There Will Be Fraud: A Shutdown Could Provide a Madoff Moment

Photograph by Ocean/Corbis

Updated at 5:01 p.m. to add commentary from Duke University law professor James Cox in paragraphs eight and nine.

Plotting a pump-and-dump stock scheme? Waiting to trade on that hush-hush tip you got from a friend? Looking to corner the market on pork bellies? Now might be your chance for any and all of those shenanigans.

The thousands of people who keep U.S. financial markets running smoothly and fraud-free could be on unpaid leave starting tomorrow, along with the National Park rangers that corral unruly grizzly bears and the scientists tracking deadly pathogens at the Centers for Disease Control and Prevention.

A few days ago, Bart Chilton, head of the U.S. Commodity Future Trading Commission, said the shutdown could have “disastrous impacts” for consumers. “You can bet the do-badders are licking their chops,” his statement read.

The government will continue to employ workers “needed to … protect life or property.” At the CFTC, this amounts to a skeleton crew of about 30 people overseeing active court cases and performing a “bare minimum level of oversight and surveillance.” Some 650 others at the commission—including most of the investigation and enforcement staff, as well as the chief economist and public affairs personnel—will be furloughed, forbidden from even checking e-mail. Here’s the CFTC’s shutdown plan (PDF).

The Securities and Exchange Commission said it will operate at full strength for an indefinite period. If Congressional appropriations run short, almost 4,000 SEC employees may have the chance to fire up the computer and day-trade in their pajamas, according to a contingency report the agency filed this week. The regulator’s plan calls for only 252 workers to remain in place, overseeing market activity, routing filings to the Web, and watching for technical glitches in the digital plumbing of U.S. markets.

What the SEC does on any given day can be hard to grasp, but a list of its recent enforcement actions provides a good sense of the chicanery that could go unchecked in coming days. In short, Ponzi schemes and two-bit fraud are way more common than blockbuster IPOs.

Although there won’t be any of those, either. Processing new registrations at the SEC, including the IPO applications of Twitter and Chrysler, will have to wait until Congress hammers out a deal. Freedom of Information Act requests will also go unprocessed. Here’s the SEC’s shutdown plan (PDF).

James Cox, who teaches securities law professor at Duke University, said a shutdown would exacerbate stock-market volatility and throw the deal pipeline into chaos. In a worst-case scenario, a federal impasse would be the trigger for a broad economic downturn.

“So much of finance is emotional and psychological,” Cox said. “This could well point out the notion that you can’t have a healthy economy that under a dysfunctional government.”

Ironically, it’s all systems go at the Consumer Financial Protection Bureau, a relatively new government body that many lawmakers tried to crush as aggressively as they did Obamacare. The CFPB is funded by the Federal Reserve, not Congress. Its 1,000 or so employees will continue their campaign to cultivate financial literacy and crack down on deceptive fine print tied to mortgages, credit cards, and student loans. Today, while SEC investigators were setting up their out-of-the-office e-mail messages, the CFPB was hosting a forum on banking for college kids.

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