The Inside Story on the Breakdown at the SEC

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Illustration by Sean McCabe for TIME; Getty (4); AP; Reuters

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Franklin Roosevelt created the SEC during the Great Depression to clean up financial scandals and rebuild investor confidence. For three-quarters of a century, the agency waged high-profile wars against insider trading, corporate bribery and fraud in cases ranging from junk-bond king Michael Milken to Enron. Cox took charge in August 2005 after 17 years of representing Orange County, California. A Harvard-trained lawyer, he was a key leader of Newt Gingrich's Republican revolution, helping enact a provision of the GOP's Contract with America that restricted investor lawsuits against companies accused of securities fraud.

At the SEC, Cox initially sought consensus by soliciting the opinions of two Democrats on the five-member body. But his desire for harmony played into the hands of the most conservative Republican commissioner, Paul Atkins, who opposed aggressive enforcement. Not that the Democratic commissioners offered much resistance: one stepped down in 2007, the other in early 2008. President Bush didn't fill either of the vacant seats until last summer, giving the Republicans more latitude. Meanwhile, the world the SEC regulated was turning upside down.

In 2007, Cox pushed through a rule requiring SEC staff to get authorization from commissioners for financial penalties before settling a case. Cox says the rule was an experiment designed to streamline the process.

In fact, it quickly created delays and obstacles, so much so that SEC officials often stopped seeking penalties. "It wasn't worth it," a former commissioner says. "All they got was abuse every time they went before the commission and asked for penalties." Some investigations didn't get even that far. Gary Aguirre, a senior SEC lawyer, sought to question the chairman of Morgan Stanley in a fraud investigation but was denied permission before Cox arrived. He later told Congress that his superiors, fearing the banker's "very powerful political connections" in Washington, had delayed the probe, dooming any chance of making a case--allegations that a Republican Senate report later found credible.

Eventually, enforcers at the SEC grew demoralized. One by one, key officials left the agency; Aguirre was fired under Cox. Sensitive cases seemed to lag. Cox has admitted that his staff brushed off "credible and specific" reports of fraud committed by Madoff over the past 10 years and did not seek subpoena power or bring tips to the attention of commissioners. Although 2008 saw the second highest number of enforcement actions in the agency's history, many involved smaller cases, as the value of penalties dropped. Critics say the SEC wanted to avoid upsetting the powerful securities industry.

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