from the deal.

So you had a big Wall Street bank. It's top executive. A high-flying hedge fund. A famous money manager. One of America's best-known companies. All allegedly tied together in some sort of neat knot of insider trading. And then there was the fact that Mack was said to be close to President George Bush, adding the scent of political favoritism to the whole mess. It was practically the perfect corporate crime storm. And it proved irresistible to the press.

One problem with the story of this particular crime of the century was that the facts had a way of not panning out. The SEC launched renewed investigations into the Heller transaction and cleared everyone involved. Mack, Samberg, Morgan Stanley and Pequot had all had their names dragged through the mud for months without anything substantiating the charges other than a former investigator's theory and a couple of phone records showing that Mack had called Samberg around the time of the Heller deal.

Another problem was that Aguirre kept saying that his real beef was not with the targets of his investigation but with the SEC. Aguirre was alleging that the most powerful firms on Wall Street got special treatment from the SEC, in part because the regulators had a too cozy relationship with the folks they were supposed to be regulating. This story never got as much attention, perhaps because it was a lot less sexy.

Unfortunately it was this part of Aguirre tale that made the most sense. There is a revolving door between the SEC's upper echelons and the top Wall Street firms, who often hire former investigators, regulators and commissioners once they leave the agency. What's more, the SEC was more or less created by Wall Street to help boost investor confidence by creating the impression that someone was policing the financial sector and protecting investor interests. And from the start the SEC had helped stifle competition on Wall Street by increasing regulatory overhead and banning many of very the practices that had led some Wall Street giants to accumulate their power and capital. With the SEC around, for instance, it became much harder to build a new investment banking giant. (And this is one reason so much of the brains on Wall Street has fled to private equity and hedge funds.)

And this might be the heart of the reason that the real heart of Aguirre's story never got the attention it deserved, while the less-substantiated and more thrilling insider trading storyline hogged the headlines. At it's heart, Aguirre's story is not even news. It's something we've known for a long, long time. And that old story about how bureaucracies operate doesn't really translate into the sort of civil rights storyline reporters think will win them Pulitzers. So we don't hear much about that.

Remember Gary Aguirre? He was the former Securities and Exchange Commission investigator whose explosive charges led to a series of hearings on Capital Hill and a lot of alarm-bell ringing publicity, particularly from Gretchen Morgenson of the New York Times. Aguirre's main charge was that he was fired from the SEC after an investigation into possible insider trading led him toward a top Wall Street executive.

Today the Guardian reminds us that not only is Aguirre still around. So are the problems he became famous exposing:

"What you have at the SEC is people rotating from jobs where you make $180,000 a year into jobs where you make over a million," Aguirre tells the Guardian in an interview, on what he sees as a mutually back-scratching relationship between the regulator and Wall Street. "It's very friendly - it's a club. I'm here, I'm inside, now I'm outside, now I'm inside again.

"When the SEC starts playing favourites and they decide not to go after Wall Street elite and focus on small fry, then they're not focusing on the players that really impact the capital markets. It's not the penny stock dealers that could trigger a credit crisis in this country."

It won't come as a surprise to DealBreaker readers that the SEC's proposed rule to drastically increase the SEC's net worth standard for hedge fund investors has been met with overwhelming disapproval from the investing public. Or at least the part of the investing public that is writing emails and letters to the SEC since it proposed the new rule in December.

Fortune's Bethany McLean was the first journalist (or, you know, the first one we noticed) to report on flood of negative comments. Now the Los Angeles Times is in on the game, noting that one commenter refers to the proposed rule as "communistic." Practically every other business news outfit has run similar stories. In fact, CNBC is promoting a segment discussing the reaction even as we write this item.

But far more interesting than this unsurprisingly negative reaction to the paternalistic regulation, is the rift in the hedge fund community that the new rules have revealed. As we've noted many times, regulations are hardly ever neutral. They tend to help some firms and hurt others. And the firms they tend to help are the ones with the most sway with lawmakers and regulators. In other words, those who are best at buying or otherwise obtaining influence in politics.

The proposed net worth increases would hurt smaller hedge funds—which often rely on less wealthy investors to obtain the funds they manage—while leaving the larger hedge funds—which often have minimum investment rules that rule out many of those whose net worth might pass even the higher standards under the proposed rule—untouched.

And this isn't something that is lost on either the large hedge funds or the small ones. Here's the Los Angels Times reporting on the rift:

The SEC's request for comments also demonstrated the split within the hedge fund industry over the agency's plan.

Proposal by SEC To Curb Hedge Funds Met With Ire

The Managed Funds Association, a trade group for hedge funds, is "supportive" of the SEC's goals with the proposed changes, John Gaine, the group's president, said in an interview.

