With the stock market in the doldrums, there’s a greater value than ever in good investment management and research. Unfortunately, thanks to the Bush administration’s Securities and Exchange Commission, many investment advisory firms are spending their time, and their clients’ money, on answering to regulators instead of on making money. The SEC itself has expressed a derisive attitude to these quite legitimate concerns that have been expressed by Wall Street. “It has seemed to me that firms that are now spending lots of money and time on their compliance programs, and some of the firms who are doing no small amount of complaining about it, probably should have been better resourcing their compliance infrastructure all along,” said Lori Richards, the director of the SEC’s Office of Compliance Inspections and Examinations, in a February 28 speech.

“The misconduct we have seen emerge in this industry – and not by a few bad apples but by a wide range of large and small industry participants – must change the way we all think about compliance,” Ms. Richards said, thereby essentially tarring the entire financial industry as rotten apples.

The SEC’s heavy-handedness has extended to the heretofore lightly regulated hedge fund industry. In addition to requiring registration of hedge funds under a new rule, the SEC has launched some fishing expeditions that are breathtaking in their scope. The New York Sun has seen a copy of one letter from the SEC to an investment management firm asking the firm to supply 22 things, including, as no.14, “All e-mail communications sent or received by Registrant’s Chief Executive Officer for the period from September 1, 2004 through September 30, 2004, Chief Investment Officer for the period from October 1, 2004 through October 31, 2004, Chief Financial Officer for the period from November 1, 2004 through November 30, 2004, and Head Trader for the period from December 1, 2004 through December 31, 2004. If any one individual holds more than one of these titles, please provide the e-mails from the most recent of the months.”

Another request, no. 9, asks for, over the entire year 2004, “lists of any third-party and proprietary soft dollar arrangements to which Registrant is or has been a party. … These lists should include

a. The name of the broker or other entity involved in each arrangement,

b. A description of the products or services received by Registrant under each arrangement;

c. Whether the product or service is within the Section 28(e) safe harbor;

d. The value of each product or service;

e. The soft dollar ratios with respect to each item;

f. Any formal or informal targets or quotas expected to be met to receive these products or services. If targets or quotas exist, please describe in detail;

g. The quantity of each product or service obtained;

h. The personnel who utilize each product or service;

i. The purpose for which the product/service is used;

j. For third-party arrangements, the names of the third parties or individuals who produce the products and services received as part of the third-party soft dollar arrangements; and

k. A list showing the total brokerage commissions used to satisfy soft dollar commitments and the soft dollar commitments with each broker-dealer. …

Please provide this record in electronic format (preferably in Microsoft Excel format.)”

The cost of complying with these absurdly expansive regulatory requests is enough to drive smaller hedge funds out of business and to add to the expenses of larger ones in a way that diminishes returns. Simply as a Fourth Amendment matter, it seems to us – court rulings to the contrary notwithstanding – that the SEC should need a warrant or probable cause before asking to read a month’s worth of a CEO’s e-mail. But these requests appear to be part of routine examinations rather than prompted by any specific allegation of criminal or even civil wrongdoing. At least three investment advisers, and possibly dozens of them, have received similar requests. Such letters are understandable if one holds the view that bad apples are the rule, not the exception, but they are not understandable if one has a general faith in the capitalist system. Nor does it make sense for the SEC to expend this kind of energy on investment advisers serving mainly wealthy and sophisticated investors who can fend for themselves.

Last week’s announcement that the director of the SEC’s enforcement division, Stephen Cutler, would be leaving the agency provides the hope that his replacement will help turn things around. But in the final analysis, this is a policy matter too important to be left to the SEC staff. There’s a role for the White House, the Congress, and the commissioners of the SEC in making clear that while no one wants to go easy on genuine corporate criminals, it’s just bad for the economy and for business when the government starts treating every money manager as if he’s a potential crook.