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Dodd-Frank Rulemaking Like ‘Shoveling Manure’: SEC’s Gallagher

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The Securities and Exchange Commission has “lost its way” by focusing too much time on Dodd-Frank mandated rules, Commissioner Daniel Gallagher said in a recent speech, and instead should be focusing on issues related to the agency’s core mission, such as changes to the fixed-income markets and capital formation for small businesses under the JOBS Act.

“The incredible burden imposed on the Commission by Congress through the Dodd-Frank Act has handcuffed and politicized what is supposed to be — indeed, must be — an independent agency,” Gallagher, a Republican, said during an Oct. 24 speech to the Los Angeles County Bar Association titled “The Importance of the SEC’s Rulemaking Agenda — You Are What You Prioritize.

“Rather than tending our regulatory garden, so to speak, by focusing on policy issues that are core to our mission, the Commission has spent much, if not most, of its time and resources for nearly half a decade shoveling manure, in some cases for no discernable purpose whatsoever,” Gallagher said. “Even after all this effort, of the 100 rulemakings mandated to the SEC by Dodd-Frank, we still have more than half left to finalize.”

The Commission, Gallagher said, “is at a precipice, teetering on the edge of irrelevancy as we devote a wildly disproportionate amount of resources to implementing an agenda that is no less political than other, more widely discussed pieces of single-party legislation.”

Gallagher said that he “often” tells people that the SEC won “the Dodd-Frank ‘booby prize,’ and we are still paying the price over four years later.” The financial reform law is “packed with roughly 400 mandated rulemakings and studies for the federal regulatory agencies, with approximately 100 assigned to the SEC — far and away the most of any of the agencies involved,” he said.

Meanwhile, the fixed income markets need the SEC’s “immediate attention,” Gallagher said. Two areas of the debt markets, he said, “should concern us all.”

First, “the heavy exposure of retail investors to products and trading practices that are little understood by and all too opaque to the average investor,” including asset-backed securities, where there is approximately $11.3 trillion of debt outstanding in the corporate bond markets.

Approximately 45% of that, he continued, “is held by retail customers, and nearly a quarter of that is held directly. Retail participation is even more pronounced in the municipal debt markets, where nearly 75% of the $3.7 trillion in outstanding debt is held by retail investors.”

Those numbers “should be a wake-up call to us all that such a staggering percentage of our fixed-income markets rests in the hands of ordinary investors who often do not understand the product they hold or the accompanying risks, including the devastating effect an inevitable interest rate hike could have on their investment.”

The second “major concern,” he said, is “the clear and present danger of a liquidity cliff” in the debt markets. “Over the past few years, these markets have witnessed historic growth due to a zero percent interest rate environment. While investors have been flocking to bonds at a record pace, dealer inventories have shrunk by nearly 75% since 2008 as financial institutions have been forced to deleverage in the wake of Basel III, the Volcker Rule, and other constraints introduced by prudential regulators ostensibly in response to the crisis,” Gallagher said. “This has set the stage for a potentially dire liquidity crisis. When interest rates rise — which the Fed has indicated could happen as early as next summer — outflows from high yielding and less liquid debt could drive bond prices down. Which raises the question of the hour — where is the necessary liquidity going to come from?”

Another “critically important area” that the agency needs to address, he continued, is capital formation for small businesses. The Jumpstart Our Business Startups Act, passed in early 2012, “was all about capital formation and job growth for Main Street, not Wall Street.”

The JOBS Act streamlined the initial public offering process for emerging growth companies, eliminated the ban on general solicitation for private offerings and created a crowdfunding capital formation regime. It also mandated that the SEC raise the size limit of offerings that can be made with reduced regulatory scrutiny to $50 million from $5 million.

Gallagher noted that the agency has “made some progress” under its JOBS Act mandates, including “finalizing a rule on general solicitation and issuing a proposed rule on crowdfunding.”

However, he said, “I am committed to finalizing our rulemaking on crowdfunding in a workable fashion. If that isn’t possible under the JOBS Act as enacted, then the Commission should be loudly telling Congress that we need a legislative fix, and that we need it now.”

Sen. Mark Warner, D-Va., urged White during a Senate Banking Committee hearing in early September to press ahead with rules on equity crowdfunding under the JOBS Act. “While we may not get [equity crowdfunding] 100% right, we have to try and use that tool, sooner rather than later,” Warner said.

White said earlier this year that final implementation of crowdfunding rules was an SEC priority for 2014.

— Check out SEC on a Dodd-Frank ‘Death March’: Gallagher on ThinkAdvisor.