He said the industry had to be careful "not to go down the food chain" to average investors who might not understand the risks involved.

But managers of some relatively small hedge funds said the proposal would make it difficult for them to grow, while favoring funds that have big-money clients.

"This rule mainly just punishes small managers like myself, increases barriers to entry ... and benefits the elite in our society," Rick Puglisi of Apprecia Capital Advisors in New York wrote.

Proposal by SEC To Curb Hedge Funds Met With Ire [LA Times in NY Sun]

Last week we wondered aloud if recent comments coming from the Securities and Exchange Commission's enforcement division signaled that the regulators might be backing away from criminalizing the backdating of stock-options. The comments certainly seemed aimed at lowering expectations that the numerous investigations by federal authorities into the controversial practice would produce dozens, if not hundreds, of criminal cases.

On Friday, however, investigators seemed to answer our query about whether they were backing off with a loud and unequivocal: "Not a chance." The Wall Street Journal ran a story on the front page under the headline "Probes of Backdating Move to Faster Track."

Probes of Backdating Move to Faster Track [$$] [Wall Street Journal]

Totally terrifying thought. But not beyond the range of the barely credible. We’ve written a lot about SEC regulation. And sometimes it did seem as if the SEC was listening. After we celebrated the court decision striking down regulations requiring hedge fund registration, and decried the possibility of an SEC appeal or new regulations trying to get around the decision, the SEC totally decided that it was just going to start studying hedge funds, impose some tighter investor requirements and not go all registration crazy again. Backdating? Well, after we started pointing out that a lot of the backdating “scandal” was a lot less scandalous than it seemed, the SEC’s prosecutorial zeal seemed to slacken.

So, post hoc, ergo hoc? Yeah, probably not. But according to Reuters, SEC chairman Chris Cox is reading blogs and using them to figure out what the public is thinking.

The chairman of the U.S. Securities and Exchange Commission, a technology cheerleader who recently posted on a corporate blog, said on Monday that he uses blogs to gauge public reaction on securities issues.

Christopher Cox, speaking at the Reuters Regulation Summit in Washington, also said the commission will be looking further at what corporate Internet posts might constitute public disclosure.

Cox has been an outspoken proponent on using technology to improve company transparency and investor education, especially pushing to make SEC filings rich with interactive data.

But he also uses technology to get an early peek at how the public will react to SEC action on issues.

SEC's Cox uses blogs to gauge public sentiment [Reuters]

We've been pointing out for a long time that the really (potentially) explosive issue raised by former SEC investigator Gary Aguirre was not the now-officially dismissed suspicions of insider trading by Pequot Capital or illegal tipping by John Mack, but the still largely univestigated charges of favoritism at the SEC. Recall that Aguirre claimed he was fired from the SEC for trying to subpoena John Mack, who was then about to become the top man at Morgan Stanley. Now the mainstream media, for reasons of its own, has enjoyed playing up Mack's connections to the Bush administration but a more relevant fact is probably his status as the head of a major Wall Street bank. This raises the fear that the SEC has been captured by the very industry its supposed to regulate. (By the way, even this might be too optimistic, since the words "been captured" imply that the regulatory agency was not created, owned and operated by the largest investment banks right from the start.)

In today's Wall Street Journal, the Aguirre makes it clear that this was the whole point of his testimony to the Senate.

My allegations to the Senate have focused only on the SEC. I have alleged: (1) senior SEC officials gave Mr. Mack favored treatment; (2) those officials fired me for questioning that favored treatment; and (3) the SEC's inspector general whitewashed the whole affair.

My Charges Against SEC Are Justified [Wall Street Journal]

The Wall Street Journal reports that more hedge fund managers are taking themselves out of the now completely voluntary SEC registration. The real question isn't why so many hedge funds are backing out but why so many have remained registered. Why potentially subject yourself to additional SEC oversite if it's not required? As far as we can tell, there is just about zero investor demand or premium for registered hedge funds.

Oh, wait. Now we remember why. It's because you probably have to get the lawyers on the phone to deregister. And why talk to lawyers when its not absolutely necessary?

From the Journal:

Dozens more hedge-fund advisers withdrew from registration with the Securities and Exchange Commission in the past three months, adding to the effects of a June court decision that tossed out an SEC rule requiring registration.

Some 275 hedge-fund advisers have withdrawn from registration with the SEC since an appeals court said the rule was arbitrary and couldn't stand, according to SEC statistics gathered as of Dec. 7. That is up from 106 that were withdrawn as of Sept. 14.

