From the December 2014 issue of Investment Advisor • Subscribe!

The SEC Is Broken

How a decades-old law and the origin of new commissioners stymie consensus building and rulemaking

Several factors make it difficult for the SEC to efficiently fulfill its mandates. Several factors make it difficult for the SEC to efficiently fulfill its mandates.

The Securities and Exchange Commission has three primary mandates: to protect investors; to maintain fair, orderly and efficient markets; and to facilitate capital formation.

However, as the commission has demonstrated in recent years, especially since it took on the massive job of implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act, it is a broken agency that is failing to do its job.

The reasons, as described by industry experts and former SEC officials, are varied, but they all revolve around politics—imposed from the outside by a Congress that is far more interested in the securities laws than it was a decade ago, but also by internal rules and traditions that keep the SEC from being an efficient regulator.

Personality and political clashes have always plagued the agency when trying to reach a consensus on rules. Thanks to the Bernie Madoff Ponzi scheme, the financial crisis and Congress’ reaction to the crisis with Dodd-Frank, lawmakers’ “far greater activism and deeper immersion” in matters that impact the agency has resulted in Congress now becoming a “major and continuous player” in SEC matters, said Steve Wallman, founder and CEO of Foliofn and a former SEC commissioner. Those developments, he said, directly impact the SEC's agenda.

The SEC also continues to be stymied by a nearly 40-year-old law that prohibits a majority of the agency's commissioners from collaborating on policy issues.

Unintended Consequences

That law, the Government in the Sunshine Act, took effect in 1976 and was part of a package of “well-intentioned” measures to shed more light on what's taking place at government agencies, Wallman said. However, the law “does impede any kind of deliberative consensus making” among the SEC's chair and the commissioners, said Wallman, who served as a commissioner from 1994 to 1997. The Sunshine Act “doesn't allow for the formulation of rulemaking in a collaborative way,” Wallman said.

Why? Because under the Act, the SEC chairperson cannot “get all of the commissioners in a room together” to discuss rulemakings, added Bob Plaze, a partner with the law firm Stroock & Stroock & Lavan in Washington, who spent 30 years at the commission, including a stint as deputy director of the SEC's Division of Investment Management. The Act states that three commissioners—a majority of the five-member commission—“can never get into a room together and talk business,” except to discuss an enforcement action, housekeeping or personnel issues.

Since the Sunshine Act passed, “commissioners have never been able to talk to each other and hammer out compromises [on rulemakings], except through staff,” Plaze said. “That really, really disables a regulatory agency from functioning to the optimal level.”

Wallman, who tried (unsuccessfully) during his time as a commissioner to have the Act amended, agreed that the inability of the chair and the four commissioners to discuss policy issues “contributes to bad rulemakings.” While the Sunshine Act is “generally a great statute and part of good government,” Wallman said, the Act should be updated to “work better than it does and to allow for more consultation within government.”

With the exception of single-administrator agencies like the U.S. Treasury and Justice Departments and the Environmental Protection Agency, for instance, all federal regulatory agencies like the SEC and the Commodity Futures Trading Commission are held to the Sunshine Act's mandate that no more than two commissioners can meet to collaborate on policy decisions. The end result of this, however, in Wallman's view, is “polarization and less thoughtful rulemakings.” The Act inhibits the agency's ability to benefit from “a multi-headed commission.”

Plaze agreed that the SEC, where the commissioners are always equally constituted by Republicans and Democrats, with the chair traditionally coming from the party that holds the White House, would be better able to “achieve the objectives of the commission” if they were allowed to reach a consensus in “private” on regulatory matters.

Arthur Levitt

Arthur Levitt, who was the longest-serving SEC chairman, from 1993 to 2001, said that during his time at the commission, the Sunshine Act didn't create what he views as significant problems because he was dealing with a “much less political and ideological” commission.

