Ex-SEC Heads Pitt, Levitt Fault Missed Tips, Regulatory Capture

U.S. regulators failed to act on “a gift” of a tip from Paulson & Co. Inc. that a major brokerage had approached the hedge fund to solicit help in a scheme to manipulate markets, former Securities and Exchange Commission Chairman Harvey Pitt said.

“We had the name of the person who made the call. We had the language the person used,” Pitt said in an interview with the Financial Crisis Inquiry Commission on Sept. 17, which was posted on its website yesterday. Pitt was an adviser to the New York-based hedge fund at the time. “This was a gift, and no cases were brought,” he said.

In June 2007, the hedge fund told the SEC to be on the lookout for manipulation of bonds backed by subprime mortgages. The firm said investment banks were seeking to pay inflated prices to buy bad loans underlying some bonds in order to prevent the bonds from defaulting, which would trigger losses in the banks’ derivatives investments.

Pitt said he met with regulators on Paulson’s behalf, including the SEC, the Federal Deposit Insurance Corp., the Commodity Futures Trading Commission and the Federal Reserve. The regulators had difficulty understanding the scheme, and each agency questioned whether it had the authority to stop it, Pitt said.

Pitt said the scheme did not go forward, in part because of attention from some government agencies. Pitt didn’t specify the date of the discussions and didn’t identify the brokerage firm that allegedly approached Paulson. Armel Leslie, a spokesman for Paulson & Co., declined to comment.

Skills Lacking

Arthur Levitt, who served as SEC chairman from 1993 to 2001, echoed Pitt’s comments about regulators’ shortcomings.

“They lacked the skills to compete with the array of power represented by the business community and their lobbyists and their lawyers and their staffs,” Levitt said in an interview with the FCIC on Oct. 1, which was posted by the commission yesterday.

In addition to government agencies’ inability to keep up with industry, “regulatory capture” was also to blame for weak oversight, Levitt said. “When you meet with the head of a stock exchange, or the head of an accounting firm, or a lawyer, or a market maker” as a regulator, a friendship develops, he said.

“Over a period of time, that friendship allows you to look at the regulatory process with less skepticism than that which should be the attitude of every regulator,” Levitt said.

Avoiding Friendship

Levitt, the longest-serving chairman in the SEC’s history, said the structure of regulatory agencies and the people who conduct the oversight should “constantly change” to prevent regulators from becoming too friendly with industry.

Levitt is an adviser to the Carlyle Group, Promontory Financial Group and Goldman Sachs Group Inc. He is also on the board of Bloomberg LP, the parent company of Bloomberg News.

“I’ve had enough experience both in business and government to understand the seductions thrown at regulators,” Levitt said. “These are not criminal seductions in most cases but they’re just as pernicious in many ways.”

The FCIC was created by Congress to study the causes of the worst economic slump since the 1930s. The commission’s findings, which were published last month, were endorsed by the panel’s Democratic majority. Four Republican members issued two dissenting assessments of the causes of the financial crisis.

Editors: Maura Reynolds, Gregory Mott

To contact the reporters on this story: Joshua Gallu in Washington at jgallu@bloomberg.net; Jesse Hamilton in Washington at jhamilton33@bloomberg.net.

To contact the editor responsible for this story: Lawrence Roberts at lroberts13@bloomberg.net.

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