High wire for top cop on Wall St.

Back when the Securities and Exchange Commission was created – amid a wave of Wall Street scandals – people figured President Franklin Roosevelt had picked a fox to guard the henhouse when he appointed Joseph Kennedy as the first SEC chairman.

Joe Kennedy, John F. Kennedy's father, hadn't been exactly scrupulous about government rules on his way to becoming a millionaire. But FDR figured his background would be an advantage when it came to tracking down Wall Street's tricks.

Now, amid another wave of corporate scandals, critics are similarly questioning whether current SEC chief Harvey Pitt is up to the job of chief US securities regulator. As a former top securities lawyer, is Mr. Pitt too cozy with the industry he's supposed to police?

It's an important question. The SEC is the nation's beat cop when it comes to keeping markets clean, and investors must have faith in its intentions if they are ever to recover faith in the markets themselves. "If people don't have faith in Wall Street, investors don't make money" – and the economy suffers, observes Anne Khademian, author of "The SEC & Capital Market Regulation."

In some ways, the controversy over Pitt's approach to regulation is simply a subset of a long-running discussion about the SEC itself. The agency has long had the difficult task of being both a tough enforcement agency and a quiet liaison between the worlds of government and high finance.

That's largely a reflection of necessity. As a small, overworked bureaucracy, the SEC is simply has no way to do its job without a lot of help from those it oversees.

There are only around 3,000 total SEC employees, and their beat includes all US public corporations, brokerages, and investment firms. Between 1991 and 2000, the staff in the enforcement division grew by 16 percent, while the number of complaints and inquiries it got jumped by 100 percent, according to a recent government report.

Being overwhelmed has led to lax enforcement. The SEC did not uncover massive accounting problems at either Enron, WorldCom, or Xerox. People inside the firms did. Its investigators had even been scouring WorldCom for months – but didn't discover the $3.8 billion hole in the firm's books.

As is the case with most government regulatory agencies, high turnover from lawyers fleeing to high-pay private jobs is a constant problem. Currently, SEC employees make at least 50 percent less than they could in the private sector – and 39 percent less than other financial regulators.

This turnover means that even important cases can take years for the SEC to pursue.

Remember Sunbeam? It was the Enron of 1998. Yet the SEC case against Sunbeam executives for alleged accounting fraud is still far from closed, years later. At that pace WorldCom may keep civil service GS-14 lawyers busy for years.

Yet it would be a mistake to view the agency as a bunch of overburdened timeservers. It contains many dedicated litigators for whom the pursuit of rich miscreants is a moral calling.

Thus there was some consternation in the ranks when Pitt first took command at the agency. He talked about a "kinder, gentler" SEC, as if the agency had been acting as too much the scourge of modern markets.

But that was before Enron, et al. Pitt now vows that he will be a tough enforcer, and thus his background representing major accounting firms, among other clients, is an asset.

The expiration of ethics restrictions in place for his first year in office means that Pitt will now be able to take an active role in cases against his former clients. And he will do so with a vengeance, he told The New York Times in an interview this week.

"The fact is it is an enormous advantage to the public to have somebody who knows about the securities business and the securities law as I do, and it would be unthinkable to deprive people of my expertise," Pitt told the newspaper.

After all, Joseph P. Kennedy, who once famously told a friend, "It's easy to make money in this market – we'd better get in before they start making laws against it," turned into a successful SEC chief, by some accounts.

Pitt has pledged the SEC will review annual reports of every Fortune 500 firm. And the SEC reportedly filed 415 lawsuits against companies or individuals by July 1 of this year – compared with 484 in all of last year.

It's arguable whether tough enforcement is all that's needed to make corporations clean up their act. Even critics of Pitt's tenure, such as his predecessor Arthur Levitt, say that markets and media – rather than long jail terms for executives – are the best deterrents.

"Humiliation and embarrassment tend to change behavior faster than rules and legislation," former SEC chairman Levitt said at a Monitor breakfast earlier this year.

Others argue that what matters is the certainty – not the severity – of the punishment. Whether the jail sentence is two years or 10 years, "you still lose your membership in the country club," says Adam Pritchard, a former SEC staffer. That alone may prompt second thoughts among potential cheaters.