H. David Kotz knows what it's like to have all conversation stop the moment he steps into a crowded elevator at work—and resume the moment he exits.
But the inspector general of the Securities and Exchange Commission isn't much concerned with being popular. He's far more interested in "rolling up my sleeves in a matter and trying to figure out what happened," he says.
His investigations range from minor issues (an employee who yells and curses at colleagues) to colossal scandals (Bernard Madoff's $65 billion fraud) to just plain embarrassing (workplace porn, anyone?). "The primary role I have is to ensure the agency is able to perform its mission in an effective and efficient manner," says Kotz, 44, in a lengthy interview in his second-floor office in a far corner of SEC headquarters overlooking a parking lot. With a tight-knit staff of 22, Kotz conducts audits and investigations that touch every aspect of agency operations. Since joining the SEC in late 2007, he's produced explosive reports that have documented SEC shortcomings in painful detail—and led directly to major internal reforms.
"When he got to [the SEC], it was a mess. It's a totally different agency now, in large part because of his efforts," says whistle-blower Harry Markopolos, who tried without success to alert the SEC to Madoff's Ponzi scheme for nearly a decade. "I had lost my faith in government. But he was unflagging. Nothing deterred him or his team. He restored my faith."
Kotz's scrutiny of the SEC remains relentless. In a 109-page semiannual report sent to Congress in May, he uncovered dozens of new mistakes and problems. For example, a regional staff attorney disclosed the name of a confidential Federal Bureau of Investigation informant to an investor and witness, and revealed that the informant was secretly taping conversations.
In another instance, an SEC employee provided "false, misleading, and nonpublic information to investors about an active enforcement investigation and litigation." The employee was an investor in the company, which the report doesn't name—but the dates cited match the SEC's case against Imperia Invest IBC. The company, an alleged Ponzi scheme, targeted deaf investors. The SEC won a court order for millions in disgorgement in February.
Kotz's report also details widespread problems, like granting contractors access to SEC buildings and computer systems before their background investigations are complete. And it flags an ongoing investigation into the SEC's $557 million lease for 900,000 square feet of unneeded office space in downtown Washington, D.C.
On a more personal—and mortifying—note, the report found that SEC lawyers and accountants are still using their office computers to view pornography during work hours, despite a much-publicized prior report from Kotz about the practice. One lawyer received hundreds of "access request denials" for Web sites classified as pornographic, but still managed to view dirty images on his SEC computer. He subsequently quit. Another lawyer looked at numerous photos of partially or fully nude women at work and is being fired.
But Covington & Burling securities practice cohead David Martin wonders if "you couldn't go into any organization in the country, any corporation or government agency," and find similar behavior. "I'm not condoning it, but don't see that the case has been made that the SEC is much different than the rest of the world in this respect," he says.
Martin, who formerly headed the SEC's division of corporation finance but does not know Kotz personally, said the inspector general's high-profile approach to his job "could strengthen the SEC if it makes everyone careful about what they do." But there is a balance to be struck, he cautions: "A little fear is good, but too much is a bad thing."
Kotz earned his J.D. from Cornell Law School in 1990 and is married to Boston Globe health reporter Deborah Kotz. The couple has three children. Kotz prides himself on never missing a parent-teacher conference—he's even found time over the years to coach Little League and soccer teams.
He began his legal career in private practice, working for the now-defunct Graham & James, then Stults & Balber, and Pepper Hamilton, where he was a litigator. In 1999 he moved to the U.S. Agency for International Development and became inspector general of the Peace Corps in 2006.
At the Peace Corps, much of his work focused on the safety and security of the overseas volunteers. When he was hired to be SEC inspector general in 2007 by then-chairman Christopher Cox, the reaction from many people, he recalls, was: "Well, this is very different from the Peace Corps; you're going to have to get up to speed on securities issues."
They quickly offered help. "I remember the chairman and the chief of staff gave me these very, very large books with all kinds of analysis on securities regulation," he says. "And then the first three or four investigations that I worked on at the SEC were identical to ones I worked on at the Peace Corps—procurement fraud, inappropriate use of the computer, things like that."
But he soon found himself in the thick of the securities world with the collapse of Bear Stearns Companies, Inc., in March 2008. His first major report, released six months later, looked at the SEC's role in overseeing the investment bank. "It is undisputable that [the SEC] failed to carry out its mission in its oversight of Bear Stearns," the report stated. There were "numerous potential red flags prior to Bear Stearns's collapse."
Bear Stearns was followed by the bankruptcy of Lehman Brothers Holdings Inc. and the emergency sale of Merrill Lynch and Co., Inc. But for Kotz, nothing compared to the call from Cox to investigate how the SEC, despite receiving six substantive complaints, failed to detect that Madoff defrauded thousands of clients out of billions of dollars.
After nine months of near round-the-clock work, Kotz and his team produced a 477-page document that whistle-blower Markopolos called "the most unbelievable report produced by an inspector general in the history of government. He told the truth. Every system of checks and balances failed."
Kotz remembers the weight his office was under: "It was a massive undertaking. There was a lot of pressure from Congress to get it done in a timely manner. But we also needed to make sure that after the report was issued, questions didn't linger."
In the course of the investigation—almost on a whim—Kotz decided to request an interview with Madoff himself. He figured, "Who better than Bernie Madoff to find out how Bernie Madoff misled the SEC?"
It was a long shot: "Initially, I didn't think he would talk to me." Madoff had not yet been sentenced, and was not cooperating with the government.
To Kotz's surprise, Madoff agreed. On June 17, 2009, Kotz and deputy inspector general Noelle Frangipane interviewed Madoff at the Metropolitan Correctional Center in New York City. The disgraced financier was led out in leg irons, and spoke with Kotz for nearly four hours. "He was very forthcoming. He didn't hold back or refuse to answer any questions," Kotz says. "He was very concerned about his reputation . . . but he did not express a lot of remorse for victims."
Kotz came away with some insights into Madoff's character. "I asked him, 'Did you provide the SEC with any false documents?' He said, 'No. In fact, the documents I provided to the SEC were exactly the ones I provided to my customers.' I said 'Okay, but weren't both of them false?' He said, 'No.'
"I said, 'All right, let me try again. Didn't the documents that you provided to the SEC reflect trades that didn't occur?' So he thought for about 30 seconds and said, 'Yeah, I guess I can see how you might view them as false.'
"I think his psychology was that he almost believed he wasn't perpetrating a fraud," Kotz says. "I think that's why he was so effective."
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