Federal regulators for now are taking small steps instead of pushing for oversight powers associated with registration. Wednesday, the SEC proposed raising to $2.5 million the amount in financial investments held by an individual before he or she invests in a hedge fund. The SEC also proposed barring hedge-fund advisers from defrauding investors as the agency seeks to regain some powers called into question by the appeals court's decision.

More Hedge Funds Leave the Ranks Of SEC's Registry [Wall Street Journal]

A long, long time ago we had dinner with a prominent federal appeals court judge who was known to be a proponent of the idea that regulatory agencies tend to be controlled by the very interests they are meant to regulate. To show how smart we are, we explained how this kind of regulatory capture happens—the standard public choice stuff about how industry has an immense and concentrated interest in the operations of the agency, while the broader public it is supposed to protect has only a slight, passing, and disparate interest and is largely too ignorant to follow the debate.

“Wrong!” the judge told us. Describing the agencies as “captured” he said implies that they were ever independent, when in fact the entire process of agency control by special interests operates right from the start. “Agencies are not captured, they are created at the behest of special interests and operated to meet the goals of those interests,” he said.

Since then, we’ve tried to tamper our cynicism about agencies but to little avail. Because things like this keep happening: yesterday JPMorgan Chase hired Stephen Cutler, the former head of enforcement at the SEC, to be it’s top legal counsel.

And of course, this is hardly the first time an SEC hotshot has landed in a Wall Street sweet spot:

The appointment makes Cutler the third former SEC enforcement chief on Wall Street, following a path cleared by former government regulators, including Deutsche Bank AG General Counsel Richard Walker and Gary Lynch, the top lawyer at Morgan Stanley. Cutler will succeed Joan Guggenheimer, who was among the closest advisers to JPMorgan Chief Executive Officer Jamie Dimon before she died of cancer in July at age 54.

The Securities and Exchange Commission fined Jeffries & Co. $9.7 million yesterday for the activities of a vice-president charged with recruiting institutional client and was given an annual travel and entertainment budget of $1.5 million to get the job done. At the time, the industry regulator NASD had rules limiting gifts to $100. You can do the math on that yourself.

Okay, we'll do it for you. With a budget like that, Jeffries could have been providing $100 gifts to 15,000 traders. Of course, the man Jeffries handed this budget had a plan, and it didn't include spreading the wealth around quite that broadly. Quinn gave special attention to the boys trading equities at Fidelity, according to the SEC and NASD.

Not surprisingly, while the Reuters story on this is a bit vague, the New York Post has the glorious details of Quinn's entertaining.

He spent $125,000 to take Fidelity pros to the Super Bowl in Houston with a weekend of entertainment that included parties hosted by Maxim and Playboy magazines.

While every Wall Street firm wines and dines clients, Jefferies raised the bar in March 2003 when it paid more than $75,000 for Fidelity's Thomas Bruderman - a key equity trader - to have a truly memorable bachelor party.

Quinn booked a private jet and hired limos for the party in Miami; festivities included dwarf-tossing and ogling strippers.

Danny Black, The Lansing, Mich.-based dwarf at the center of the party, confirmed to The Post that dwarf tossing was part of the activities.

"What's a party without drunken dwarf tossing?" asked Black. He confirmed that "scantily clad" strippers were around the party, but declined further comment on the activities.

Party's Over! Jeffries Fined $10M [New York Post]

Well, we sure went through a lot for this result. Fired SEC investigators, charges of political favoritism, hearing before the Senate. And now this: the SEC has cleared Morgan Stanley bossman John Mack in its (second) investigation into allegations of insider trading at Pequot Capital, according to the official word from Morgan Stanley. This isn't exactly surprising news. Charlie Gasparino reported that the SEC had cleared Mack close to two months ago.

What is surprising is that it took so long for the official word to come down. Pequot itself was cleared a while back. And if Pequot was engaged in insider trading, no amount of tipping from Mack (assuming for the sake of argument there was any) would amount to a crime.

The U.S. Securities and Exchange Commission formally cleared Morgan Stanley (MS.N: Quote, Profile , Research) Chairman and Chief Executive John Mack in the commission's insider trading probe against hedge fund firm Pequot Capital Management, a bank spokeswoman said on Friday.

Morgan Stanley spokeswoman Jeanmarie McFadden said the SEC advised Mack in a letter "a few days ago" that it would not pursue any enforcement action against him. She declined further comment.

Morgan Stanley says SEC clears Mack in Pequot probe [Reuters]

Here’s a good question: why should taxpayers be subsidizing the supervision of investment vehicles for the wealthy?

