The SEC’s Failed Cover Up

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SEC officials redacted extensive portions of the agency’s internal watchdog’s report exposing its internally documented failures overseeing failed investment bank, Bear Stearns. But an unredacted version is published by Senator Charles Grassley, Senate Banking Committee Member who requested the study.

The failed cover up is ironic for an agency charged with promoting transparency in corporate America. It makes a mockery of todays’s SEC roundtable on how the SEC can help investors by promoting corporate transparency.

Many of the failed deletions refer to internal SEC documents showing that the SEC knew of problems that it left unaddressed. Also deleted are judgments the inspector makes about SEC performance, including one concerning the existence of ignored red flags.

It is not obvious why it is appropriate for SEC officials to delete these materials. Indeed, Senator Grassley obviously believes there is no basis for doing so. Below I highlight differences between the SEC’s redacted version (available in full here) and Senator Grassley’s published version of the original (available in full here).


Following are excerpts from the SEC Internal Inspector report on its oversight of Bear Stearns. TM means the SEC’s Division of Trading and Markets; OCIE is its Office of Compliance Inspections and Examinations; CSE is Consolidated Supervised Entities, the program to supervise banks like Bear Stearns. Text highlighted in bold are portions that the SEC deleted from the public version that appear in the version that Senator Grassley has made public.

p. 12: From April 2006 to March 2008, Bear Steams’ Basel capital ratio decreased from 21.4 percent to 11.5 percent. . . . According to TM documentation of its meetings with Bear Stearns, in November 2006, Bear Steams initiated a plan to increase its availability of secured funding at the holding company level.

p. 15: Bear Stearns told TM that the secured funding initiative was improving the firm’s performance in the 60-day stress scenarios . . .

p. 16: Internal TM memoranda indicate that TM believed that the secured funding initiative helped Bear Stearns weather the credit difficulties it faced during the summer of 2007 when two hedge funds sponsored by Bear Steams’ Asset Management (BSAM) failed.

p. 16: According to internal TM memoranda, Bear Stearns had a goal of arranging committed secured evergreen facilities . . . .

p. 17: TM did not adequately address several significant risks, which affected the overall effectiveness of the CSE program. Notes from TM’s meeting with Bear Stearns’ management indicate that TM often discussed risks, which turned out to be relevant, but the discussions did not prompt TM to exert sufficient influence over Bear Steams to make changes as a result of the risks identified.

p. 18: TM staff even found that the amount of mortgage securities was occasionally well beyond Bear Stearns’ internal limits. For instance, TM stated: “We [TM staff] will continued to discuss with risk management the size of Adjustable Rate Mortgage (“ARM”) business as it continues to operate in excess of allocated limits, reaching new highs with respect to the net market value of its positions.” Furthermore, according to TM’s own documentation, a portion of Bear Stearns’ mortgage securities (e.g., adjustable rate mortgages) represented a significant concentration of market risk . . . Yet, notwithstanding, these “red flags” that TM knew about, and warnings in the Basel standards, TM did not make any efforts to limit Bear Steams’ mortgage securities concentration.

p. 20: Prior to Bear Steams’ approval as a CSE in November 2005, OCIE found that Bear Stearns did not periodically evaluate its valuation models, not did it timely update inputs to its VaR models nor did it timely update inputs to its VaR [value at risk] models. . . Further, OCIE found that Bear Stearns used outdated models that were more than ten years old to value mortgage derivatives and had limited documentation on how the models worked. As a result, Bear Stearns’ daily VaR amounts could have been based on obsolete data. It was critically imperative for Bear Steams’ risk managers to review mortgage models because its primary business dealt with buying and selling mortgage-backed securities.

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1 Response

  1. Michael Guttentag says:

    What an embarrassment for the agency. Interesting that it was a full disclosure (by the Senator’s office) that revealed their hanky-panky.

    This is extremely egregious and a bit off point, but I think generally supports my call over at the Conglomerate for imposing more market-like disclosure requirements on Federal agencies engaged in market activities.