May 7 (Bloomberg) -- The U.S. Securities and Exchange Commission's inability to avert the collapse of Bear Stearns Cos. may be traced to funding levels at the agency that haven't kept pace with the complexity of Wall Street's biggest companies.

SEC spending, which rose in response to frauds at Enron Corp. and WorldCom Inc., decreased by 1.3 percent to $875.5 million in fiscal 2007 from fiscal 2005, according to agency budget requests. The regulator also lost 386 full-time employees in the two-year period, a 10 percent drop, while headcounts at investment banks such as Bear Stearns, Merrill Lynch & Co. and Lehman Brothers Holdings Inc. increased at least 10 percent.

Revenue at the five largest U.S. securities firms climbed 74 percent from 2001 to 2006, and more than 30 percent of their earnings may have been derived from structured credit, which includes bonds backed by mortgages, according to estimates by Charles Peabody, an analyst at Portales Partners LLC in New York.

``I've been concerned for some time that flat budgets would create gaps in the SEC's oversight and enforcement efforts,'' said Harvey Goldschmid, a former SEC commissioner who left the agency in 2005 and is now a professor at Columbia Law School in New York. ``That may have been responsible for the failure to identify some of the problems at Bear Stearns.''

The SEC's supervision of securities firms and the adequacy of its resources for monitoring them drew scrutiny today from the U.S. Senate at two hearings.

Fed Lending

Congress is examining the SEC's role in the wake of the Federal Reserve's rescue of New York-based Bear Stearns in March, after customers and lenders abandoned the fifth-biggest U.S. securities firm over concern that it faced a cash shortage. The crisis prompted the Fed to begin lending to investment banks for the first time since the Great Depression.

The Bush administration requested $913 million for the SEC for the 12 months starting Oct. 1, an increase of less than 1 percent from fiscal 2008. SEC Chairman Christopher Cox, testifying before a Senate subcommittee today, said the budget will allow the agency to regulate ``aggressively.''

Erik Sirri, who heads the SEC division of trading and markets, told lawmakers today that the agency wants to ``step up'' its capital and liquidity requirements for investment banks.

The SEC also plans to increase the number of agency staff members who monitor risk at securities firms to 40 from 25, Sirri said in testimony before the Senate subcommittee on securities, insurance and investment.

One-Year Target

As the investment banking industry's main regulator, the SEC tries to ensure firms have enough funds to meet expected obligations for at least a year during periods of market stress.

That test failed to account for the ``unprecedented'' situation at Bear Stearns, which couldn't secure loans even when it offered ``high-quality collateral,'' Cox said in April 3 testimony before the Senate Banking Committee. The SEC is reevaluating its approach, he said.

Cox said the SEC's oversight of Bear Stearns succeeded in accomplishing its intended purpose, which is ensuring that the firm's brokerage clients didn't lose any money.

Ten Democratic senators, including Senate Banking Committee Chairman Christopher Dodd and Rhode Island's Jack Reed, said the SEC should receive $963 million in fiscal 2009, $50 million more than Bush has requested.

`Robust Funding'

``The SEC needs robust funding to replace gaping holes in the regulation of our capital markets,'' the lawmakers said in a letter dated today to Senator Richard Durbin, the Illinois Democrat who heads the appropriations subcommittee that oversees SEC funding.

The agency would ``welcome congressional consideration of dedicated funding for the SEC's oversight of investment banks,'' SEC spokesman John Nester said.

SEC staffing levels peaked in 2005 at 3,851 full-time employees, including 1,232 in its enforcement division, which investigates fraud. The agency had 3,465 full-time employees in the fiscal year ended last September and staffing in the enforcement unit dropped to 1,111.

``Staffing levels haven't kept pace with the urgent work needing to be done,'' Arthur Levitt, a former chairman of the SEC, said today in a Bloomberg Television interview. ``We need more people in enforcement and more people at the commission. Those budget cuts have got to be restored.'' Levitt is a board member of Bloomberg LP, the parent of Bloomberg News.

Unspent Funds

Under Cox, who became chairman in August 2005, the SEC has left money on the table. The 2007 budget included $14 million in ``available balances from prior years,'' according to the SEC's 2009 funding request. The $906 million Congress granted the SEC in 2008 includes $63.3 million unspent from earlier years.

``This is akin to the fire department laying off people as the house burns down,'' said Lynn Turner, a former SEC chief accountant.

Nester said more than 90 percent of the money carried over to the 2008 budget from earlier years can't be used for staff salaries. Most of the $63.3 million represents funding intended for contract work such as technology upgrades, he said.

Cox said in April 16 testimony before the House Appropriations Subcommittee on Financial Services and General Government that the SEC is in ``very good shape'' to recruit and retain employees. He said the staff turnover rate is 25 percent lower than in the 1990s.

Congress, in approving the 2002 Sarbanes-Oxley Act, almost doubled the SEC budget after its resources were deemed inadequate to prevent accounting scandals at Enron and WorldCom. The law enabled the SEC to employ more accountants, enforcement lawyers and examiners.

To contact the reporter on this story: Jesse Westbrook in Washington at jwestbrook1@bloomberg.net.

Last Updated: May 7, 2008 19:06 EDT