Image via U.S. Securities and Exchange Commission
Do white-collar criminals have reason to fear the feds?
If you believe some of the critics, the Securities and Exchange Commission (SEC) under Mary Jo White has been treating corporate chicanery and questionable political spending with kid gloves since she was confirmed as chair in 2013.
“Mary Jo White Doesn't Scare Anybody,” Alec MacGillis wrote in a May 14 story in The New Republic, charging that White “has almost prided herself on her languor” in pushing for greater transparency on corporate contributions to political campaigns. Emphasizing the point, Jesse Eisinger in The New York Times Dealbook summed up the assessments of White by former SEC staff members and financial reform advocates as ranging “from dissatisfied to infuriated.”
But a closer look at the record suggests that the criticism may be misplaced.
Some experts contacted by The Crime Report say the real problem lies with the “culture” of an agency apparently incapable of dealing with the structural issues that permitted the kind of corporate malfeasance which contributed to the 2008 financial crisis, while others say lack of funding is just as responsible for its sluggishness.
“(White) says all of the right things, but she inherited a dysfunctional bureaucracy, which is the fault of a Congress that created a dysfunctional agency,” says James Angel, a Georgetown University professor who specializes in financial regulation.
“It will take more than one chair to turn things around,”
According to Angel, the SEC is making moves in the right direction, with the creation of initiatives such as The Center for Risk and Quantitative Analytics, which uses data to profile high-risk behaviors and transactions. But he adds that an office as big as the SEC can't easily “make a 30-degree turn.”
Nevertheless, White has instituted many reforms, such as providing better incentives for whistleblowers to come forward—once to the tune of $30 million—and devoted $450 million to whistleblower awards. The award of $30 million was made last September to a whistleblower outside the U.S. who brought the SEC original information about an ongoing fraud. The SEC's news release kept his or her identity confidential.
“Whistleblowers have become a huge priority since the program was implemented a few years ago,” says Gordon Schnell, a partner at Constantine Cannon LLP, who heads the whistleblower practice.
“The size of the awards and the new way the SEC is hyping the awards is unlike other agencies. The SEC is going out of its way to use each award as a carrot for more people to step forward.”
The intense focus on White seems to be an occupational hazard in Washington. When we examine the efficiency of federal agencies—or lack of it— we tend to look at its leader first.
High Hopes for White
And White came into office with high expectations. She was not only a hard-driving prosecutor, as U.S. Attorney for the Southern District of New York, but possessed inside knowledge of the corporate world as a shrewd and experienced head of litigation at the prominent white-shoe firm of Debevoise & Plimpton where, presumably, she was knowledgeable about every trick in the book used by white-collar wrongdoers.
Some of that experience has borne fruit. The SEC is making strides toward prosecuting more cases of high frequency trading abuses, with its latest case pursuing UBS' disclosure violations. UBS has agreed to pay a $14.4 million settlement, which is the largest penalty the SEC has received from an alternative trading system operator.
She has also received more admissions of wrongdoing than former SEC Chair Mary Schapiro.
After JP Morgan tried to dodge admitting wrongdoing, White required the bank to admit it acted recklessly. White instituted a reform in June 2013 that in cases of “egregious conduct,” the commission would require an admission of wrongdoing and make it a stipulation of the settlement.
The SEC had its first admission of wrongdoing under White's new policy from hedge fund manager Philip A. Falcone. His hedge fund Harbinger Capital Partners, was also ordered to pay $18 million. On Feb. 21, 2014, Credit Suisse admitted guilt to advising clients without registering with the SEC, and paid a $196 million settlement.
In many respects, White has done what was expected of her by getting more admissions of wrongdoing and funding for the S.E.C. as well as incentivizing whistleblowers.
The administration gave the SEC $150 million more in funding this year. That amounted to an 11 percent increase. Critics said the increase still wasn't enough for the agency to live up to its mission, “to protect investors, maintain fair, orderly, and efficient markets and facilitate capital information.”
White visited the House appropriations committee earlier this month to ask for a 15 percent increase in funding for fiscal year 2016.