The New York Post’s Roddy Boyd writes:

The SEC's Linda Thomsen, in a speech at a Securities Industry Association confab in Midtown, told attendees she expects the SEC will be filing an increasing number of claims against hedge funds for illegal trading and violating client trust. The SEC is "following the money," she said.

"These days, the money is in hedge funds, so the potential for abuse, the potential for securities law violations is there because there is so much money there," Thomsen said

Call it the Millionaire Protection Rule. The SEC will reportedly propose a higher bar for hedge fund investors when its commissioners meet in December. Current rules require “accredited investors” in hedge funds have at least $1 million in assets or have reported income above $200,000 for the past two years. Recently some lawmakers have said that increases in housing prices have upped the value of assets of many otherwise not-so rich Americans, making them eligible to invest—and possibly lose their savings—in hedge funds.

Is this really a problem? We haven’t seen any statistics on how many of these millionaires-in-housing only are putting their life-savings into hedge funds, much less losing their life savings in recently collapsed hedge funds. Without evidence to the contrary, it’s hard not to suspect that this is a manufactured “crisis” cooked up by regulators and lawmakers.

On a positive note, SEC commissioner Chris Cox’s proposal to up funding for investigating hedge fund fraud is probably a good idea. The secrecy of many hedge funds creates opportunities for fraud, and just the knowledge that the SEC is taking this seriously should provide some disincentives for would-be wrong-doers.

SEC wants bigger bankrolls for hedge fund investors [Bloomberg in the Chicago Tribune]

Since the new Democratic chairman of the House Finance Committee, Barney Frank, has already given notice that he doesn’t expect any legislative reforms of Sarbanes-Oxley to come out of his committee, attention has turned to the SEC for possible regulatory reforms. Today the Wall Street Journal reports that regulators have said they will “propose guidance next month to help companies and auditors interpret Section 404 in a way likely to save the time and money.”

The Wall Street Journal is trumpeting this as a great victory for “business” but we’re not so sure. The “guidance” coming from the SEC could be the relief businesses feeling the strain of Sarbanes-Oxley compliance have been craving. Or it could be like handing a glass of rusty nails to a thirsty man. One things seems clear, the SEC isn't preparing any substantive amendments to the SOX rules. GodThe Devil only knows what the lawyers and accountants will do with the so-called "guidance." (Most likely take it as an opportunity to "guide" hourlies even higher.)

Business Wins Its Battle to Ease A Costly Sarbanes-Oxley Rule

You know that guy who gets a laugh for one joke and can’t help taking things a bit further. The one who always winds up taking it too far. Uncomfortably far. And that joke-too-far usually involves some kind of unconventional sex act. Yeah. Chris Cox is that guy.

From the New York Times yesterday:

Manipulating stock option grants is no laughing matter. Federal investigators are combing through the files of more than 120 companies looking for evidence of backdated options. Dozens of executives have resigned or been fired. Top officers at two companies face criminal charges.

But at a corporate governance conference sponsored by Stanford University in Washington last week, Christopher Cox, the chairman of the Securities and Exchange Commission, had some fun with the terminology used to describe certain stock option abuses.

“Spring-loading sounds likes the type of thing you ask your kids not to do inside the house,” Mr. Cox said, referring to the practice of granting options ahead of positive news to reap an instant paper profit.

And backdating? “Backdating sounds like something that you wouldn’t want your daughter to do anywhere,” he added.

[Bad for daughters but not sons?--Ed. Sure. These are Republicans, after all.]

Did You Hear the One About the S.E.C. Guy? [New York Times]

Are we the only ones who don’t think that the lack of enforcement actions coming from the SEC is a sign of the apocalypse? As predictecd by Christopher Byron in yesterday’s New York Post, the SEC announced today that enforcement actions are down this year. The stunning decline: 9%.

There is at least one good reason to think that maybe there’s just less wrong-doing out there to enforce against—and it’s called Sarbanes-Oxley. Afterall, the SEC’s enforcement division spends most of its time on accounting fraud. With Sarbanes-Oxley putting chief executives personally on the hook for their financials, you’d expect that there would be less fudging and less outright fraud. If Sarbanes-Oxley is having any effect deterring fraud, there ought to be a drop off in corporate wrong-doing.

But you won’t hear that from the boys and at the SEC, of course. They’ve got budgets they want raised and staffers they want to hire. So for them its all about not having enough guys to get the job done.

SEC Enforcement Cases Decline 9% [Washington Post via DealBook]

That’s the charge coming from the New York Post’s Christopher Byron this morning. His column argues that the SEC is too focused on responding to charges that it has slowed down its prosecutions and been distracted from its core functions as it tries to respond to criticism of law-makers.

