SEC Chairman Schapiro Defends Agency, Maps Out Strategy for Revival
By: Mark D. Perlow
Congress, the media and the public have subjected the SEC to harsh criticism in recent months, charging that it failed to prevent the collapse of Bear Stearns and Lehman Brothers and to detect the long-running Ponzi scheme of Bernard Madoff. While the accusations are somewhat unfair – banking regulators failed to prevent the insolvency of many large depository institutions, and the Financial Industry Regulatory Authority also failed to detect the Madoff fraud – these charges have achieved considerable political traction, and many recent proposals for regulatory reform would strip authority from the SEC or merge it into a new or already existing regulatory agency, such as the CFTC.
SEC Chairman Mary Schapiro, however, has made clear that she intends to assert aggressively the continuing importance and relevance of the agency. In particular, in a recent speech, Chairman Schapiro made the case for the SEC and its distinctive brand of financial regulation. She stated her view that the capital markets require a different type of regulation than do financial institutions, one that is focused on the protection of investors rather than on the safety and soundness of key institutions. She argued that investor protection requires an agency that is independent and experienced in dealing with the capital markets, an implicit criticism of banking regulators as too closely tied to the banks they regulate. She detailed the SEC’s past regulatory achievements, including regulatory regimes that have fostered successful exchanges, clearing agencies, mutual funds, investment advisers and broker-dealers, all of which (other than the largest investment banks) have functioned without a systemic failure during the current crisis. Although she does not put it this way, she is arguing that if the SEC did not exist, it would have to be invented.
Nonetheless, Chairman Schapiro admitted that the SEC has not performed up to expectations recently, and she mapped out the agency’s recent efforts to revitalize itself. First and foremost, she emphasized that the SEC’s enforcement program would be tougher and more efficient. She signaled the SEC’s intention to bring “meaningful cases that have the greatest impact and send a strong message.” In an effort to achieve these goals, the agency has eliminated controversial procedures requiring the staff to get pre-approval of the full Commission to launch a formal investigation or to negotiate settlements that include penalties. In addition, the SEC will engage a consulting firm to help the agency determine how best to sort through the countless tips and complaints it receives each year. The agency will also improve training and hire staff analysts (who may not necessarily be lawyers) with more financial industry experience. These reforms will resonate with practitioners with experience of the bureaucratic ways of the enforcement program. Subjects of SEC investigations can expect to face an even more relentless Division of Enforcement.
Schapiro also summarized some of the key elements of the SEC’s current pipeline of cases, making clear the agency’s intent to bring “message” cases – 150 hedge fund investigations, two dozen municipal securities investigations, and 50 cases involving credit default swaps (“CDS”), collateralized debt obligations and other derivatives. Recently announced enforcement actions have filled out this story further: the SEC has brought several dozen cases against alleged Ponzi schemes; the first insider trading case based on transactions in CDS; a case alleging manipulation of a municipal securities market; a case alleging that an investment adviser did not have adequate procedures to protect against conflicts of interest in its proxy voting procedures; an action against the manager of a money market fund that broke the buck for allegedly inadequate disclosures; and a case against executives of a subprime lender for allegedly misleading investors about the riskiness of its loan portfolio.
As Schapiro pointed out, the SEC also has a full rule-making agenda. In April, it proposed reinstating the short-sale uptick rule (or some variant on it); in May, it proposed a revamp of the client asset custody regime for registered investment advisers, including proposals to require surprise audits and independent compliance reviews, with the clear intent to prevent another Madoff. The SEC has also issued a controversial proposal to provide public company and investment company shareholders with access to the company’s proxy statement both to nominate a short slate of directors and to propose amendments to company nomination process bylaws. Schapiro’s willingness to take up this topic, which has been considered in various forms almost since the creation of the SEC and vigorously opposed by many industry groups, reflects her determination to restore the agency’s reputation with the public by picking a high-profile fight. Later this month, the SEC will propose new rules on money market funds, and is considering an expansion of the municipal pay-to-play rules and municipal securities disclosure, new rules regulating hedge funds, and seeking authority over whistleblower actions.
The Obama Administration has stated that it wants to see Congress pass a financial regulatory bill by the end of the year, and the chairs of the relevant Congressional committees have agreed to this timetable. The SEC is on a mission to demonstrate its importance and competence before the serious legislative sausage-making begins in the fall, all against the backdrop of deep public disillusionment with the financial sector. As one aspect of that campaign, subjects of SEC investigations and examinations, and industries targeted in SEC rulemaking proposals, should expect a tougher fight than at any time in recent memory.