Nevertheless, critics argue that she is focusing too much on prosecuting individual cases rather than focus on the incentives that drive people to manipulate the market in the first place. That in turn has only accentuated the problems that some experts say plague her institution: an inability to prioritize cases and act fast; bad recruiting and hiring practices; and the revolving door between the SEC and Wall Street.
Campaign Finance Reform
One of the broader issues financial reform advocates would like White to tackle is campaign finance reform. A group of law professors filed a petition back in 2011 for an SEC rule requiring corporations to disclose their campaign contributions, but White hasn't taken action on the issue.
In 2013, White said disclosure rules on campaign finance disclosure rules had more to do with “societal pressure on companies to change behavior, rather than to disclosure financial information that primarily informs investment decisions.”
In the meantime, she's being featured as a superhero in Washington DC metro stations in a campaign to persuade the SEC (perhaps through that aforementioned “societal pressure” White mentioned) to act on the rule. This isn't the only eye-catching campaign to focus on campaign finance reform, and it isn't likely to be swept under the rug in 2016, especially when you consider the influence of Massachusetts Senator Elizabeth Warren on Hillary Clinton's campaign message.
A man recently landed a gyrocopter on the Capitol to prove a point about the issue, and a group called New Hampshire Rebellion is in the process of getting 500 volunteers to ask primary candidates what reforms they would advance to end the influence of money in politics.
The SEC was also slow to move on the JOBS Act, or the Jumpstart Our Business Startup Act. The Act, which would allow more small and mid-sized companies to raise as much as $50 million a year through public offerings and allow equity-based crowdfunding, was passed by Congress and signed by the President in 2012; but rule changes were only approved April 15.
The legislation was aimed at economic revitalization, through leveling the playing field both for smaller businesses that wanted the same crowdfunding freedom as big public companies, and for ordinary investors who may be interested in investing in startups as opposed to only accredited investors. The legislation gave businesses another option for when banks aren't lending money—an issue many small businesses struggled with following the recession.
White would probably counter, however, that it took so long because mandated rulemaking is difficult to balance with the SEC's other responsibilities. White said to the House Appropriations Financial Services Subcommittee last month, “the challenge is the volume and complexity and not having mandated rulemaking crowd out the other things we do.”
Help for Investors
There is one big-picture issue White has shown she's willing to take on. The SEC recently announced that it will pursue a rule on a uniform fiduciary standard. This comes after the President gave the Department of Labor the go-ahead to propose new standards on financial advice.
Currently, there are two standards, suitability and fiduciary standards, with the former only requiring broker-dealers to suggest suitable investments (without being required to put their interests below their client), while the latter requires advisors to suggest the best possible investment for that individual and put the investor's interests before their own.
The argument from proponents of one standard is that financial professionals under the suitability standard will always choose the mutual fund that earns them more money, and few investors know which standard their advisor operates under, or even that such differences exist. White is moving on this despite the fact that the Financial Industry Regulatory Authority (FINRA) said current rules are sufficient to protect investors.
And just last month, the SEC began the process of proposing new rules, a requirement of the Dodd-Frank Act, that would require publicly traded companies to inform investors of how the pay of top executives affects shareholder return.
On cases such as the JOBS Act and campaign finance reform, it's worth noting that White's failure to act may reflect the difficulty of making headway in an SEC culture that has been slow to move on serious reforms in recent decades.
Eugene Goldman, a partner with the law firm McDermott Will & Emery and a former SEC lawyer, says the SEC is working as hard as possible to bring back investors' confidence in the market.
“I do think it's interesting that they boosted the SEC budget by $150 million on a bi-partisan basis,” Goldman says. “That shows White is viewed as credible with a viable package of priorities.”
He adds: “The other wrinkle in this is how badly people viewed the SEC's (prior)performance: missing Bernie Madoff's fraud put the Commission in quite a hole.”
The bipartisan support, however, came with a price. In order to secure the SEC budget increase, Democrats agreed to a deal with Republicans that would reverse Dodd-Frank rules that require banks put some derivatives trading into entities not backed by the FDIC, The Washington Post reports.