“It's much more difficult running the agency today than when I was there,” Levitt told IA. “By and large during my years at the commission, the environment was collegial. We were a fairly close-knit group; it was almost a family environment. We tended to know what each other thought about a particular issue and our counsels worked together to iron out differences.”

However, since he left the SEC, Levitt said the commission has become more politicized and “commissioners tend to represent an ideology, rather than what may benefit investors or what may be good for the markets.” The commissioners “look upon every decision in terms of whether it coincides or clashes with their political ideology, whatever that might be.”

The growing trend over the years of appointing former Capitol Hill staff members to SEC commissioner posts has contributed to a politically charged agency. “The commission is made of up largely of former [Hill] staffers, rather than as in the past [when it consisted of] distinguished lawyers and accountants,” Levitt said. These commissioners “tend to carry with them the biases of the people they’ve worked for” on the Hill.

Congress Weighs In

Wallman said that it was difficult in the 1990s to get Congress involved in securities matters “even when the commission wanted them involved,” like with the National Securities Markets Improvement Act (NSMIA), “where congressional action was needed and eventually won; but it was an effort.” Since Enron, Sarbanes-Oxley and eventually Madoff, the financial crisis and the resulting Dodd-Frank Act, Congress exerted “greater involvement” in regulating Wall Street, and “the industry also became even more involved with Congress,” he said.

The “inevitable partisan perspectives in Congress have become more pervasive and more forceful. That has a significant impact on the SEC, its agenda and the way it works,” Wallman continued.

However, Wallman maintains that the commissioners themselves have been “no more political or partisan” than they have been in the past. “I do not think it is [the commissioners] who have changed. I think the current group is an amazingly talented group and the commission is as good now as it has been.” Instead, Wallman said that what “has changed, very significantly, is the environment in which they are acting.”

Plaze agreed that the SEC has become a much more highly politicized agency over the past decade, which he said reflects the “larger disagreements” endemic to Washington.

For most of the SEC's history, he said, there has been a “great deal of consensus on regulatory policy,” but over the past 10 years, “commissioners with very strong views on a lot of [issues] have come onto the commission.” In the “old days,” he said, “people came on to the commission […] without a particular agenda or political weighting.”

Airing Dirty Laundry

Thomas Gorman, a partner at the law firm Dorsey & White in Washington, who served for seven years in various positions at the SEC, including as senior counsel in the agency's Enforcement Division and Special Trial Counsel in the Office of the General Counsel, said that independent agencies like the SEC “are supposed to be apolitical,” but that gridlock on Capitol Hill, for example, has “impacted” these agencies. “Traditionally, commissioners did not air their differences in public,” Gorman said. “Now [at] the SEC, it is not uncommon to see commissioners take opposing views and have [regulatory] actions approved by a 3-2 vote.”

Gorman believes that commissioners’ expressing “their views on critical issues in speeches” has more of a negative impact on the effectiveness of the agency—including at times undercutting the SEC's authority—than does the Sunshine Act restrictions.

Because the SEC chair controls the agency's agenda, “commissioners often use speeches and other public statements to publish their views,” added Steve Crimmins, a partner with the law firm K&L Gates in Washington, who served for eight years as the SEC's deputy chief litigation counsel. “Over the years, disagreement among commissioners has been one of the SEC's greatest strengths.”

Two of the SEC's current commissioners, Kara Stein and Michael Piwowar, are former Capitol Hill staffers. Stein, a Democrat who was sworn in as a commissioner in August 2013, served as legal counsel and senior policy advisor for securities and banking issues to Sen. Jack Reed, D-R.I. From 2009 to 2013, she was staff director of the Senate Banking Committee's Securities, Insurance and Investment Subcommittee. During her time there, she is credited with playing “an integral role” in drafting and negotiating significant provisions of the Dodd-Frank Act.