The column actually makes us feel bad for the boys at the SEC. They can’t win for trying. After all, it’s not as if SEC chairman Chris Cox can just ignore the investigation by the General Accounting Office prompted by Senator Charles Grassley’s letter.

KBR's IPO Oddity [New York Post]

That’s the gist of today’s Wall Street Journal editorial discussing the pressure coming for tighter regulations on hedge funds from, well, just about anywhere you look. There’s Senator Charles Grassley’s letter to regulators looking for suggestions on how to regulate hedge funds. (Our bet is that they’ll somehow come up with a couple!) And Connecticut’s Attorney General Richard Blumenthal’s mini-Spitzerism. And the noise from Germany about putting global regulations in place. (Look for more of this if Barney Frank gets control of the House Finance Committee.)

You see, a regulated industry is an industry whose players need to make campaign donations in order to influence lawmakers. It’s a pretty simple formula: regulate an industry and you instantly politicize it. Which is another way of saying that you monetize the industry for politicians.

But it’s not all about wringing donations from hedge fund managers. There’s also corporate managers who are tired of getting those pesky shareholder letters from hedge fund types, and worried they could lose their jobs as hedge funds buy up their shares. And those folks have lots of money to spend on campaign donations, as well. It’s a win-win if you’re a politician.

All the other talk—about “systemic risk” or pension funds or low-liquidity real estate millionaires—is just the sound of a policy in search of a rationale. And that policy, of course, is the enrichment of politicians. That’s always the policy.

Targeting Hedge Funds [Wall Street Journal]

Yeah. He’s still going to be running JPMorgan Chase when all is said and done but its got to be a headache to have to deal with another SEC investigation. This time it’s JPMorgan’s relationship with the Bysis group that’s caught the SEC’s attention. Bisys is the mutual fund administrator that’s paid millions in fines to the regulators. As it turns out, a fund owned by Bank One was mixed up with them, and JP Morgan inherited the problem when it picked up Bank One.

SEC investigation turns to J.P. Morgan Chase [New York TImes]

The New York Sun thinks that the allegations made against Pequot Capital and Morgan Stanley chief John Mack have been getting a little too much ink from the New York Times. And they think they know why.

Mystified New Yorkers were left wondering what could possibly explain the Times's fascination with this story. Some might say it's Mr. Mack's connection to Mr. Bush, but it could just as easily be Mr. Mack's connection to Morgan Stanley. That is the bank that, earlier this year, withheld its proxy votes for members of the board of the New York Times Co. to protest the Sulzberger family's preferential voting status. A Morgan Stanley analyst complained at the time that the Times was underperforming as a business in large part because of the ossified management perpetuated by the ruling family's use of super-voting shares to control the Times despite a relatively puny stake in the Times company.

It's a scandal about the scandal! And just insanely paranoid enough to possibly be true!

‘A Full Airing' [New York Sun]

[Disclaimer: John Carney has written for the New York Sun and the Times, and he's friendly with a couple of the girls at both papers. Morgan Stanley was a client on several deals he worked on. He's never met John Mack or anyone named Sulzberger. George Bush won't return his phone calls.]

One of our favorite hobby horses is finally getting a real ride. We’ve often pointed out that Gary Aguirre charges against the SEC, made under oath before a Senate committee, were very serious and deserved serious investigation. Now it seems that someone’s been listening. The New York Times reported this morning that Senate Finance chairman Charles Grassley has greenlighted an investigation into the SEC by the Government Accounting Office.

If you thought the SEC was full of dullish accounting mavens and lawyers, you haven’t seen anything yet. The GAO is like the special forces of super-nerds. Basically, as good as it gets when it comes to government accounting (which is almost an oxymoron).

So, yes, it is on.
S.E.C. Facing Wide Review of Practices [New York Times]

Although the SEC has subsequently reinvestigated and cleared Pequot Capital and Morgan Stanley chief John Mack in connection with Pequot’s acquisition of a large state in Heller Financial in the weeks leading up its acquisition by GE, questions still linger over allegations that the initial investigation was quashed when the lead investigator sought to subpoena Mack. Now two Senate investigations are underway to determine whether the SEC failed to thoroughly conduct the initial investigation and whether politics played a role in that failure.

On Sunday the New York Times ran a story based on files the canned SEC investigator, Gary Aguirre, had turned over to Senate investigators. The evidence seems pretty damning.

The file shows that after Mr. Aguirre was blocked from questioning Mr. Mack about the Heller deal, Mr. Hanson, the S.E.C. branch chief, acknowledged in e-mail messages that he had discussed Mr. Mack’s “political clout” and the “juice” of his lawyers with officials at the commission.

