Throughout the remainder of this year and into 2009, all eyes will be on how Treasury's Blueprint for financial services reform plays out. We've already seen, quite earlier than many financial services executives expected, a piece of the Blueprint implemented--the memorandum of understanding (MOU) between the Securities and
Exchange Commission and the Fed, which cements a deeper information-sharing relationship between the two. An information-sharing accord was also struck between the SEC and Department of Labor (DOL) in mid-July.
In testimony before the House Financial Services Committee July 24, SEC Chairman Christopher Cox said the current market turmoil demonstrates how "interconnected the markets have become." In the past, he said, "stovepipe regulation of different products could be justified on the ground that the boundaries in the marketplace were clear enough." Today, however, "when derivatives compete with securities, and futures and insurance products are sold for their investment features, that is no longer true. As we approach the end of the first decade of the 21st century, the growing gaps and crevices in our venerable system are beginning to show."
It is precisely those gaps that Congress will focus heavily on next year as it continues to debate financial services reform. As the debate ensues, one thing seems to be clear: the SEC will have to aggressively defend its regulatory turf. Former SEC Commissioner Roel Campos is just one informed industry observer who isn't shy about acknowledging this fact. Campos left the SEC in September 2007, and is now a partner at the Washington, D.C. law firm Cooley Godward Cronish. I spoke with Campos in July about how he sees financial services reform taking shape, and where the SEC stands in that debate.
Do you think the SEC is at risk of being marginalized under Treasury's Blueprint? For instance, there is talk of combining the SEC and the Commodities Futures Trading Commission (CFTC) and the Fed getting more regulatory control over all types of financial institutions.
I've been very public about my views on that. I think that in whatever final form of restructuring--whether it's the original Blueprint or the subsequent iterations of the Blueprint where you have the Fed taking on more and more responsibility as a systemic risk regulator--whatever that is and whatever combination of the banking agencies, whatever consolidation that occurs there, where you have some sort of prudential regulator--I first think the Fed needs to be involved in day-to-day oversight of the financial institutions. Only in that way will it really have the ability and the data available to know when to intervene, and intervene in advance of a problem. Otherwise it's always coming in after the train has wrecked.
The SEC has to be maintained in terms of its current mission and the way it does business. By design, Congress created the SEC, as we know, in the aftermath of the Depression as an enforcement agency that is meant to maintain integrity in the markets, investor confidence, and to promote capital formation. If you start discussing consolidating the SEC with the CFTC, which is now clearly a prudential regulator, then you start essentially diluting the culture and the mission of the SEC--there's no way you cannot do that. However the restructuring goes forward, the SEC's mission has to be maintained scrupulously.
I think it's likely going to share, if not lose outright, its consolidated supervised entity program. I think the SEC has been unfairly blamed for much of what happened with Bear Stearns, which is a matter of not really having the whole story come out on behalf of the agency. I think that the prudential regulation of the particular investment banks. . .the SEC has been there but it just doesn't have the liquidity option that the Fed does. [The SEC and Fed] currently have the Memorandum of Understanding that will be worked out even further, but I think that the SEC has a role in maintaining its oversight, possibly in conjunction with the Fed, of the investment banks. The SEC has huge expertise and history with the investment banks and can bring that to a very useful function.
Why do you think the SEC will share or lose outright its consolidated supervised entity program? What is this program's function?
[SEC Chairman] Cox asked Congress [in his testimony July 24] to formalize the grant of authority for the SEC to be the official oversight regulator of the investment banks that were originally broker/dealers--Merrill Lynch, Lehman, JPMorgan. The thinking in restructuring regulation is that the Fed is the agency best suited to deal with systemic risk, and that is the view of Treasury and many academics. Few in government and in academia understand the consolidated supervised entity program and how the SEC performs it, so unless the SEC vigorously fights and defends its capabilities and role, it's my prediction that it will lose that function to a new Blueprint--whatever the Administration ends up being next year [that function would be given to the Fed.] The SEC is being very smart in pointing out, in Cox's testimony, about its historical examination role and understanding the functions of investment banking, and its willingness to essentially co-report with the Fed--have the Fed also be involved in the program (the SEC has already signed its memorandum of understanding with the Fed.) The SEC can certainly make the argument well, but it has to be made aggressively.
Do you think that FINRA will eventually have oversight over investment advisors?
I don't know where that's going. I don't think this is an area where there has to be exclusivity. I think that the exam division of the SEC [Office of Compliance Inspection and Examination], has examination rights; they have limited resources, so I could see a program where they worked with FINRA to do the right kind of examination and [provide] the right kind of guidance to advisors. I think one of the problems in the past is that the examination process has been a bit mysterious; the SEC has worked hard to make that less so. I think advisors know what's important and what's likely to be examined.
Is the Blueprint the biggest regulatory issue now and going forward?
The Blueprint is symptomatic of the biggest issue. The biggest issue, essentially, is what types of regulatory oversight is appropriate for parts of the financial markets that people don't understand and have been vague and opaque--the creation of structured products, derivatives, and on and on are areas for which there is not a consensus solution. However you restructure regulation, you still have to come to grips with how that will be dealt with and what oversight and market approaches will work. That still has to be worked out. The exact place where regulators are with credit rating agencies, with investment banks structuring products, with respect to short trading, all of that is still to be worked out.
The largest problem is how to deal with systemic risk on a national and global basis. What we have and what we've found with subprime and the current credit crisis is there is an extensive interconnectedness and that dominos start falling very rapidly. The role in regulation in terms of how to intervene and create oversight structures that prevent the dominos from beginning to fall is up in the air, and is being studied by all manner of regulators, academics--that is going to be the big challenge, and whether the Blueprint and the restructuring that's being contemplated accomplishes, that is really the whole question. The restructuring has to be able to address that issue.
Do you think we'll be seeing pieces of the Blueprint playing out as we go along?
The agencies [SEC, the Fed, CFTC, and Department of Labor] working together is very much a part of the future of regulation. The question is whether it should be under one roof and one set of commissioners or several and so forth. Exactly what will be monitored and what kinds of actions can and should regulators take? All of those are tough questions, and what I suspect is that Congress will weigh in fully next year. Congress will be involved; the efforts from this Administration will remain behind and the new Administration will pick that up and it will be something that's vigorously debated next year on the Hill by the different agencies.
Washington Bureau Chief Melanie Waddell can be reached at firstname.lastname@example.org.