Aug. 30 (Bloomberg) — Thanks to Darcy Flynn, a longtime attorney at the Securities and Exchange Commission, we now have all the ammunition we need to do what should have been done years ago: terminate the SEC, with extreme prejudice, and in its place construct a new regulatory watchdog for Wall Street free of obvious conflicts of interest.

Flynn’s courage has almost been lost in all the recent apocalyptic talk of earthquakes and hurricanes, but a few weeks back he did something remarkable. After raising concerns internally at the SEC last year — and getting nowhere — Flynn went public and alleged in a formal whistleblower complaint that for at least 17 years the SEC “followed a policy of systematically destroying documents” related to what are known as Matters Under Investigation, or MUIs, most of which were focused on possibly illicit or illegal behavior at Wall Street firms. MUIs are the first step in investigating a case that may lead to a formal SEC inquiry.

Flynn alleged the MUIs were destroyed after the cases were closed when they should have been retained. He catalogued his complaints in a letter to Senator Charles Grassley, an Iowa Republican and the ranking member of the Senate Judiciary Committee. Grassley wrote to Mary Schapiro, the head of the SEC, asking her to respond to him about Flynn’s allegations by tomorrow. She hasn’t yet done so as of yesterday.

In his letter to Grassley, Flynn alleged that the SEC had destroyed documents related to MUIs involving Bernard Madoff; Goldman Sachs Group Inc.’s trading in the credit-default swaps of insurer American International Group Inc.; “financial fraud” at Wells Fargo & Co. and Bank of America Corp.; and “insider-trading investigations” at Deutsche Bank AG, Lehman Brothers Holdings Inc. and SAC Capital Advisors LP.

‘Doesn’t Make Sense’

“It doesn’t make sense that an agency responsible for investigations would want to get rid of potential evidence,” Grassley said in a press release that accompanied his letter to Schapiro. “If these charges are true, the agency needs to explain why it destroyed documents, how many documents it destroyed over what timeframe, and to what extent its actions were consistent with the law.”

This case alone is reason enough to shut the SEC and design a new agency worthy of its budget of more than $1 billion. But, of course, there are many more instances of the ineptitude that makes the SEC so infuriating and ineffectual. Top among them is the agency’s abject failure during the leadership of former Representative Christopher Cox to hold Wall Street the slightest bit accountable for its actions.

Cox Run Amok

Cox came to define laissez-faire regulation run amok, allowing the financial industry to get away with an excess of abuses, the extent of which may never be fully known, thanks partly to the SEC’s alleged document destruction. Then there is William H. Donaldson, Cox’s predecessor. How could Donaldson and the other SEC commissioners have blithely ruled in 2004 that the biggest securities firms could dramatically increase the leverage on their balance sheets without thinking through the possible ramifications of such enhanced risk — where a mere 2 percent decline in asset values could wipe out a firm’s equity cushion? No doubt that decision helped lead to the downfall of Bear Stearns Cos., Lehman Brothers and Merrill Lynch & Co., and to the near-failure of both Morgan Stanley and Goldman Sachs. Thanks, Bill.

The SEC has long had a too-cozy relationship with Wall Street. Witness Robert Khuzami, the SEC’s director of enforcement, who used to be the general counsel for the Americas at Deutsche Bank in New York, a firm that issued one fatally flawed mortgage-backed security and collateralized-debt obligation after another during the early part of the last decade. (A Senate subcommittee report on the financial crisis devotes 45 pages to Deutsche Bank’s squirrelly securities business and the role it played in fomenting the meltdown.)

Targeting Goldman

Is it any surprise that Khuzami set his sights on Goldman Sachs, rather than on his old company, in trying to create some accountability for the mortgage mess? Deutsche Bank was a bigger player in the mortgage-securitization and CDO markets than Goldman Sachs was, yet it was Goldman that the SEC ended up going after in April 2010 when the agency filed — to great fanfare — a politically useful civil suit related to a synthetic CDO that Goldman created and sold in April 2007. (Deutsche Bank did many similar deals.) Goldman Sachs settled the accusations in July 2010 for $550 million, more to make the bad publicity go away than because it did anything different from any other Wall Street firm.

Obvious Conflict

There’s no evidence of impropriety on Khuzami’s part, but it should hardly give investors confidence that someone with such an obvious conflict of interest could bring a suit against a competitor of his old employer. (Schapiro, meanwhile, was previously head of the Financial Industry Regulatory Authority, and was paid almost $9 million when she left to join the SEC.) It goes both ways: For years, top SEC officials have been turning in their regulatory credentials for compensation bonanzas at the very companies they were once charged with overseeing.

Then there’s the SEC’s ongoing obfuscation when it comes to Freedom of Information Act requests. The SEC is the black hole of such applications, hanging them up for years and ultimately ignoring them. This is a violation of trust that threatens our democracy and makes it difficult for journalists and historians to figure out what went wrong. Maybe that’s the point.

In Rolling Stone’s Sept. 1 issue, Matt Taibbi broke the story of Darcy Flynn’s complaint against the SEC. It’s worth reading for its rich detail about what Flynn alleges the SEC has been doing for decades. And it only reinforces the idea that the agency is unsalvageable — and needs to be replaced.

Remade SEC

A new SEC would pay its top officials much higher salaries (in line with top private-sector attorneys) but not allow any of them to have previously worked on Wall Street or to go there for five years after they leave the agency. It would have genuine law-enforcement power, as opposed to the SEC’s civil-suit-only mandate, and be able to indict a firm and its top executives for wrongdoing. In other words, the agency would have the chops to regulate a powerful industry badly in need of it, free of conflicts of interest.

It’s now crystal clear — and beyond unconscionable — that the SEC stopped doing its job long ago. We need to rebuild it on a more secure foundation.

(William D. Cohan, a former investment banker and the author of “Money and Power: How Goldman Sachs Came to Rule the World,” is a Bloomberg View columnist. The opinions expressed are his own.)

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