In an exchange of e-mails in the summer of 2005, Mr. Hanson said that he had merely been trying to “alert folks above me,” and that politics did not influence S.E.C. decisions. Mr. Aguirre replied: “Bob, this is spin. You told me it would be tough to take Mack’s testimony because he has political clout.”

Ironically, these allegations of political corruption at the SEC are being substantiated at the same time lawmakers are considering giving the SEC more clout over hedge funds. This summer a federal court struck down regulations requiring hedge fund managers to register with the SEC and permit investigators to examine their books.

But if the SEC has trouble engaging in its core functions—investigating things like insider trading—does it really make sense to give the agency an even broader scope of authority?

S.E.C. Inquiry on Hedge Fund Draws Scrutiny

It’s no secret that political pressure to regulate some of our more high-flying financiers has been mounting recently. From recent Senate hearings on hedge funds, a Justice Department investigation into private equity club deals, the Connecticut Attorney General’s hedge fund task force, the Connecticut banking regulators new hedge fund unit to legislation recently passed ordering a study into new federal hedge fund regulation, the writing has been on the wall. And hedge funds and private equity shops are starting to respond by forming their own advocacy groups to lobby regulators and lawmakers and launching law suits in US courts.

That’s all well and good. It’s the normal process of American politics. Politicians, regulators and lobbyists were bound to respond to the opportunities presented by events like the Amaranth collapse to enhance their power and prestige. Public ignorance of financial markets and government operations would allow the fear-mongering exploitation by political jobbers. Some of the larger and wealthier financiers would sense an opportunity to burden smaller competition with ungainly regulatory costs. And, of course, enough money is being made in New York and Connecticut that eventually some of it is going to have to get siphoned off to campaign funds and lobbying groups. This is, after all, still a democracy.

But what is the financial community going to do about the new pressure for regulation starting to emerge from international bodies? In the last two-days we’ve heard concerned noises about hedge funds and private equity from both the future head of the G8 economic group—Germany—and the United Nations. As it turns out, in many parts of the world the increase in foreign investment and cross-border deals isn’t seen as universally enhancing efficiency and spreading wealth. In Germany, for instance, private equity shops are affectionately known as “locusts.”

So how do you lobby the G8 or the UN? Where do you go to court to get international regulations overturned on constitutional grounds? Who do you pay off to keep these political jobbers out of your coffers? Does the rise of global finance require the rise of some sort of global governance? There are (or will be) answer to these questions. Answers we all may be discovering soon enough.

Private Equity Has Few Friends Abroad, Report Finds [DealBook]

Germany Wants G8 Summit to Consider Hedge Funds [DealBook]

Morgan Stanley is saying that chief executive John Mack has also been cleared by the SEC of the insider trading allegations raised by a former SEC investigation, CNBC’s Charlie Gasparino reported a few moments ago.

Former SEC investigator Gary Aguirre has said that he was investigating insider trading at Pequot Capital when he was abruptly fired after he sought to depose a top Wall Streeter. The SEC launched an inquiry after Aguirre went public with his charges, testifying before a Senate committee looking into hedge funds.

We should note that clearing Pequot and Mack of insider trading doesn’t make the allegations of political interference with Aguirre’s initial allegations go away. Those allegations were made under oath and penalty of perjury, and so far we haven’t seen any evidence that they’ve been seriously investigated.

Just because John Mack wasn’t engaged in insider trading doesn’t mean someone in the Bush administration didn’t try to protect him from an investigation.

The Score: Pequot and Mack: in the clear. The Sec: still an open question.

Paul Atkins is our favorite SEC commissioner. When last we met him, Atkins was explaining how certain kinds of options timing schemes might not be quite the scandal they were being made out to be. Today he’s being quoted in the press saying that the Amaranth meltdown shows that the post-LTC risk controls work and no further regulation is needed.

"If you look at the latest one with Amaranth, it looked like the system worked as far as the prime broker getting nervous about exposure and taking steps to ensure it did not grow," Atkins told reporters during a tour of Europe.

"On the whole, from what I can see... the system worked."

Asked if new regulation was needed, Atkins said: "Not at all."

SEC's Atkins says risk system worked with Amaranth [Reuters]

Gary Weiss, author of Wall Street Versus Americapoints out that today is the close of the comment period for the Securities and Exchange Commission rule proposal on "fails to deliver" securities—basically, the anti-naked short regulation.

