By: Mark D. Perlow
On January 15, 2009, Mary L. Schapiro, President Obama’s nominee to chair the U.S. Securities and Exchange Commission (“Commission”), testified before the U.S. Senate Committee on Banking, Housing and Urban Affairs (“Committee”) in a hearing to consider whether to recommend her nomination to the full Senate. Her appointment was confirmed by the Committee and the Senate on January 22. During her confirmation hearing, Ms. Schapiro outlined her priorities for the days ahead.
Ms. Schapiro stated that her “first and foremost” priority will be to “move aggressively to reinvigorate enforcement at the SEC” — an implicit repudiation of the direction that SEC enforcement has taken under Chairman Christopher Cox. Under Mr. Cox, the size of the enforcement staff has declined in recent years, and the Commission has instituted additional layers of review for the approval of an investigation. In addition, it issued guidance that limited the circumstances under which monetary penalties can be imposed upon corporations, noting that in many cases penalties have the effect of harming the corporation’s innocent shareholders. The SEC also instituted a pilot program requiring the Commission’s pre-approval for the enforcement staff to negotiate monetary penalties in settlements, with the Commission first approving an acceptable range for the penalties. Critics contend that these measures have hamstrung and demoralized the enforcement staff, while defenders argue that they have restored balance to an overly aggressive program. In either case, Ms. Schapiro’s chairmanship most likey will result in more aggressive enforcement.
Second, Ms. Schapiro articulated her vision of the SEC’s mission as the “investor’s advocate,” focused on “investor protection, transparency, accountability and disclosure.” She expressed a desire to preserve these missions in the coming regulatory overhaul, which seems to concede that the SEC would serve as a regulator of business conduct but not as a prudential regulator of safety and soundness. The U.S. Treasury’s Blueprint for a Modernized Financial Regulatory Structure, proposed in March 2008, advocated consolidating the many federal financial regulators into three – a market stability regulator, a prudential regulator, and a business conduct regulator, and this broad vision (if not the specifics of the Treasury’s proposals) has gained currency among the Congressional leadership. Ms. Schapiro may have thus signalled that she will not fight to regain what the SEC has already in fact lost, the power to impose capital, liquidity and other prudential standards on systemically important broker-dealers. Indeed, she implicitly endorsed regulatory consolidation when she expressed her view that one reason why regulators did not uncover the alleged Madoff fraud was the current “stovepiped” approach to regulation. Nonetheless, she pointed out to a largely sympathetic Committee that the SEC’s core functions — examinations of investment companies and advisers and securities firms, regulation of corporate disclosure, exchange regulation and oversight — need to be preserved in any combined agency.
Ms. Schapiro also said that the SEC’s approach to regulating credit rating agencies should be reconsidered. These firms have garnered much criticism for allegedly allowing their standards to slip in overrating many of the asset-backed securities that now clog the balance sheets of financial institutions. In particular, the business model of these firms has come under attack: because the issuer of the security pays the rating agency, critics, including the SEC itself, have alleged that this conflict of interest compromised the independence and methods of the ratings agencies. Ms. Schapiro said that two ideas in particular merit attention – first, requiring that the rating agencies receive their compensation from small transaction or listing fees rather than from the issuers of securities, and second, establishing a dedicated regulator with powers modelled after those of the Public Company Accounting Oversight Board to set standards and conduct comprehensive examinations.
Ms. Schapiro also advocated mandatory SEC registration and regulation of hedge fund managers. While she acknowledged that the SEC does not currently have this authority, since the agency’s effort to impose a hedge fund registration rule was struck down by the DC Circuit Court of Appeals, Ms. Schapiro recognized that Congress will likely soon expressly grant the SEC this authority. Ms. Schapiro said that the agency will begin working on proposals that will govern hedge fund disclosures and provide for “better and stronger checks and balances.” Even before Congress enacts any legislation, such rules could be applied to hedge fund managers currently registered with the SEC.
