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Peter Henning, former SEC lawyer, offers some expert thoughts on the NYT’s Dealbook.  He notes a bunch of red flags: a single advisor (Madoff), tiny accounting firm outside of NYC with no other investment business clients (“[a]single investment manager and an almost non-existent auditor is a ticket to fraud“], filings showing far less invested than the purported $17 billion under management, and the likelihood that an investigation would have “revealed that the reported gains could not have been generated in a declining market.”

But Henning says the SEC lacked time and manpower given its supervision of more than 11,000 investment advisers. The SEC can only respond to certain kinds of complaints, and is gun-shy about going after “heavyweights without a clear indication that it can win the case,” especially after “well-connected counsel came on the scene.” So the “staff would only undertake an investigation of someone of Mr. Madoff’s stature if there was significant evidence of wrongdoing.”

In other words, the SEC lacks the resources and the will to penetrate beyond surface appearances. If a clever fraudster can fool investors, it looks like he can fool the SEC.

So the SEC’s business seems mainly to be high-profile investigations against insider traders, populist forays against high-paid executives, and upholding so-called “shareholder democracy.”

The SEC should either get out of the fraud protection business and serve warning to investors that the market is their best protection, or get serious about fraud protection and not waste time on the other stuff.

I’d vote for the former. I doubt that any government agency will ever do as good a job as a vibrant market whose participants are alert to the potential for fraud rather than lulled into a false sense of complacency. Moreover, more aggressive enforcement involves the risk of error or worse (politically motivated decisions, Blagojevichism).

Nevertheless, it looks like we taxpayers are going to be buying beefed up enforcement.  And maybe the bureaucracy will have a new name.  I vote for “Keystone Cops” — at least that would solve the complacency problem.

This post was originally published by Prof. Larry Ribstein on Ideoblog