WASHINGTON — The Securities and Exchange Commission, besieged on all sides by critics and infuriated constituents, is undergoing its biggest overhaul in 30 years, one that is to crescendo with the imminent passage of the financial regulatory reform bill this month. In its current iteration the mammoth 1,400-page Senate document includes at least nine reforms that directly impact the commission. It’s a good start, say former chairmen, commissioners and top-level staff – but don’t stop there.
Reforms include mandates that the SEC provide Congress with reports on its examinations, financial control audits and personnel management; for SEC employees to give confidential suggestions on improving the commission; and to allow the SEC to fund itself instead of relying on a yearly budget that requires government approval. What’s more, it will require hedge funds larger than $100 million to register with the commission, something they have not had to do previously. The rules do not go far enough to bring the regulator on the level with the technological eruption in the interconnected markets of ever-increasing size and complexity, former top regulators and industry participants say. And what it is doing on its own may not be enough.
“There’s widespread agreement that the SEC is not up to where it needs to be,” says David Hirschmann, the president of center for capital markets at the U.S. Chamber of Commerce.
SEC’s headquarters in Washington, D.C., where myriad changes are occurring because of Congress and from within. (Max Frumes/MNS)
Assessing the pieces
- The bill gives the SEC self-funding authority, which will provide it with more money, even though its budget has nearly tripled to $1 billion in the past decade. “Nothing was accomplished because you just spent more money doing what had been done in the past.” – Jack Katz, secretary of the SEC from 1986 -2006.
- The bill gives the SEC power over 10,000 hedge funds, private equity firms, and more detailed obligations with respect to rating agencies. “The bill would give the SEC powers it simply isn’t capable of executing because of the outmoded concepts that it is still bound by.” – Harvey Pitt, SEC Chairman 2001-03
- The bill creates two new regulatory bodies, the Consumer Fincial Protection Bureau, housed at the Fed but completely independent, and a financial gatherer under the Treasurer – but does not merge any others. “At the end of this we’re plus two – that’s half the problem.” – David Hirschmann, president of the center for capital markets at the U.S. Chamber of Commerce.
- The bill does not break down internal divisions: “With an internal culture that’s resistant to change, the chairman will need the help of sustained congressional pressure to be able to force through the necessary reforms. A major disappointment with the FinRegReform bill is that it doesn’t contain provisions addressing this problem.” – Brian Cartwright, SEC general counsel 2006-08.
Already since she took over in January 2009, SEC Chairwoman Mary Schapiro has been on a tear, taking one action – among many – to replace the heads of the most important units of the SEC. Most notably she handpicked former New York prosecutor Robert Khuzami to fill the tough-guy role and run the enforcement division.
Khuzami in turn flipped the division on its side and increased specialization among the enforcement groups – something that in part led to the Goldman Sachs case. The SEC tagged Goldman with an infraction of disclosure rules within the highly specialized products of collateralized debt obligations.
Schapiro is positioning herself as the defender of the investor. It has invigorated a once-demoralized staff and may be the key to reestablishing the respect lost after the country’s financial markets went wild and then tanked on the SEC’s watch.
“She’s got to be known as the investors’ agency and fight every power in town,” says Arthur Levitt, chairman of the SEC from 1993 to 2001.
Is she doing so to the point that could be detrimental to business? In response to the commission’s plans for “surprise exams” of investment firms, the Managed Funds Association sent a letter to the SEC saying that would be “overly burdensome, inefficient, and unresponsive to investor demands.”
So too in the political arena, Schapiro may need to be careful not to undercut the legitimacy of the regulatory actions with the appearance of politically motivated actions. The Goldman case went forward along party lines with a 3-2 vote, along with some other important decisions this year.
Brian Cartwright, the SEC’s general counsel under Schapiro’s predecessor, said this is expected every once in a while, but too often can cause problems.
“The perceived legitimacy of major regulatory actions – particularly at an independent agency – could be undermined if they came to be seen as too frequently having a partisan underpinning,” Cartwright said.
In February, Schapiro joined the other Democrat commissioners Luis Aguilar and Elisse Walter in 3-2 votes for rules to restrict betting against stocks and to encourage disclosure of environmental impact on financial results. This has even earned her the nick-name “full-count Mary” among political wags.
