As we’ve detailed in numerous posts, the performance of SEC enforcement chief Robert Khuzami has been abysmal. It was bad enough that the SEC was weak before the crisis. But the fact that the agency hasn’t upped its game in the wake of the biggest financial markets debacle in history is a colossal fail. And as we’ve pointed out, there’s good reason Khuzami has engaged in (at best) entering into settlements with banks that Judge Jed Rakoff described as mere “cost of doing business” level punishments. Any serious pursuit into the conduct at the heart of the crisis would have implicated him. He was General Counsel for the Americas for Deutsche Bank, and its senior trader Greg Lippmann was patient zero of toxic CDOs, so Khuzami was directly responsible for the failure to rein him in (specifically, note that Khuzami sued Goldman over one of 27 Abacus CDOs but did not sue Deutsche over a similar Deutsche Bank CDO program called Start).

The latest revelation makes it clear that the new head of the SEC needs to replace Khuzami. In Huffington Post, investigator John Powers describes how a well funded whistleblower program, created by Dodd Frank to prevent recurrences of the Madoff scandal, in which tips by fraud investigator Harry Markopolos were ignored. Powers describes in general terms the fraud he’s discovered, which includes a $200 million Ponzi scheme. He’s got the sort of background that the SEC ought to take seriously, and he also made clear he had the goods:

I submitted a detailed report to the SEC and offered to share my confidential files, which contain hundreds of pages of courtroom-ready evidence, including copies of email correspondence, internal documents, audio recordings and witness statements. My facts and my message were clear: “The risk to potential investors is extraordinarily high and this matter warrants further investigation by the SEC.”

Eight months later, he’s heard zip from the SEC. Now it’s hard to take that seriously in isolation; people who work to put together a damning dossier are often frustrated by the slow responses. It’s when Powers puts together the performance of the program that you realize something serious is amiss. The SEC has made one, repeat one, payout from its $450 million whistleblower fund last summer, a whopping $50,000. That was a full two years after the program was established. And there hasn’t been a single payout since then.

This is particularly distressing since whistleblowers are insiders and therefore should in many cases have access to the sort of internal documents that would serve to substantiate conduct and save the SEC a ton of time. In other words, this should be a prime, potentially its best, source of leads, since the SEC would be further along in case development if any of these tips had meat (ie, both damning info and on target with a clear violation).

The SEC is not suffering from a want of leads under this program. Again from Powers:

They’re digging out from under an avalanche of information, overwhelmed by tips of Wall Street crimes and corporate malfeasance. The SEC whistleblower program received 334 tips in its first seven weeks in August 2011, and over the past year has averaged nearly 10 new tips per day.

And Khuzami has confirmed that quality of the leads is good. From Thomson Reuters:

TR: How has the quality and type of whistleblower tips differed since bounties were offered than before they were established by the Dodd-Frank Act? Khuzami: Anecdotally, the quality of tips has increased with more detail and greater supporting documentation. This may be explained by the fact that a greater percentage of tipsters are hiring lawyers to help them. In large measure due to the publicity about the whistleblower program generated by Dodd-Frank, we’re seeing tips across a wider range of subject areas – financial disclosure, Foreign Corrupt Practices Act, broker-dealer conduct, to name a few – and we are receiving tips from around the nation and many foreign countries. What we are not getting is an avalanche of frivolous and non-securities law related matters such as human resources and workplace claims that critics of the bounties said we would get.

And…drumroll…Khuzami claims to have restructured the agency to be better at this sort of triage process. From his Wikipedia entry (which reads like straight up PR):

He created a new system to collect, organize, investigate and data mine tips and complaints,[1] tens of thousands of which are received by the SEC every year. The new units focus on probes into investment advisers, investment companies, hedge funds and private equity funds; financial derivatives and other “complex financial products;” market abuses, such as large-scale insider trading and market manipulations; municipal securities and public pension funds; and violations of the Foreign Corrupt Practices Act. Khuzami obtained Commission approval to delegate to senior staff the authority to issue subpoenas without preapproval, and created the first-ever Office of the Chief Operating Officer (COO) for the Division to handle IT, project management, budget, HR and similar issues that previously had been handled by lawyers. Khuzami also hired industry experts, non-lawyers with genuine market expertise such as portfolio managers, traders, operations personnel, structurers, and risk managers who “know where the rocks are and what is buried beneath them.” Khuzami adopted these changes to make the Division smarter and quicker, noting “whether you are dealing with terrorism or securities fraud, it is better to be in the prevention business than the cleanup business. We want to be able to detect wrongdoing earlier in the cycle and minimize harm to investors.”

We have no choice but to conclude that this initiative was a cock-up. no matter how smart it sounds.

Powers contends that Khuzami’s problem is his strained budget and argues the SEC enforcement chief should use some of the whistleblower funds to pay for more staff to go through documents like his:

Though the SEC’s responsibilities have grown considerably, its enforcement budget — relative to total managed investment assets in the market — has fallen by nearly 50 percent since 2005…. Fulfilling your ethical duty to report a crime would require no reward in a corporate culture that truly values accountability. It remains to be seen what impact, if any, these bounties will have on Wall Street. The average year-end cash bonus at Wall Street firms exceeded $120,000 last year, and at Goldman Sachs it was nearly $370,000. The prospect of a $50,000 lump sum payment from the SEC is unlikely to persuade anyone in this crowd to put their job at risk. The SEC now has almost a half billion dollars of taxpayer funds to pay informants. Most of that money would be better allocated to hiring more SEC investigators and enforcement attorneys, rather than paying bonuses to the same people the agency is supposed to be policing. Otherwise we’ll just be throwing good money after bad.

Now obviously, the SEC can pay more than $50,000 per informant, but the general observation still holds: that the nearest best term use of that $450 million would be to devote some of it to bulking up internally, particularly since the SEC is in no danger of running out of tipster money. If the SEC were to pay tippers $50,000 a day, it would take them 25 years to exhaust their kitty.

But Khuzami isn’t putting these funds to much use, nor, if there are impediments to him adding staff or hiring outside firms to help him go through the whistleblower submissions, does he seem to be complaining about it. It’s normal for budget-starved agency heads and department chiefs to bleat about how funding problems are crimping their operations. His apparent silence on this front (a quick Google search came up empty) says that not making much progress against the bad guys looks to be exactly how Khuzami wants things to be.