What Is The Future Of Securities Regulation? Some Guiding Principles
What a difference a year makes. This year we begin with a new administration about to take over, a new nominee for SEC Chairwoman and repeated calls for reform and more regulation. Bills are pending in Congress that might dramatically reshape the regulatory landscape. There are calls for the merger of the SEC and the CFTC and even of those two agencies with the Federal Reserve. Others have called for new regulation and additional enforcement. Next year, where will all this have taken securities regulation and enforcement? While nobody knows the answer to this question, it is clear that if Congress does not properly address the situation, there is little likelihood of avoiding a future repetition of the current crisis. In this regard, it is essential that three key points be considered.
Merging agencies: Should the SEC be merged with other regulatory agencies? The current Treasury Secretary called for this months ago. Some agree and some do not. The incoming Chairwoman, Mary Schapiro, certainly has the familiarity with both the CFTC and the SEC that would be necessary to run such an agency. In many ways, this seems like a good idea. Both are regulatory agencies. Both have supervision over certain market based financial products. Adding the Federal Reserve to this could complete the marriage of financial market regulators.
At the same time the SEC, CFTC and Federal Reserve have fundamentally different approaches to those they regulate, although there are similarities in some instances. The approach of each regulator evolved from its origins and the markets and institutions they regulate. For example, banking regulation under the Federal Reserve focuses on the financial soundness of the institution and the faith the public had in it. This approach evolved from the bank failures of the 1930s. While the SEC’s approach evolved from the same time period, it is geared to the securities markets, and not depository institutions. The CFTC crafted its approach beginning in a different time period than either the SEC or the Federal Reserve. Like those two agencies however, the CFTC’s approach has been tailored to its historical markets which differ from those of the SEC and the Federal Reserve.
All of this is to say that while there are common overlapping elements of regulation among these agencies, simply putting the SEC and CFTC together and perhaps adding the Federal Reserve is not that simple and may not work. There is no such thing as a “one size fits all” regulatory scheme or approach to regulation. In evaluating the question of merger or continued independence of these entities, it is essential that Congress carefully consider the focus and manner of regulation that each has traditionally used as well as any possible efficiencies which might be achieved through merger. While mergers might result in better regulation, it may just be that an overhaul of each agency in view of current market conditions would be a better choice.
Regulatory reform: The current market crisis and events clearly point to the need for a careful evaluation of the regulatory framework of each financial regulator. Since the creation of the SEC, Federal Reserve and the CFTC, Wall Street has been ever creative, constantly turning out new financial products and inventions. Frequently, those products are designed to take advantage of inefficiencies in the markets or the regulatory system. In some instances, the new products fall in a crack of the regulatory system. The much talked about credit default swaps are just once example. This product, which has become the poster child of the current market debacle, was not known or even thought of when the SEC, Federal Reserve, or even the CFTC was created. No doubt in the future Wall Street will create additional as yet unheard of products.
This suggests that in evaluating the regulatory jurisdiction of each agency — regardless of whether there is a merger — it is critical that Congress look carefully at the historic roots of each agency and at the regulatory landscape today. Perhaps even of more importance, Congress must look beyond today to tomorrow. While it might be tempting to simply extend regulation over CDS and move on, this would be a mistake. Rather, Congress should carefully consider the entire financial products landscape and give financial regulators a mandate not just to monitor the market of today, but also of tomorrow. While regulators may have difficulty keeping pace with the innovation of Wall Street, if a repetition of the current market crisis is to be avoided, it is essential that Congress direct regulators to look be forward looking.
Enforcement: A key to revamping the regulatory landscape is to ensure that there is an effective cop on the beat. Whether this is the securities or commodity markets or financial institutions, everyone should recall the recent testimony of former Fed Chairman Alan Greenspan. In that testimony Mr. Greenspan expressed surprise and regret at the total deregulatory approach he espoused for years. Markets are not self-policing when there are millions and billions of dollars at stake. Current events are a testament to this point. A cop on the beat is essential if markets are to serve the needs of the investing public on Main Street as well as those of Wall Street and the nation.
At the same time, it is essential that any cop and new regulation be balanced. Over regulation or over zealous enforcement can be worse than too little regulation and lax enforcement. It is often tempting in situations like the current market crisis to swing the pendulum to far in the other direction. What is critical here is that Congress carefully considers the markets and regulatory landscape, fully assess the need for additional regulation and enforcement and then institute the appropriate measures. Grabbing at the obvious or at easy answers like merging agencies or regulating credit default swaps or throwing more resources at the enforcement divisions of each agency may feel good today, but it has little chance of preventing a market meltdown in the future.