It's pretty easy to beat up the Securities and Exchange Commission's Christopher Cox. From the failure to anticipate Lehman Brothers Holdings Inc. collapse to his feckless pursuit of rumor-mongers and shorts to his powerlessness in bureaucratic turf wars with Treasury and the Federal Reserve, he has looked increasingly lame and passive. But the coup de grace, the admission that the SEC had some concerns about Bernie Madoff, which were repeatedly ignored, actually elicits mild sympathy for Cox. The first concern about Madoff registered nine years ago, which, if memory serves, was Arthur Levitt's SEC. Cox inherited a regulatory institution that was underfunded, punch drunk and confused about its mission and its philosophy. Harvey Pitt was a disaster; William Donaldson was better, but continually engaged in bureaucratic battles. And under Cox, an ideological free-market Republican and deregulator in an administration that often opposed the very idea of rule-making, the commission sank still further.
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Now President-elect Barack Obama has nominated Mary Schapiro to run the SEC. What will Schapiro face? Well, the SEC has seen its mission and operations undermined over decades, with its confidence and authority chipped away by ideological, political and fiscal pressures. Those, in fact, may be the easy problems that can be tackled with more money, a rationalized institutional structure and some regulatory elan. What's more difficult is wrestling with issues that have been rotting the foundations of the SEC for decades. Consider these three:
The technology and information gap. The SEC was trying to supervise firms that were infinitely better funded, with far superior information technologies. This disadvantage only grew with time, and as these firms -- mostly the investment banks -- grew larger, more complex and more global. The SEC was consigned to monitoring capital levels on a quarterly basis, when these firms were engaged in massive leveraging activities every day. The SEC also had no reason to be in the markets, and thus it was fatally caught out as finance swung from firm-centric to market-centric. There is also a sense that the SEC thought it was still dealing with firms from the '80s, when insider trading was the issue du jour. Scandals from Enron to the Spitzerian research jihad to the backdating scandals caught the SEC flatfooted, each of them posing complex problems that the commission hadn't seen before. And finally, since much of the risk in the markets occurred with nonregulated instruments, the SEC hadn't a clue of systemic issues (and, of course, neither did anyone else).
It is nice that the Cox SEC is pushing ahead with interactive data for investors, but that's hardly a fundamental change, like actually knowing what might happen to overleveraged operations in a financial meltdown.
The breakdown of transparency. A smart thief can pull the wool over any regulator, at least for awhile, although the Madoff case is absurd. But, in fact, the SEC's traditional dependence on disclosure has been slowly undermined, in part by some of its traditional allies. Institutions increasingly favor trading in opaque, or "dark" markets. And investors like hedge funds simply refuse to give up any information, even their addresses. An increasingly complex tax code and financial products that can serve a variety of purposes has made accounting a nightmare; and basic valuation methodologies have broken down. Attempts to treat all shareholders equally -- a pure reading of the shareholder-centric corporate governance model -- creates massive disclosure problems, which resulted in vast, complex and Procrustean rules-making exercises like Reg FD, the so-called Aircraft Carrier or Cox's own panicked attack on rumors, shorts and naked shorts. These problems go back some time. Levitt, Spitzer and others from both parties bear some of the blame here for promoting the notion that markets, which were growing more powerful, complex and institutional, needed to be "level-playing fields" for retail investors -- harmless little playgrounds of profit. This was vaguely utopian and fated to fail.
Conceptual failure and mission creep. Again, this began long before Cox. The SEC was designed to protect investors. But as markets proliferated and deepened, as institutional investing evolved a variety of potent life forms, from index funds to hedge funds, adhering to this became more and more difficult. What was good for institutions was not necessary good for retail. Mission creep also occurred, as it did across the regulatory system. The SEC went from investor protection to corporate governance cop to (one of the) guardians of American competitiveness. The result of all this was that the SEC increasingly lost its focus and became a juggler of interest groups. Cox, with his consensus rule on commission decisions, embodied this paralyzing tendency. Offer a little to corporate interests on "say on pay," let "investors" have a little something on proxy voting, give to the hedge funds with one hand, take away with the other. There often seemed to be no coherent philosophy beyond a kind of lobbyist-driven realpolitik and risk aversion -- "risk" in this case being congressional wrath.
All of these are extremely knotty problems that require a fundamental rethinking of regulation. Cox wasn't up to it, but then no one else has been either. Now he is the caretaker of a house collapsing around him. He could have done a better job of fixing it up, but the rot was very deep. Schapiro may have to tear it down and build anew. - Robert Teitelman
Robert Teitelman is the editor in chief of The Deal.
Comments
Attached is an article I wrote regarding the US tax implications
of risk management transactions of hedge fund managers. Some of the
tax analysis could apply to Madoff and his foreign investors as well.
Selva Ozelli, Esq, CPA
http://www.hedgeweek.com/download/259124/Comment%20-%20Cracks%20in%20the%20facade%20-%20risk%20management%20transactions%20of%20hedge%20fund%20managers,%20by%20Selva%20Ozelli.pdf