The U.S. Securities and Exchange Commission is better prepared to act when financial fraud is suspected than it was 20 years ago, when SEC examiners warned that financier R. Allen Stanford could be running a massive Ponzi scheme but were powerless to get the enforcement division to investigate him, says former SEC policymaker Norm Champ, in an interview. By 2009, Stanford had defrauded 30,000 investors out of $7 billion.
Champ writes about that and his 2010-2015 stint at the SEC in “Going Public: My Adventures Inside the SEC and How to Prevent the Next Devastating Crisis” (McGraw-Hill Education 2017). The attorney, 55, worked at the agency in the years following the global meltdown as it tried to stabilize the U.S. financial system.
The hedge fund industry and securities lawyer, 55, is now a partner and member of the investment funds group of Kirkland & Ellis. In 2010, he was hired by then-Chair Mary Schapiro as part of her effort to better oversee the markets by staffing the SEC with people who had actually worked in financial services.
During the crisis, the Commission had been widely criticized as failing in its watchdog responsibility. At the agency, Champ recommended and established policy changes that were designed to protect investors.
He argues in the interview that if national policies and procedures similar to those he put in place had already been in effect, Stanford — and likely Bernie Madoff — could never have committed devastating fraud.
Champ joined the SEC in Washington as deputy director of the Office of Compliance Inspections and Examinations, and was later appointed director of the Division of Investment Management, having started as associate regional director of examinations in the SEC’s New York regional office.
Under his leadership, the Commission adopted new rules to reform money market mutual funds as well as other policy changes in the investment management division.
In the interview, he discusses how the SEC’s former lax procedures allowed Stanford — who was indicted in June 2009, almost to the day that Madoff was charged — to perpetrate his ruinous scheme.
ThinkAdvisor recently spoke with Champ, on the phone from his New York City office. In our conversation, he opined on what he calls the worst part of the Dodd-Frank Act and how he expects it to be changed. Here are excerpts:
THINKADVISOR: R. Allen Stanford’s Ponzi scheme defrauded 30,000 investors out of $7 billion. He was arrested in 2009 and three years later sentenced to 110 years in prison. An SEC BD examiner group had spotted his “possible fraud” in 1997, but they couldn’t get SEC Enforcement to “take the case,” you write. Pretty shocking.
NORM CHAMP: The examiners realized that something was wrong. But they were unable to interest the Enforcement division in it. One of the main things we wanted to get done was to make sure that examiners were empowered to see that that didn’t happen again. So we put in place policies and procedures that said: If you think there’s fraud, you need to escalate that up the chain. You can’t just think, “Oh, Enforcement will take it.”
Is the SEC in better shape now to deal with another financial crisis?
We know that the next crisis will come from some unexpected direction, as they always do. So I don’t think the SEC is going to head off the next crisis, but I do think they’re better equipped with information. They’re doing more with the data they have and have a much better capacity to process it. If something goes wrong, they have a better chance of understanding it and starting to move on it.
It’s surprising that the SEC, such an important organization, had few formal policies and procedures in the examiner and investment management divisions at the time you joined.
The financial crisis gave us the moment to focus and get something in place that, hopefully, will help avoid another situation like those of 2008. For example, Bernie Madoff and Allen Stanford caused incredible harm to people — in many cases their life savings were stolen. So it was important to have [policies] because those frauds left individuals terribly harmed.
When you started at the SEC, what was your biggest obstacle?
Before the crisis, the SEC had one of the great reputations of any regulator ever — very well respected and presiding over the world’s best capital markets. So when there’s a massive failure by a long-term successful organization, people inside it don’t believe it’s a result of how they were doing things. [The SEC] believed that the five biggest broker-dealers they regulated that went out of business, were taken over by banks or that became banks were isolated incidents that didn’t have anything to do with how the Commission was doing things.
What challenge did that pose for you?
When there’s a lot of success and then a failure, people don’t say, “Maybe we should do things differently.” In fact, they mostly want to just hang onto what they’re doing. So the biggest issue [was] making people understand that maybe those events were related to how they did things.