Piwowar, who was also sworn in by President Barack Obama in August 2013, served as the Republican chief economist for the Senate Committee on Banking, Housing and Urban Affairs under Sens. Mike Crapo, R-Idaho, and Richard Shelby, R-Ala. Piwowar was the lead Republican economist on the four SEC-related titles of the Dodd-Frank and the Jumpstart Our Business Startups (JOBS) Acts.

Ah, Dodd-Frank!

Congress has been pressuring current SEC Chairwoman Mary Jo White to complete the agency's 100 Dodd-Frank-mandated rulemakings, as well as rules under the JOBS Act like crowdfunding.

Since passage of Dodd-Frank four years ago, the agency has completed less than half of the Dodd-Frank rules.

SEC Commissioner Daniel Gallagher, a Republican, has been very vocal in airing his distaste for the Dodd-Frank-mandated rules. Gallagher has held various positions at the SEC over the years, including as counsel to former SEC Chairman Christopher Cox (who served 17 years in Congress before being appointed as SEC chair in 2005) as well as a deputy and co-director of the agency's Division of Trading and Markets.

In an October speech to the Los Angeles County Bar Association titled “The Importance of the SEC's Rulemaking Agenda—You Are What You Prioritize,” Gallagher proclaimed that the SEC has “lost its way” by focusing too much time on Dodd-Frank-mandated rules instead of focusing on issues related to the agency's core mission.

In an early July speech, Gallagher stated that the SEC was on a Dodd-Frank “death march” to finish rulemakings mandated by the Act, and lamented the fact that Congress was pushing the agency to finish more.

White shot back a day after Gallagher's July speech that Dodd-Frank Act mandates that “stand apart” to her (which are core to the SEC's mission) include “asset management, especially private fund advisors; proprietary activities by financial institutions; derivatives; clearance and settlement; credit rating agencies; asset-backed securities; municipal advisors; and executive compensation.”

The commission, Gallagher said in his October speech, “is at a precipice, teetering on the edge of irrelevancy as we devote a wildly disproportionate amount of resources to implementing [a Dodd-Frank] agenda that is no less political than other, more widely discussed pieces of single-party legislation.”

Hester Peirce, senior research fellow at the conservative-leaning Mercatus Center at George Washington University in Washington, who served as an SEC staff attorney and as counsel to former SEC Commissioner Paul Atkins, said the SEC needs to get back to basics. “The SEC, in part because Congress gave it mandates that are far from its core mission […], has forgotten what its mission is and is struggling to implement rules that are far outside its expertise,” she said. The SEC “needs to get back to protecting investors, facilitating capital formation and maintaining fair, orderly and efficient markets.” 

To get back on course, the agency must reassess some internal management issues, Peirce said. “For example, to what extent are investors being denied access to innovative investment products because they die a slow death on SEC staffers’ desks?” she asked. The agency must also examine to “what extent are decisions (both on the enforcement and regulatory side) being made without commission-level input?” as well as “How well is the agency adhering to Administrative Procedure Act mandates?”

Split Votes

The exhausting implementation of Dodd-Frank rules has been only one issue that has divided the current commission. The rule to require further reforms to money market funds was passed by a split 3-2 vote in July, with White securing approval from both Gallagher and SEC Commissioner Luis Aguilar, a Democrat. White also moved forward with a split 3-2 vote in passing the recent rules to strengthen credit rating agency rules.

Some industry officials hope that White moves ahead with a similar split vote on the agency's rule to put brokers under a fiduciary mandate. However, recent comments by Piwowar, who has been seen as one of the two commissioners that would oppose such rulemaking, may render the need for a split vote moot.

To be sure, the SEC is a much more highly scrutinized agency than in years past—and it will continue to be—not only because of its so-called failings to police the securities markets and to stop the biggest Ponzi scheme in history, but also because, as Plaze said, “participation in the capital markets—from mutual funds to growth in the 401(k) market—is huge today,” with “the number of direct stakeholders in what the SEC does [being] enormous.”

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