The SEC: new leader, new era? - Skip Kaltenheuser

SEC Chairwoman Mary Jo White vowed the regulator wouldn’t kowtow to the finance sector. As she approaches the end of her first year in the role, Global Insight assesses how she’s done so far as well as current and future challenges.

Skip Kaltenheuser

Five years on from the nadir of the financial crisis, marked by the collapse of Lehman Brothers, US job growth is at its weakest since 2010. The bubbling stock market generates little excitement for the vast majority of Americans, whose median income – adjusted for inflation – continues to sink. A recent study by the University of California found that 95 per cent of income gains are going to the top one per cent of the population. The aftermath of the global financial crisis with financial scandals continuing to emerge and prolonged economic fragility – has created a pressing need to scrutinise the financial services sector significantly more closely than was the case in the early years of the  21st century. This places SEC Chairwoman Mary Jo White, formerly of Debevoise & Plimpton, well and truly in the spotlight.

There is currently some overlap between the responsibilities of the bodies which regulate the financial services sector in the US. The Securities and Exchange Commission (SEC), which is charged with tasks including investor protection and fair markets, came under fire when the economy went into crisis in 2008. The conclusions of America’s official Financial Crisis Inquiry Commission was damning: ‘the SEC could have required more capital and halted risky practices at the big investment banks. It did not.’

‘The SEC could have required more capital and halted risky practices at the big investment banks. It did not’

Financial Crisis Inquiry Commission

To an extent it’s unfair to criticise agencies with limited funds and resources, such as the SEC. However, there have been instances in the past where the regulators appear to have ignored warnings of wrongdoing when they were laid at its door. For example, alarm bells over Bernhard Madoff were rung for years by financial fraud investigator Harry Markopolos, before Madoff was finally discovered.

‘Too big to fail’ still a concern

Edward Greene is a former general counsel of the SEC and was a member of the IBA Task Force on the Financial Crisis 20092010. He’s now senior counsel with Cleary, Gottlieb, Steen & Hamilton. Greene says the SEC faces a two-fold challenge: enforcement and surveillance. Importantly, measuring success based on cases brought, or fines imposed, is not the best way to assess the SEC’s effectiveness, he argues. Greene would encourage the SEC to focus on coordination with other foreign regulators, to address the challenges of conducting cross-border business in the new regulatory environment. In that regard, harmonising critical regulations with Europe remains important, says Greene, as well as coordination as to the appropriate way to regulate money market funds which, unlike bank deposits, are not insured. Greene also points to a need to determine the forms of enhanced regulation required, as both bank and non-bank financial entities are currently designated as posing systemic risk to domestic and global markets. The Financial Stability Oversight Council has designated three such entities posing enhanced risk to the US financial markets, and the Financial Stability Board has designated 29 banks and nine insurance companies posing such risks globally.

‘Too big to fail’ remains a key concern for the SEC and other regulators, says Greene. Critical to addressing that issue is the ability to resolve or wind down an entity without creating the havoc caused by the Lehman Brothers bankruptcy. In that regard, the single point of entry approach pioneered by the Federal Deposit Insurance Corporation, and now under active international consideration, is an important step for the SEC to take in dealing with too big to fail. By concentrating debt and equity at the holding company level, Greene believes the holding company regulator can intervene to restructure debt and equity and to oversee the sale, continuation or winding down of the financial institution and of its subsidiaries, wherever they are located. The hope is that this approach will lessen the incentive for regulators to ring fence the assets and liabilities of subsidiaries doing business in their jurisdictions.

Steve Hall, a securities specialist with Better Markets, the not-for-profit independent Wall Street watchdog, is alarmed at the pressure on Congress to cut the budget of agencies such as the SEC and the Commodity Futures Trading Corporation (CFTC), after staggering responsibilities have been heaped on them. The SEC is getting $325m less than it requested. In terms of a cost-benefit analysis, funding of regulators should be considered in the context of the overall cost of the financial crisis, which has been put at many trillions of dollars in the US alone. A regulator tasked with policing the kinds of practices that lead to such a huge cost to the nation, should probably be allocated a budget that will genuinely enable it to prevent such a catastrophe from happening again.