Goldman says that given the challenges facing White, she has made substantial progress.
“It's a continuation of the work of Shapiro … There are a lot of burdens on the SEC [through Dodd-Frank] to conduct studies and come out with rules. There are stand-alone mandates and provisions requiring SEC to promulgate rules,” he adds.
One of the chief critiques of the SEC is that it moves too slowly to police an increasingly fast-paced Wall Street.
The challenges were summed up well in an October 2013 Journal of Financial Services Research paper, “Into the Breech: The Increasing Gap Between Algorithmic Trading Securities Regulation.”
It explained how the SEC remains focused on an older model of regulatory oversight and has become distracted watching disclosures.
“..we argue that the rules … have been replaced by computational models that trigger large-scale purchases and sales. As a result, the very nature of 'the market' has fundamentally changed, leaving regulators struggling to keep pace … the SEC, in both its regulatory and enforcement activities, has spent much of its time and resources focusing on the disclosure obligations of corporations. Regulating the market itself is something that, the SEC, by and large, has left alone.”
Georgetown's James Angel agrees that the agency is too focused on small potatoes and would benefit from better prioritizing cases and punishing paperwork infractions with the “equivalent of a parking ticket” versus far more damaging crimes.
He says it has to start by hiring people with at least two years of industry experience, with a degree in finance or a CFA/ CPA classification, instead of someone fresh out of law school who took courses in corporate finance.
“Even lawyers have a glacial way of thinking about this stuff,” Angel says. “Even in cases where there is public violation, the SEC has taken no public action. What incentive does this give?
“If I let this bad security go maybe six years from now my boss will have to pay a fine or maybe you hire more compliance officers.”
He adds: “In order to change an organization you have to change the people who work there. After the all of the layoffs, there are plenty of people who would love to work for the other side who have no love lost for Wall Street.
The revolving door goes the wrong way.”
One of the best recent examples of the “revolving door” problem is Peter Khuzami, who left his four-year position as head of enforcement for the law firm Kirkland & Ellis, which agreed to pay him a salary of over $5 million.
Before him, Peter H. Bresnan, deputy director of the division of enforcement, resigned in 2007 and began working for Simpson Thacher & Bartlett LLP in 2009.
A September 2014 research paper, “Does the Revolving Door Affect the SEC's Enforcement Outcomes?” found 58 percent of the 336 lawyers studied continued to work for the SEC by the end of the data collection period, with 11 percent joining employers other law firms and the remaining 31 percent of the lawyers quitting to join private law firms, or “revolvers.”
The Project on Government Oversight found that, between 2006 and 2010, former SEC employees filed 789 post-employment statements indicating they were representing an outside client before the Commission in a 2011 report. The report noted that the SEC Office of Inspector General found cases, such as Bear Stearns and the Stanford Ponzi scheme, where the revolving door may have “staved off SEC enforcement and other types of SEC oversight.”
“How do they attract people? Helping to keep our capital markets strong and protect investors is a strong motivating force to join the SEC. It was for me,” Goldman says. “I've been impressed with the recruitment of people from financial markets. I have no criticism at all on that. It helps when the regulators have people who know how the markets work.”
Angel adds that the SEC needs to remember it is not simply a reactive body. It can be a proactive body.
“The SEC doesn't grasp the economic importance of what they do,” Angel says. “They think of enforcing laws, but they also make the rules, so they have lost sight of the basic goal to protect consumers and economic growth in the SEC statute.”
When asked what kind of chairperson would help the SEC work more efficiently, Angel said, “You'd have to be Superman without the Kryptonite.”
He explains: “You need the political skills to get Congress to do things and (you) need someone with organization skills to take out the dysfunctional things that people labor under, with a budget that is too small to do the job. (You need to) be someone who understands priorities and can make the right trade-offs.”
Will that person turn out to be Mary Jo White?
Ultimately, the final answer to that question will be written by whomever occupies the White House in January 2017.
Casey Quinlan is an editor of the investing section at U.S. News and World Report. She has written for the New York Daily News, City Limits, The Atlantic and Minyanville. She welcomes comments from readers.