Former SEC commissioner Troy Paredes defended the agency’s enforcement record in the aftermath of the financial crisis during a recent talk at Wharton. Arguing that there are sound legal reasons for the SEC’s enforcement decisions, Paredes nevertheless acknowledged that he has repeatedly heard the question: Why aren’t more people in jail for offenses? “One response is that the SEC does not put people in jail,” he noted.

Paredes also acknowledged a more general question often being asked: “Why hasn’t there been more accountability? Somebody surely is to blame for what this country has experienced.”

“I understand the sentiment and respect the perspective,” Paredes said. “But when people make these points, and sometimes in sharp terms … we have to allow for the law and the facts and the proper regard for due process to win the day.” Paredes, who practiced law in California with a focus on finance, mergers and acquisitions, and corporate governance, also is a former law professor at Washington University in St. Louis. His presentation was part of the Penn-Wharton Public Policy Initiative‘s speaker series.

Sometimes people just make mistakes, Paredes continued, referring to alleged misdeeds. “And I don’t say that to be an apologist.” Rather, he went on, “Folks trying to get it right, folks trying to act in good faith, sometimes make mistakes.” Maybe those mistakes are so egregious that they amount to recklessness — or only to negligence, he noted. “Maybe they don’t even amount to negligence; maybe it is just a good old-fashioned mistake in a complicated environment. Just because there was a bad outcome does not mean someone acted with intent or negligence.”

Given the complexity of the rules, it’s not difficult to make “mistakes,” Paredes added. Take a 1,000-page rule release. “I always ask, what does it mean?” Would a lawyer know how to advise on where the legal lines are drawn, let alone if “I were on a trading desk? Can folks understand in a way that allows them, when they are trying to comply, to comply? That is a real practical challenge.”

If a trader thinks, “When I put on this trade — well, can I or can I not? If at each and every turn I find myself having to call my lawyer, well guess what, the economics that drove the trade just went away,” Paredes noted.

Decision-making for market participants has become “even more complicated” under the so-called Volcker rule of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which banned proprietary trading by commercial banks. Now, Paredes said, more agencies are involved. “The SEC may do it this way and banking regulators may do it that way, and the Fed may do it another way, so I may be cool with the SEC, but if I’m not cool with the banking regulators, what do I do?”

“Why hasn’t there been more accountability? Somebody surely is to blame for what this country has experienced.”

If that’s the case, then “the regulators may have to sit down and figure it all out again,” he pointed out.

Paredes also challenged the value of deterrence as a lever for containing fraud, which officials often refer to when announcing the details of a particular case. “Standard accounts of law enforcement depend on deterrence — the probability of detection times the magnitude of sanctions [and] expected pay off — and [the idea that] people then make rational decisions about whether to engage in some misconduct.”

But he said the latest research shows that the way people actually think is more complicated than a purely rational balancing of the gains and risks. Studies on “behaviorism, psychology, judgment and decision making, and neural science … [show] that a model based on incentives is very informative, but is missing a lot in the way humans actually make decisions.”

One response is to understand better why people invest in things that appear “too good to be true” and to look at solutions that involve better financial literacy and investor education, Paredes said. That way, investors can be better equipped to be the first line of defense against fraud and to prevent incidents that might allow them to be taken advantage of as part of an affinity group — such what as occurred in the Bernie Madoff case, where many investors lost their life savings.

“The SEC may do it this way and banking regulators may do it that way, and the Fed may do it another way…”

In the aftermath of perceived SEC ineffectiveness on the Madoff case, and around the financial crisis in general, it was important that the Commission “didn’t shy away from saying, ‘OK, we need to figure out what we can do and not get defensive on the point, and … not say we are perfect in every way. These things happen. We need to understand what happened and take steps to improve,” Paredes stated. That is part of “revamping the tips and complaints and referral system” … based “on a risk-based examination process.” This also includes an increased focus on data, “and hiring more experts “to bolster the ranks.”

In post mortems, the SEC had many discussions about “breaking down silos” and the need for more coordination and communication internally, Paredes added. He noted that such initiatives take a “lot of commitment” and suggested that the SEC has made “a lot of strides” in these areas.

Regarding specific cases of alleged misconduct, Paredes further noted: “When you have evidence that is more circumstantial, or lots of explanations that would be entirely plausible, and benign explanations, then you have to not lose sight of the fact that government bears the burden [of proof] as well.”