As he notes, the National Coalition Against Naked Short Selling—described by Weiss as an “”astroturf’(phony grassroots) group pushing the agenda of penny stock promoters and CEOs of foundering companies”—has submitted a 23 page comment letter. We were just about to pull it up to see exactly what NCANS were going to say, but fortunately Weiss saves us the trouble.

...I was looking forward to seeing that evidence when the anonymous NCANS said on its various anonymous websites it has got 1,100 actual people to send in their signatures to the SEC. I said to myself, "Surely these people are going to scribble in a note about what happened to them!"

But when I saw what the NCANS was sending in, all I saw were signatures below a statement saying that "The undersigned have been negatively affected by delivery failures of equity securities in the U.S. markets, and by the crediting of security entitlements in quantities far in excess of the issued securities they claim to represent."

Just name and address. No space for "what happened" or "what stock I owned that got counterfeited or naked shorted or stuff."

So they still haven't provided a single example of a company being hurt by "stock counterfeiting" or "naked short selling."

Annals of Baloney (continued) [Gary-Weiss.com]

Prudential is the latest financial institution to settle charges brought by the SEC that it had facilitated improper trading of mutual funds. The cost to Prudential is $600M, which seems like a lot of money but it really would have to be measured against the gains and potential gains of the alleged conduct in order to be properly evaluated. You see, this is how is allegedly worked—Prudential brokers would allow favored clients, mostly hedge funds, to trade on news breaking after 4 PM. These late trades gave favored investors a knowledge edge that other investors lacked—think of it like insider trading via time travel. Two Prudential brokers pleaded guilty to criminal charges last year.

Prudential to pay $600 mln, resolve charges-source [Reuters]

We’re not saying that DealBreaker’s insistence that lawmakers start paying attention to allegations that the SEC fired an investigator whose investigation pointed toward corruption at the highest levels of Wall Street is what made Arlen Specter and Charles Grassley pen a letter to Chris Cox. We’re not saying it. But we totally think it.

US lawmakers question SEC handling of Pequot case [Reuters]

The Washington Post came out against regulating the hedge fund industry in yesterday’s edition, striking out against three prominent arguments in favor of hedge fund regulation. One they skipped over—the SEC kinda sucks at what it does now. Who says it can do better regulating even more complex financial institutions?

[Excerpts from the WaPo editorial after the jump]

The Securities and Exchange Commission yesterday announced it was filing civil securities fraud charges against Nicholas Czuczko, a thirty-five year old who operated TheStockster.Com from his Beverly Hills residence. It looks like standard pump-and-dump stuff—Czuczko would tout penny-stocks on the site and sell into the rally. According to the Feds, he managed to make $2.7 million doing this.

The SEC press release linked below is pretty standard stuff but don’t miss the screenshot of Czuczko’s website. It’s laughably ametuerish. Like he was touting stocks from back in 1997.

SEC Charges Operator of Stock Picking Website with Secretly Profiting in Investment Scam [SEC]

We’re not sure exactly how he survived the boredom (we did with the help of Adderall), but Gary Weiss, author of Wall Street Versus America, also watched the banking committee hearings. He thinks these were less stupid than the judiciary committee hearings. And he too found it surprising that not one word was voiced about Gary Aguirre.

The elephant on the panel was the whistleblower Gary Aguirre, who was fired after trying to question Morgan Stanely's John Mack in a trading probe. Unless I missed it, as I may have dozed during the fascinating repartee, not one question about Aguirre emanated from the lips of the senators.

It's important, by the way, to distinguish between Aguirre's allegations and the effort to suppress him. As veteran financial journalist Don Bauder noted in a good wrapup on the subject, Aguirre's widely publicized allegations have been attacked as "flimsy."

Whether Aguirre is credible or not, this whole Mack business is troubling and should be investigated -- by actual investigators, not the U.S. Senate.

That was it? The Senate banking committee held its hearing on hedge funds today and the only impression we came away with was that the perennial faith of Senators and bureaucrats that they can pass laws and regulations to protect investors from fraud and loss is, like, stronger than ever. It was like stumbling across a group of druids in the woods practicing a long-dead religion.

Some highlights from our viewing of the webcast after the jump.

SEC Chairman Chris Cox took Senator Richard Shelby’s baby away, swearing in longtime aide Kathleen Casey as an SEC commissioner. Casey has served Shelby in one capacity or another since graduating from George Mason’s law school. In May she was nominated by President Bush to the SEC.

The recent resignation of Casey’s predecessor has left many SEC watchers unsure of where the commission will come out on some high-profile issues, such as backdating and hedge fund regulation. On backdating, however, Senator Shelby’s harsh criticisms—he recently referred to the practice as “fraud”—may reflect the views of his staffer, to whom the senator reportedly often deferred on complex financial matters.