The SEC whistleblower programme brings in tips as to wrongdoing to be investigated. More attention needs to be paid to the extent to which funding cuts will limit its capacity to follow up these leads – an inability to act for which it may later find itself being criticised. Funding issues were underscored in mid-January when Congress took away half the $50m the SEC had set aside for technology initiatives targeting illegal trades and accounting fraud, a vital investment to make in an era of high-speed trading and mystifying algorithms.

Dark pools of liquidity

Another worry is so-called dark pools of liquidity: large anonymous trades offered away from public exchanges through electronic trading. Their impact on the market is skirted by concealing the identities of those involved and the size of the trade, until it’s filled, with prices agreed by the players in the dark pools behind closed doors, thereby limiting market transparency. These pools, with operators including Goldman Sachs, Barclays and Credit Suisse Group AG, are now significant, estimated by the Tabb Group as constituting 13 per cent of daily trading. Shah Gulani, an author with Money Morning financial newsletters, questions why the SEC isn’t tougher on related matters, such as sharing confidential client trading information with dark pool trading units and manipulating prices on public exchanges to influence trades in dark pools. Gulani has written that he believes some dark pool operators are market-makers, trading for themselves based on the order flow from big customers, who think those orders are ‘blind’. Greene believes we need to continue to actively monitor how much trading takes place in dark pools and its effects on the public markets, as well as the continuing impact of high frequency trading.

New leader, new era?

So, amidst these multiple challenges, has the perception of the SEC changed under the leadership of its new chair, Mary Jo White? White’s been there nearly a year, and many observers retain an open mind on her leadership and see positive signs. Greene gives her very high marks; he believes that she is ‘a strong, independent leader and will help the agency deal effectively with the multiple challenges it faces in an increasingly international world.’ 

‘[Mary Jo White] is a strong, independent leader and will help the agency deal effectively with the multiple challenges it faces in an increasingly international world’

Edward Greene
Former General Counsel of the SEC and a member of the IBA Task Force on the Financial Crisis, 2009–2010

There is some concern amongst commentators that White may not be as tough in practice as she suggests. Akshat Tewary, cofounder of the public policy group Occupy the SEC, worries that after White said the SEC wouldn’t kowtow to finance sector pressure, there has been a tendency to allow smaller banks to engage and trade in riskier products. Nevertheless, Bart Naylor, a financial policy advocate for Public Citizen, sees more positive action from the SEC under White than under her predecessor, Mary Schapiro, whom he felt was intimidated by cost-benefit analysis attacks. Naylor applauds White’s stated intention to make companies that settle with the SEC publically admit guilt of wrongdoing, or face litigation. He does worry, however, that White moved too quickly on the JOBS Act - a law intended to encourage funding of United States small businesses by easing various securities regulations — without examining alternatives. Greene feels that the JOBS Act was an executive response that did not involve the SEC in a significant way in its development and which adopted controversial ad hoc changes to how capital can be raised domestically. He would have preferred to see a special study, comparable to one done in the 1960s, as to how the markets could be improved, especially in light of the growing amounts of capital raised on a cross-border basis. Greene sees basing proposed regulatory changes on such a study as preferable to the ad hoc approach taken with the JOBS Act.

In terms of its implementation of Dodd-Frank reforms, Hall notes that the SEC is lagging behind the CFTC, including in the derivatives space. Assessing the status of these reforms can be difficult, as they continue to be attacked on various fronts, including in court, where Hall says the scorecard has been mixed. Tewary is encouraged by the aim of enhancing enforcement authority under the Volcker Rule, which comes under the Dodd-Frank reforms. But, he’s concerned that loopholes peppered throughout the final rule will have to be watched carefully. 

Skip Kaltenheuser is a freelance journalist based in Washington. He can be contacted at