IS TOO BIG TO FAIL BECOMING TOO SMALL TO SUCCEED?
Too big to fail has been a favorite theme on Capital Hill since the market crisis began. Throughout the debates which produced the most comprehensive financial reform bill since the 1930s, now known as Dodd-Frank, a key point of concern was preventing a reoccurrence of the kind of situation which lead to massive government bail-outs of collapsing corporations deemed critical to the economy and the welfare of the country. Whether Congress succeeded remains to be seen.
Now as that crisis recedes and the economy recovers budget cuts have become the theme of the day on Capital Hill. No agreement on what to cut has translated into no budget for the federal government, just continuing resolutions. That means the government’s budget is frozen in the past.
For the SEC replacing too big to fail with an out of date budget may mean the agency is becoming too small to succeed. As SEC Chairman Schapiro stated in her recent remarks at SEC Speaks last week (here), over the past decade the task of the Commission has dramatically increased in size, scope and complexity. Trading volume, for example, has more than doubled. The number of investment advisers has increased by 50% during that period. The funds under management have increased to $38 trillion. The Commission is expected to regulate and police all of this and more.
There is, as they say in the TV commercials, more. Following Dodd-Frank the tasks Congress has directed the Commission to handle are even more daunting. That Act gave the Commission a whole new set of responsibilities regarding hedge funds, rating agencies, the derivatives market and others. The legislation also directs the SEC to create and staff five new offices.
There is more. Under Dodd-Frank the SEC is required to write dozens of new rules and prepare a series of studies. Most of this work is being done at such a rapid pace that many have expressed concern that insufficient consideration may be given to important measures. While the time periods in the legislation contribute to the burden, there can be little doubt that inadequate staffing at the Commission is adding to the strain.
In view of these new obligations the Chairman estimated that about 800 new staff members would be needed. Job fairs were held to seek out qualified candidates. Senior positions, such as an Associate Director in Enforcement for the new whistleblower program, were posted. The new staff members have not been hired however. The Associate Director slot has not been filled. The other new offices remain vacant. While doing more with less is a great slogan and always popular when talking about government agencies and workers it simply does not work. If there is one lesson from the financial crisis that should be clear, it is the consequences of inadequate regulation. Even former Federal Reserve Chairman Alan Greenspan who has long championed free markets and little regulation admits to having learned this lesson.
Yet while Congress emulates the Roman Emperor Nero, the ability of the Commission to effectively carry out its critical mission is coming unraveled. Commissioner Luis A. Aguilar in his remarks at SEC Speaks (here) rattled off a few examples to illustrate the impact of the current budget crisis:
• A hiring freeze has been instituted
• There is a cut back on travel for examinations
• The agency has limited its use of expert witnesses in certain trials
• There have been limitations on taking depositions
A hiring freeze means the 800 new staff members needed are not being hired. It also means the five new offices created by Dodd-Frank are not being staffed. A limitation on inspections increases the chances that something may be missed. Limits on the ability to prosecute cases in court can translate to inadequate preparation and may mean the loss of an enforcement action with merit. This is particularly true give the well healed opposition the Commission often faces.
Unfortunately these examples are only the beginning. Others such as the failure to invest in the technology necessary to analyze the complex transactions the agency is charged with regulating and policing will have a lasting impact over the long term that can significantly hamper the ability of the SEC to carry out its statutory obligations. Ultimately as Commissioner Atkins noted, all of this simply leaves investors more vulnerable. If the SEC is the investor’s advocate as former Chairman William O. Douglas once stated, the current strain and stress is making that advocate hoarse and soon, voiceless.
Critics on Capital Hill point to the Commission’s well know recent failures such as the Madoff debacle to support a contention that more money will not solve such problems. True enough. No amount of extra cash in the budget would have changed the outcome there. It is equally true however that having suffered through those errors, and after working hard to remedy the conditions that caused them, inadequate funding in the future may well precipitate more missed opportunities to protect investors. In the future a lack of funding may well equate to more failures.
If Congress is serious about taking steps to avoid another market crisis, it begins with adequately funding for the SEC so the agency can fully implement its statutory mission. In the age of budget cuts this can be as simple as letting the agency keep what it collects. Last year the SEC returned almost $300 million more to the treasury from transaction fees than it spent. Those figures do not even consider the over $2 billion returned to harmed investors who might otherwise have nothing while leaving the fraudsters who harmed them to enjoy their ill-gotten gains.
If Congress is serious about preventing another market crisis, investor protection and ensuring the integrity of the U.S. capital markets, it is time to give to give the SEC the necessary resources. If not self-funding then at least adequate funding must be made available now. Otherwise the SEC ‘s ability to carry out its mission will continue to unravel. Too big to fail in the age of budget cuts will become too small to succeed. That result would be a tragedy for all.