SEC Failed in Its Oversight of Bear Stearns, Says Inspector General

The Securities and Exchange Commission’s Office of the Inspector General says the agency failed to fulfill its mission in the oversight of Bear Stearns. Inspector General David Kotz says not only did the SEC neglect to order the company to cut back on risk taking, but it missed possible “red flags” leading up to JP Moran Chase & Co.’s purchase of the faltering investment bank.

Kotz’s report says that despite identifying the risks that would lead to the sub-prime mortgage crisis, the SEC staff did not exert its influence to mandate that Bear Stearns add a potential market collapse scenario to its list of possible risks.

Kotz is accusing the SEC of not making any efforts to make Bear Stearns raise money or lower its debt. He is also criticizing the agency for allowing internal audits, rather than external audits, at Bear Stearns.

Also in his report, Inspector General Cox accuses the agency of not doing anything to find the shortcomings in Bear Stearn’s risk management of mortgages and failing to avail of opportunities to prod management at Bear Stearns to deal with problems. He says the SEC should have taken more time to evaluate Bear Stearn’s 2006 annual report and get additional information from the investment firm, which would have required the company to reveal more information about its mortgage portfolio to investors.

The SEC’s division of trading and markets disagrees with Kotz’s findings and claims that that the report began with incorrect assumptions and arrived at unrealistic and inaccurate conclusions that were not practical. SEC Chairman Christopher Cox says that, if anything, the SEC’s failures occurred because the agency had not been given enough authority to oversee the investment banks and that Kotz’s report affirms this.

The sale of Bear Stearns and Merrill Lynch & Co, Lehman Brothers Holding Company’s bankruptcy, and the filings by Goldman Sachs Group Inc. and Morgan Stanley to become bank holding companies means that the SEC is no longer overseeing any large investment firms. While the agency will continue reviewing broker-dealer businesses, it is terminating its oversight program of independent investment banks’ parent companies.

Related Web Resources:

SEC Watchdog Faults Agency in a Bear Case, Wall Street Journal, October 11, 2008
SEC Office of Inspector General

Bear Stearns, A Division of JP Morgan
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