What approach did you take to make them understand?
Talked to everyone in the exam division, got their input and developed with them measures to make change. The biggest thing is that change is hard.
You say you’re hoping that the SEC — indeed, the entire federal government — knows the consequences of rules and polices they issue before making them. Why is that critical?
The lead-up to the financial crisis proceeded from the conviction that everyone should own a home, that it’s a great thing on the road to wealth. But if you talk to people who were foreclosed on in 2009 and 2010, they’re not going to tell you that homeownership is a route to wealth. So we have to be more realistic about how we’re making policy. One of the great things that [ex-Chair] Mary Schapiro did [while I was at the SEC] was a rigorous economic analysis before any rulemaking was done on money market mutual fund reform.
Did you recommend such reform to the Commission?
Yes. They made their decision based on a prediction that after the rule was passed, there would be migration from institutional money market funds to government money market funds. The prediction turned out to be true. That’s exactly what happened.
You’ve never been a fan of the Dodd-Frank Act. What’s the worst part of it, to your way of thinking?
That’s a long list. Probably the most damaging part of Dodd-Frank long-term has been measures to add additional disclosures to public companies — for reasons that are not related to shareholder value. That’s part of a long pattern of discouraging companies from going public.
When did that start?
We have only about half the public companies we had 20 years ago and about half the annual IPOs compared to before 2000. Our capital markets have fueled us and the world for decades. So measures that discourage people from going public are very detrimental.
What are your expectations for Jay Clayton, the new SEC chair?
He’s off to a great start. He’s emphasized getting more companies to go public in the U.S. It’s a critical goal, so that alone is a big accomplishment. The chair’s focus on encouraging companies to go public is spot-on.
You write that you don’t believe the Glass-Steagall Act will ever be restored and that “under a Glass-Steagall regime, the asset sector would never be too big to fail.” Please explain.
A possible [alternative] approach to Dodd-Frank would have been to restore Glass-Steagall. Instead, they did the Volcker Rule [requiring banks to have larger capital resources]. I think we might be better off if we went back to splitting the large financial institutions [per Glass-Steagall]. It’s a more elegant way to draw the distinction between a bank and an investment bank.
You write that “alarm bells went off” when Morgan Stanley Chair-CEO James Gorman told you the firm was transitioning some clients from “free” brokerage accounts to fee-based asset management accounts. Did the SEC do anything to help investors understand the difference in cost?
Our main message on any subject like that was that there needs to be full disclosure of fees. The SEC isn’t in the business of picking good or bad but just making sure that there’s adequate disclosure and that investors are informed of what’s going on.
The SEC had “a yawning technology gap” when you arrived, so you write. That’s disconcerting.
It’s a very cumbersome process to acquire technology for the government, so that’s a big challenge. And a sad story: I had high security clearance at the SEC and therefore had to submit all sorts of information about myself. All such files, including mine, that were kept at the main HR office were hacked. So all my information was exposed. How could it be that security- background check files at the SEC were able to be hacked!
You left the Commission three years ago. What overall grade would you give it now?
Probably an A-minus. There’s been a ton of improvement, but there’s always room for a little more. I think the SEC is in great hands with Chair Clayton.
When your book was published last year, what was the SEC’s reaction?
I spent my whole time there trying to improve the chances for staff members to succeed. For example, without a process to elevate a belief that someone is committing fraud, your chances of success are really reduced. All the policies I put in place were meant to enable staff to do their job better. So I received a ton of positive messages from them.
What was Mary Schapiro’s reaction to the book?
I’m not going to comment on conversations with friends.
You write about having had a painful, chaotic childhood, during which you often diffused family conflicts. Did that background help with your work at the SEC?
It’s helped me throughout my career — remaining calm when things are at a crisis level and trying to analyze the problem to see if we can find a solution. When you’re faced with a crisis and difficult things happening, it’s important to stay calm, analyze the facts, try to figure out what the solutions are and see if you can solve the problem.
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