Published September 7, 2009

Good regulation means making sellers beware as well

By R SIVANITHY

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A REPORT last week by the US Securities and Exchange Commission's (SEC's) inspector-general found that regulatory incompetence and inexperienced staff were the main reasons convicted fraudster Bernard Madoff managed to cheat the public and avoid detection for as long as he did. 'The fact that for 16 years the SEC had on blinders and ear muffs is mind-numbing,' a federal prosecutor was quoted as saying.

A hard-hitting but nonetheless accurate conclusion, no doubt. But was it really only the US SEC's incompetence and inexperience that helped Madoff pull off his scam, or were there other factors?

Could it, for instance, also have been a case of over-reliance on Wall Street's brand of doing business that bred complacency among everyone connected with the industry? After all, surely over the course of almost two decades some SEC staff would have amassed sufficient experience to uncover Madoff's trickery?

Yes, incompetence and inexperience could have been contributory factors. But it was equally a case of believing in the 'casino capitalism' (a term coined by a commentator who was critical of the American regulatory authorities) founded on the maxim of 'caveat emptor' that Wall Street lobbied successfully for, and a compliant Federal Reserve allowed to flourish under its watch, which over time morphed into that hazy creature known as 'industry best practice'.

Moreover, since it was good enough for the US, then it must be good enough for others, which meant that casino capitalism under the guise of 'industry best practice' then found its way into almost all other markets around the world.

Here, it influenced local regulatory culture and permitted US investment banks to sell complicated structured products via local financial intermediaries to uneducated and unsophisticated customers under the pretence that they were safe, high-yield products.

It filtered down to the corporate sector, allowing companies some years ago to announce laughably outrageous, profit-guaranteed deals which never materialised because they were in all likelihood figments of the imagination of clever corporate financiers and brokers who knew that they would probably not be exposed but even if they were, they could easily claim the defence of 'buyer beware'.

In his excellent article 'Beware the risks of corruption' (BT, Sept 4) Mak Yuen Teen suggests there are signs that in Singapore, ethical expectations and standards have been gradually lowered over the years, and warns that the trend towards poorer governance can only accelerate over time.

Prof Mak quite correctly asserts that unless companies address the risks associated with poor governance and ethics, they run the risk of being swept away into oblivion.

Advising companies to raise their ethical game is all and good - but in the meantime, how exactly should the authorities approach the question of what exactly constitutes good regulation today?

In our view, it requires lowering the reliance on 'buyer beware' and accepting that if allowed free rein, brokers, investment banks and their ilk are more likely than not to concoct scams to enrich themselves at the public's expense.

It calls for regulators and investors to adopt a strong sceptical bent and recognise that if a deal appears too good to be true, then it probably is. Unlike the customary 'innocent until proven guilty' guideline, the starting point should be the reverse - perhaps unduly harsh but unavoidable because the public's money is at stake.

It calls for strong and deterrent penalties for transgressions, to be dished out evenly to companies of all sizes - blue chips and banks included - when governance is found wanting.

It means redefining disclosure rules to force banks, underwriters and companies to state in simple English on the first page of announcements what the true nature of their products or deals are, instead of allowing these sellers leeway to bury important information in fine print, disclaimers or deep inside prospectuses.

In short, good regulation should aim to stamp out the 'casino capitalism' that Wall Street encouraged, while acknowledging that industry best practice not only means buyers have to beware, but so also sellers - especially when those sellers receive pay packets that dwarf those of buyers.