[Note: The woman pictured above is Kathy Casey, a model with the Nevada casting group. As far as we know, she is a different person from the new SEC commissioner entirely. We couldn't find a picture of the other Casey and thought the item looked prettier dolled up with this one.]

Casey Sworn in as SEC Commissioner [fednews-online]

SEC Commissioner Paul Atkins says he would be "very surprised" if the SEC appealed the federal appeals court ruling that struck down a rule requiring hedge fund managers to register as investment advisers. Now, of course, Atkins isn't directly in charge on the SEC's legal team, and is only one of five commissioners at the SEC. So it's possible that an appeal could still emerge from the innards of the regulatory beast.

SEC official: Hedge fund appeal unlikely [Bloomberg in the Boston Globe]

We told you this was going to be fun. Following Paul Kedrosky’s lead we decided to do some of our dirty-word searching in the SEC filings. It turns out that Palm Inc had an unfortunate experience with its product mix, if its December 2, 2005 quarterly report is to be believed.

Find out what got into the Palm product line after the jump.

McAfee Inc. just now filed an 8-K stating the the SEC has issued it a subpoena pursuant to a formal probe into the company's stock option granting practices.

Here's the link to the bare bones filing.

We're actually a bit hesitant to let you in on the latest cool new search tool. It is so useful that we expect to be developing lots of items from it. Maybe we should just keep it to ourselves and wow you with our research skills.

So what is this new tool? It doesn't come from Google. Or Yahoo.

It comes from the SEC. We're talking about the "full text" search for EDGAR filings. It lets you do natural language keyword searches though the last two years of filings. The advanced search function allows you to control the search by date and to specify which forms you want.

Okay. On reflection, we guess this is a bit geeky. But here at DealBreaker HQ we've gone totally Ballmers over this thing.

Now that anybody willing to browbeat a CEO is a "shareholder activist" (and that, mind you, is a good thing), Barron's uses the emergence of shareholder activism (if it was ever submerged) to browbeat the SEC for increased regulation of hedgefunds, which they argue will result in fewer shareholder activists (which would, mind you, be a bad thing):

HERE IS A NEW GROUP OF ACTIVIST shareholders who are holding CEOs' feet to the fire. ... With all the emphasis of the past few years on aggrieved investors, one would think the Securities and Exchange Commission would embrace this new class of corporate watchdogs. But instead, the SEC has taken steps to make it more difficult for these shareholders to hold management of their companies accountable. Why is an agency whose mission is investor protection putting roadblocks in the way of reform-minded investors? These particular shareholders are the dreaded hedge funds, blamed by some for everything from high oil prices to shortages of Treasury bills.

** As well as our general amorality, and as long as we're feeling confessional, occasional nihilism...

The Shareholder's Friend [Barron's]

Earlier today the SEC released its plan for dealing with some of the problems with Sarbanes-Oxley an SEC advisory panel highlighted last month. Jack Ciesielski has the goods.

One of the biggest concerns raised by the advisory panel was the disproportionate impact of tougher accounting requirements on smaller companies. According to the plan released today, the SEC solution is to give smaller companies more time to meet these requirements.

Non-accelerated filers will have until years beginning after December 16, 2006 to implement Section 404 rules. Currently, they’d have to comply in the first year ending after July 15, 2006 to comply. This will make a 404 report on internal control on non-accelerated calendar year filers first show up in 2008, on the internal controls in effect at the end of 2007.

We're sure that smaller companies will appreciate the extra time. And so will the accounting firms who get to bill them during those additional six months.

404 Relaxation: The SEC Opens Up [The AAO Weblog]

This Wednesday the SEC and the Public Control Accounting Oversight Board are throwing a party for hosting a roundtable on Sarbanes-0xley.

Of course we already know that the PCAOB thinks SOX is wonderful. And not just because PCAOB members will be stacking serious cheese while public companies attempt to comply with the law. Last week, PCAOB board member Charles D. Niemeier provided a whole bunch of reasons why we should think SOX is wonderful.

The next day, though, the GAO reported that smaller public companies are disproportionately burdened by SOX and that many companies are going private to avoid compliance.

The score: Big Business, Big Accounting and Big Government: 1. Everyone Else: 0.

Oh. And then there is Sohu founding executive Xin Ye's remark, which favorably compares the cost of compliance with Chinese government censorship to SOX compliance.

PS: Believe it or not, DealBreaker is actually interested in this all day conference on SOX compliance. Just not interested enough to actually attend the thing. If you're going for some reason, drop us an email with news, updates, personal attacks or irrelevant details from the roundtable.