Ms. Schapiro indicated that the SEC would move forward with shareholder proxy access, an issue with a long and contested history. In 2004, then-SEC Chairman William Donaldson prompted the Commission to propose a complicated rule that would have allowed shareholders that crossed certain ownership percentage and longevity thresholds to place a limited number of director nominees on an issuer’s own proxy. However, business groups strongly opposed the rule, and Donaldson stepped down before it could be adopted. In 2007, pressured by a Second Circuit Court of Appeals ruling that questioned the SEC staff’s interpretation of the SEC proxy rules, the Commission under Chairman Cox adopted a rule permitting issuers to omit access proposals from their proxy materials, which engendered opposition from some institutional shareholders’ groups. Ms. Schapiro pointed out that many other leading non-U.S. markets mandate proxy access, and she stated her preference for “the U.S. to enter that club.” However, she signalled that she would not force through a proposal, only that she was going to immediately begin discussing with other Commissioners a proxy access proposal along Donaldson’s lines.
Ms. Schapiro testified that she will re-evaluate the SEC’s current path towards the adoption of International Financial Reporting Standards (“IFRS”), thereby moving away from U.S. Generally Accepted Accounting Principles. Chairman Cox made the globalization of capital markets a theme of his tenure, and he pushed the SEC to adopt a “roadmap” to the adoption of IFRS, subject to the completion of certain “milestones.” Ms. Schapiro stated that she would not be bound by this roadmap, and indeed she expressed concerns that make clear that the SEC will move slowly on the issue. In particular, she questioned the independence of the International Accounting Standards Board, which governs IFRS, and pointed out that the Sarbanes-Oxley Act requires U.S. public companies to operate under standards promulgated by an independent authority. She also noted that conversion to IFRS would be extremely expensive and thus more burdensome during a recession, and her comments indicated concerns that IFRS, which are principles-based (rather than rules-based, as is U.S. GAAP), were not detailed enough to be effective. Each of these concerns mirrors public criticisms of IFRS by opponents of their U.S. adoption.
She similarly indicated that the SEC will reconsider whether to grant “mutual recognition” to other countries’ securities exchanges and broker-dealers. One of Chairman Cox’s initiatives on globalization, mutual recognition would recognize that certain countries have market regulatory schemes equal in effectiveness to that of the U.S. Exchanges in these countries would be allowed direct access to U.S. customers, and their broker-dealers would be permitted to operate in the U.S. and transact with U.S. customers, in each case without registration with or regulation by the SEC. Advocates of mutual recognition argue that it would eliminate unnecessary obstacles to international investing, whereas critics argue that mutual recognition would eliminate the superior investor protections under the U.S. regulatory regime. Ms. Schapiro sided with the critics and questioned whether mutual recognition was “headed in the right direction.”
Finally, Ms. Schapiro testified that she will rebuild the SEC’s Office of Risk Assessment (“ORA”) and that she wants risk assessment to “permeate everything the SEC does.” In particular, she pointed out that, given the limited number of SEC examiners, risk assessment would enable them to focus on the issues of greatest importance. Chairman Donaldson created ORA in response to the market timing and late trading scandals in the mutual fund industry in 2003-2004, but Chairman Cox gave it less emphasis and fewer resources. It is worth remembering that Chairman Donaldson created ORA in part to organize and give direction to a profusion of industry-wide, issue-focused but partially redundant “sweep” examinations that were burdening the fund and brokerage industries and wasting SEC staff resources. Ms. Schapiro seemed to be signalling that ORA will perform a similar disciplining function, but it remains to be seen whether it will also inaugurate another era of large-scale sweep examinations.
Ms. Schapiro’s testimony indicates both that she has a clear idea where she wants to lead the SEC and that she is skilled at building political support for her agenda. As a result, the securities and investment industries are almost certainly facing an era of tougher SEC enforcement and revitalized examinations, while the internationalization of SEC rules will be made a lower priority. The SEC will also seek to increase the regulation of hedge funds and credit rating agencies. While the extent of any regulatory reform is still unknown, these initiatives reflect the views of the large majority in Congress that these regulatory regimes need fixing and leave aside broader questions as to the need for a qualitative change of the SEC’s mission.