Even so Schapiro could benefit by ticking more people off, says Levitt.
“She needs to make more confrontational speeches, make more enemies if you will,” he said.
Who’s dysfunctional?
But it’s not all up to Schapiro.
The chairman must rely on the permanent staff and can be rendered ineffective if the permanent staff leans against the chairman’s initiatives. The permanent staff knows chairmen come and go every few years and often wait one out. This creates a powerful permanent staff with an inbred culture that’s resistant to change, Cartwright said.
“Someone whose future career may be in an SEC-regulated industry or may involve coming back to the staff hat-in-hand may lack the fortitude to do what’s necessary,” he said.
Cartwright’s boss was Christopher Cox, who some blame for being too lax in regulation.
“Cox didn’t believe in enforcement and he had two other likeminded commissioners who really weren’t that enthusiastic about enforcement,” said Jim Coffman, a former assistant director at division of enforcement.. They believed in the market regulating itself and were concerned that there was so much regulation in the U.S. that the business was moving overseas – something that industry participants still fear.
Paul Atkins, one of those former commissioners under Cox, says that there are issues with the SEC when he was there that continue to this day. For one, they are still bringing cases that are for “headline value,” he said.
“When I was at the SEC that was part of the problem,” Atkins said. Before Bernard Madoff, instead of bringing Ponzi scheme and pump-and-dump cases, staffers said their supervisors didn’t encourage them because those cases didn’t grab the headlines..
With an internal culture that’s resistant to change, the chairman will need the help of sustained congressional pressure to be able to force through the necessary reforms, according to Cartwright.
The bill falls short, unfortunately.
“Individually these provisions don’t provide very much,” said Jonathan Katz, secretary of SEC from 1986 to 2006.
Even the popular self-funding measure would not help, he says. The SEC’s funding nearly tripled from 2000 to close to $1 billion in 2008, according to SEC annual reports, receiving a huge growth in funding after the Enron scandal broke in 2001, but little was accomplished, he said.
“You just spent more money doing what had been done in the past,” Katz said. Part of that is the tendency to react instead of find problems out beforehand. “When you have an enforcement division that’s focusing on front-page news cases, there’s a tendency to be focused on the flavor-of-the-month cases,” Katz said. “If you’re not going to fundamentally change how the SEC functions, I don’t think the SEC’s going to accomplish much.”
And Cox wasn’t the only commissioner who did not accomplish all he may have wanted.
Harvey Pitt, chairman from 2001-03, had said for years the SEC needs increased breadth of expertise, that it was “over-lawyered,” and to examine any entity that could impact the markets every year. Pitt agrees with the self-funding part of the bill, but says many of the other provisions are misguided.
Mary & Gary
For one, Pitt said the derivatives section of the legislation actually strips the SEC of authority with respect to derivatives, and cedes all of that to the Commodities Future Trading Commission.
The SEC itself criticizes this motion.
“The bills add unnecessary complications to the regulation,” Commissioner Elisse Walter said of the derivatives provision in an April speech.
Many feel the SEC should just merge with the CFTC in order to do this.
“This is the one time I thought that merging some of the regulators might not only be a good idea, but might be feasible,” said Laura Unger, an SEC commissioner from 1997 to 2001.
The U.S. COC’s Hirschmann thinks, in fact, consolidation is the only way to proceed in today’s regulatory environment.
“The only way to have regulation is consolidation,” said Hirschmann.
Though she believes the opportunity for the merger may be slipping, Unger is encouraged by the cooperation forged between Schapiro and the CFTC Chairman Gary Gensler.
The SEC and the CFTC, in one of several displays of solidarity, have formed a joint advisory committee to address the troubling stock plunge on May 6.
“I like that with Mary and Gary are working together,” Unger said. “Second to merging the agencies is fostering a spirit of cooperation among the two.”
The bill actually does the opposite of consolidation, creating a new entity, a consumer protection board. Pitt takes exception to this as well. This could be an indication of Congress’ faith in the commission.
“This provision would create someone who would be required to evaluate the performance of every employee of the SEC,” Pitt said. “In essence, the SEC is being set up for failure.”