SEC: always playing catch-up

November 2006

New York City Mayor Michael Bloomberg and Sen. Chuck Schumer (D-N.Y.) commission a report by McKinsey on the state of the financial services industry in the United States.

The report paints an ominous picture, asserting a clear “loss in financial services competiveness” for the U.S. and criticizing the nation’s “increasingly heavy regulatory burden.” Its authors argue that the American system’s “complexity, cost, and perceived lack of responsiveness” threatens the financial sector and recommend that policymakers “re-examine implementation of [Sarbanes-Oxley]” and “undertake broader reforms,” including providing greater protection for financial institutions against lawsuits claiming wrongdoing by those institutions.

The report also suggests that proposals to strengthen capital requirements for the largest U.S. banks would put those banks at a competitive disadvantage in relation to their international rivals. The report proposes that the U.S. follow the “Basel II” regime, under which “larger institutions can implement a risk-based model.” These risk-based models later fail to capture the extent of banks’ exposure to mortgage-backed securities; their use is cited as a major factor in the Financial Crisis of 2008.

Bloomberg and Schumer also pen an op-ed in the Wall Street Journal, calling for decreased regulation of the financial services sector. Bloomberg and Schumer attack the regulatory climate in the U.S., particularly Sarbanes-Oxley, which they criticize for its high cost to business. They also call regulators “overzealous.” Warning that a failure to cut back regulation will have dire consequences, Bloomberg and Schumer recommend that the U.S. adopt a lighter regulatory system, similar to that seen in countries like England: “If we do not rise to the challenge, the speculation that New York is losing its pre-eminence in the global marketplace will become more than just chatter.”

2006

Sarbanes-Oxley continues to come under attack from industry. In December, Peter Wallison of the American Enterprise Institute tells Investor’s Business Daily that because of the law, “Corporations have now become much more focused on financial reporting than creating value.”[39]

February 2007

Accepting hedge fund industry claims that the massive investment vehicles are designed to carefully manage risk and pose no threat to the economy as a whole, the Bush Administration steps back from attempts to regulate the industry. Stephen Labaton reports in the New York Times on the Bush administration’s retreat from attempts to regulate the funds. The Administration, he writes, ultimately decided that “hedge fund companies and their lenders could adequately take care of themselves by adhering to a set of nonbinding principles.”

March 2007

Jenny Anderson reports in the New York Times on the successful lobbying efforts of the hedge fund industry: “So far the industry’s efforts have witnessed remarkable results…The Treasury Department, the Federal Reserve, Congress and the S.E.C. seem to agree: hedge funds are as regulated today as they should be.” Anderson attributes the industry’s lobbying victories — won despite a relatively small $7.7 million in donations to members of Congress between 1998 and 2006 — to an “unusually benign environment for regulation.”

June 2007

Bear Stearns informs clients that two of its hedge funds, High-Grade Structured Credit Fund and High-Grade Structured Credit Enhanced Leverage Fund, have suffered catastrophic losses on collateralized debt obligations linked to mortgage-backed securities. According to the Daily Telegraph, Bear’s letter to investors states that “there is effectively no value left” in High-Grade Fund and “very little value left” in Enhanced Leverage Fund. The SEC investigates the collapse of the funds and charges two fund managers at Bear with securities fraud, claiming they deceived investors about the value of the funds’ assets. The managers are later tried and acquitted.

July 2007

The SEC adopts a rule change that will allow the agency to file suit against hedge funds that mislead investors. The change still leaves the SEC with far less oversight authority than it would have had if the 2004 rule rejected by a court in 2006 had been sustained.

August 2007

Writing for McClatchy, Kevin G. Hall and Robert A. Rankin describe a “worrisome new wrinkle” in the financial system: “A huge share of the money through the U.S. financial markets is being invested by giant ‘hedge funds’ that aren’t subject to much regulation. No one really knows what they own. And there’s a chance that some of what they own is worthless.”

Hall and Rankin recall the fears of Rep. Richard Baker (R-La.), who had earlier that year criticized the regulatory regime in place. In the event of a crisis, Baker said, “all you would be able to do is get the license-tag number of the truck that just ran over you.”[40]

J. Bonasia reports in Investor’s Business Daily on a series of studies of the effectiveness of Sarbanes-Oxley, five years after its passage. These studies find the law has helped to curb some fraud in corporate accounting. Bonasia writes: “In 2006, restatements by large public companies that have to comply with SarbOx fell by 14 percent over the prior year…last year was the first time such restatements by larger companies have declined, notes Mark Grothe, a research analyst with Glass Lewis. He says it shows that big companies are cleaning up their books.” Industry continues to criticize the law for the cost and difficulty of compliance.[41]