WASHINGTON – The Securities and Exchange Commission does not have the money for the technological tools it needs to monitor the financial markets it is charged with policing under expanded duties outlined in the Dodd-Frank financial reform law, an SEC spokesman said.
The GOP-controlled House Appropriations Committee has already frozen the SEC’s fiscal 2012 budget at its current fiscal 2011 level of $1.19 billion.
The SEC argues that waters down its ability to monitor the securities markets using technology and systems comparable to those used by many of the entities it regulates.
“A number of financial firms spend more each year on their technology budgets alone than the SEC’s entire budget,” SEC spokesman John Nester said.
To comply with legislation, the agency says it is working toward creating a so-called Consolidated Audit Trail system that would establish a comprehensive database of orders and executions, giving regulators a new way to monitor markets and to react quickly to market disruptions and potential market abuses.
The consolidated audit trail is a trade tagging and data collection system that would help the agency track information about trading orders so it can better understand the fast-paced markets of which high-frequency traders account for more than 50 percent of volume.
Without sufficient funding, the agency lacks investment to create appropriate information technology infrastructure to take in, manage and analyze the market data on volatile market days like today when the Dow Jones Industrial Average was lately off more than 400 points, or when stocks seemed to be in free fall on May 6, 2010, known as the “flash-crash.”
Michael Smallberg, an investigator at the watchdog Project on Government Oversight in Washington, argued the SEC should be given the budget it requested.
“When you compare the size of the SEC’s budget to the size of the industry that they’re overseeing, it seems pretty clear that they’re just outgunned,” Smallberg said.
The Dodd-Frank legislation charges the commission with oversight responsibilities on the previously unregulated over-the-counter derivatives market, as well as hedge fund managers and municipal advisers.
But the agency complaints the insufficient funding is slowing its pace down.
EDGAR, the SEC’s system for storing and disseminating public filings, has not had a significant modernization since 1997 and needs to be upgraded, said Nester.
“Further delay will impede the oversight of public company disclosure and the investing public’s access to information,” Nester added.
Meanwhile, SEC Chairwoman Mary Shapiro is pleading her case to Congress for the money.
At her latest appearance on Capitol Hill, during a Senate Banking Committee hearing last month, Schapiro testified that the declining budget could severely compromise the SEC’s investments in information technology.
“Under the House appropriation, we would probably be cut about $10 million of our information technology budget, and the end result of that would be postponed critical investment in market surveillance technology,” Shapiro said.
Shapiro’s appeal echoed the voice of Massachusetts Democratic Congressman Barney Frank, the co-author of the Dodd-Frank Act, calling for fully funding the SEC so that the agency could execute its new powers, such as regulating the over-the-counter derivatives market.
“We are talking about very sophisticated banking activities. You’ve got to hire very smart people. You’ve got to have very good information technology,” Frank said.
Smallberg expressed the same concerns.
“One area where is pretty clear that the SEC is just completely outmatched is in their oversight of high-frequency traders,” Smallberg said.
By using supercomputers, high-frequency traders make a large number of trades in a matter of microseconds, or one-millionth of a second, analyzing multiple markets and executing orders based on market conditions to profit.
On the industry side, technology has exploded in recent years and the size of the securities industry quickly ballooned, but the SEC has not been able to keep up with the same level of resources to effectively oversee that market, Smallberg added.
Worth the investment?
Republicans in Congress recently have been searching for ways to cut all government spending, and the SEC’s budget is in their crosshairs.
The Republican-controlled House Appropriations Committee cut the SEC’s fiscal 2012 budget request by $222.5 million, to $1.19 billion in June, saying it is “reticent” to provide more funding because of concerns about the SEC’s lack of ability to manage its budget well, poor decisions with office leasing practices and the agency’s track record in dealing with Ponzi schemes.
But Frank argues the current SEC regime should not be starved because of the previous regime’s poor record.
“The fact that people didn’t do a good job in the past is no reason not to give them resources to do their jobs in the future,” Frank said.
Without enough funds, the SEC would not have the ability to follow up on all the complaints it gets, Frank added.
Under the bill approved by the House Appropriations Committee, the SEC is prohibited from using a $50 million reserve fund established by the Dodd-Frank legislation. The reserve fund allows the SEC to invest in multi-year information technology projects and respond to unexpected market events.
“I am sure every agency wishes it had a mandatory reserve fund, but this fund is unnecessary and lacks any meaningful Congressional oversight,” Jo Ann Emerson, the Missouri Republican who heads the House subcommittee overseeing SEC spending, said in a statement.
Douglas Elliott, a fellow at the nonpartisan Brookings Institution in Washington, said he believes the nation’s front-line defense against financial fraud, is worth more investment.
“Investing more money to allow them to do their expanded job effectively is a good investment, since regulatory failures can cost us billions, if not trillions, of dollars,” Elliott said.
Meantime, House Republicans are defending the funding cuts as necessary, reasoning that it is essential to rein in deficits and cut the cost of government in the face of a recovering economy.
“This bill makes smart, sensible reductions in nearly all areas,” said Rep. Hal Rogers, a Kentucky Republican who heads the House Appropriations Committee, in a statement.
The SEC, however, argues its funding does not contribute in any way to the deficit, as fees on securities transactions offset SEC appropriations.
A key Dodd-Frank provision mandates transaction fees paid by financial institutions to the SEC equal the agency’s appropriated funding level. Regulated firms would pay $136 million less in fiscal 2012 than they did the previous year under the House proposed budget, the SEC projected.
The Office of Management and Budget threatened that President Barack Obama’s senior advisers would recommend a veto if a bill that undermines the Dodd-Frank Act through funding limits or other restrictions is presented.
Stretched by new responsibilities?
The Dodd-Frank law passed last year gave the SEC lots of responsibilities, including promulgating 93 new regulations and 18 studies, according to a study by the international law-firm Davis Polk & Wardwell LLP.
Under Dodd-Frank, the SEC is required to establish five new offices. One of those, the Whistleblower Office, has already been set up. The Office of Minority and Women Inclusion is being established. The other three, the Office of Investor Advocate, the Office of Credit Ratings, and the Office of Municipal Securities, are in limbo as the SEC and the administration push Congress on funding for the new market watchdogs.
The five new offices within the agency, except for the Whistleblower Office, are granted high-profile powers. Each is required to report directly to Schapiro.
But due to the budget uncertainty, the tasks of the three new offices to be established are currently being performed by staff in existing divisions and offices, the SEC’s Nester said.
The Brookings Institution’s Elliott said that it would be a mistake to starve the SEC of funding when it has so much to do, including important new regulatory tasks.
“The industry itself needs clarity on the new rules of the road and we all need the new rules to be administered well, both of which take money,” Elliott added.