Modernize Wall Street Regulation Instead of Occupying the Industry

March 14, 2012

As readers of my "Street Sweeper" column are well aware, I am no fawning cheerleader of the Securities and Exchange Commission ("SEC").  Quite to the contrary - in fact, I am numbered among the leading critics of what I often consider our failed regulatory system and am often counted among the more robust voices for intelligent reform.

What passes for policing Wall Street is little more than the activity of a coroner reading toe tags in the morgue.  We are told why the victim died but there had been little, if any, pre-emptive efforts to prevent the crime. And the bodies pile up while the data is collected.

That is the impotency of current day securities industry regulation.  Regulators driving the road while only looking in the rearview mirror.  Politicians passing laws to eradicate last year's fraud.  Regulatory organizations firmly embedded in their hermetically sealed silos, unwilling to engage in neighborhood policing that incorporates all the available tools at their disposal and loathe to foster cooperation with what are viewed as competing federal, state, and self-regulatory counterparts.  Worse, as politicians fan the flames of class warfare and demonize that illusory concept referred to as "Business," we find the walls that divide our society being built even higher while the problems multiply but the solutions remain elusive.

A multitude of societal, political, and economic issues have created a fallow regulatory landscape in which both the public and the industry suffer. Make no mistake - I am not one of those fools who advocate an end to regulation nor am I from the other end of the spectrum that would castrate Capitalism and turn our boardrooms over to some paternalistic Big Brother government.  That being said, endless debate and study is not reform.  It is the cynical scraps tossed to barking dogs.

Take Goldman Sachs, JP Morgan, Merrill Lynch, Wells Fargo, Morgan Stanley out to the woodshed all you want. It's just not going to matter.  As long as regulation is little more than writing out a check and passing the cost on to shareholders, such reprisals are reduced to nothing more than a cost of doing business.  And don't just blame the banks and brokerage firms for this mess.  Keep in mind that it's the SEC itself which is appealing Judge Rakoff's rejection of the regulator's tepid settlement terms with Citigroup.

What is needed and frequently missing from regulation is for someone to look up from the muck and mud and to try and see the horizon.  For someone to understand that while there is a compelling need to fight yesterday's battles, that there is also a need to anticipate the next, new scam.

Unfortunately, the process of Wall Street reform always devolves into lobbying by special interests with the regrettable complicity of more than a few politicians and regulators.  The results of such corruption manifests itself in the same recurring tragedies: Madoff, Stanford, the Tech Wreck, the Flash Crash, and the Great Recession.  Worse, depending on the fashion of the times, we swing endlessly back and forth between blaming business, seeking it out as a savior, and then demonizing it again.

Much of that pendulum swing is the fault of business interests whose tunnel vision creates a myopia that will not focus on the bigger picture - a malady that is just as firmly entrenched in the skewed views of the left as it is with the right. The loss of the center in American politics and the inability to form a consensus has condemned us to an Either/Or political reality.  We must end that vicious cycle.

Recently posted on the SEC's website was this item: "Keynote Address at PLI - Eleventh Annual Institute on Securities Regulation in Europe" by Meredith Cross, Director, Division of Corporation Finance, U.S. Securities and Exchange Commission. London, England March 8, 2012.  It is a refreshing policy statement, quite dissimilar to the tired renditions that are presented during lunch at such conferences. I have sat through far too many bland speeches while cutting through a tasteless piece of chicken as others click away on their Blackberrys or iPhones.

I applaud Director Cross for asking provocative questions that echo issues that I have long raised: Can we afford to perpetuate the 1930s regulatory framework upon which much of our federal regulation is premised? While Cross may not have put the issue so bluntly, the challenge is certainly hinted at in her remarks. If nothing else, I thank her for gently raising the problem.

In her speech, Cross posits that:

[W]e find ourselves faced with a changed, and rapidly changing, world. One in which regulators must find ways to adapt without sacrificing the key principles of investor protection that underlie our system of rules and give investors the confidence they need to put their money at risk in our markets. In doing so, I think we have to ask ourselves some fundamental questions about how our regulatory scheme works in the context of significant changes in the markets and in the ways that we communicate . . .

A fine opening salvo.  Will the SEC now take the baton from its Director and run with it?

Will the federal regulator finally reach out to the hardcore industry interests of Wall Street, to the dissenting voices of Occupy Wall Street, to public investors and industry interests with skin in the game, and, yes, even to so-called gadflies and reformists such as me and many of my colleagues? Historically, that's not the way things get done.  Which may explain why we start with a lot of speechifying, then roundtables and panels drawn from the same incestuous gene pool, then we issue the White Paper, then the special interests chisel away, and, years later, we're left with unintelligible statutes promulgating unworkable rules.

In an effort to cultivate some long overdue realpolitik at the SEC, I offer you the following excerpt from Director Cross's remarks and urge you to inundate the SEC with suggestions and comments (footnotes deleted):

Capital Formation Initiatives

Even though we are very busy implementing Dodd-Frank, we also are keenly focused on our capital formation initiatives. Early last year, Chairman Schapiro tasked us with a new initiative. She asked us to take a fresh look at our regulations to determine how we could better facilitate capital formation without compromising critical investor protections. The Chairman asked us to look at a number of areas, including the triggers in our rules that require private companies to start Exchange Act reporting and allow reporting companies to stop reporting (or "go dark"); whether our private placement exemptions are appropriately structured to help smaller companies raise money, particularly in light of the changes in the way people communicate and interact; and whether the restrictions on communications in registered offerings, including initial public offerings, continue to be appropriate and necessary for investor protection.

If we look back sixty years at the capital markets, there has been tremendous change, some of it brought about by technology and some of it by changing attitudes and ways of thinking about regulation and capital raising. It was about sixty years ago when a part of the structure for private offerings of securities was established, with the Supreme Court decision in Ralston Purina,which allowed issuers to offer and sell securities in so-called private placements to investors who could fend for themselves - focusing the inquiry on whether an investor needs the protections that come with registration. It was about fifty years ago that the basic regulatory structure for unlisted, unregistered companies was established, when Congress added Section 12(g) to the Exchange Act: U.S. issuers with $1 million in assets and 500 shareholders of record were required to register with the SEC and became subject to the periodic reporting requirements of the Exchange Act (the Commission has since raised the asset number to $10 million).

Several decades on, we find ourselves faced with a changed, and rapidly changing, world. One in which regulators must find ways to adapt without sacrificing the key principles of investor protection that underlie our system of rules and give investors the confidence they need to put their money at risk in our markets. In doing so, I think we have to ask ourselves some fundamental questions about how our regulatory scheme works in the context of significant changes in the markets and in the ways that we communicate. Included among these are:

  • How does the concept of a private placement fit in the age of social media, bloggers, and 24/7 news coverage? And how should we think about restrictions on general solicitation against that backdrop?
  • How does a regulatory system for registered offerings originally premised on carefully controlled communications - structured so that investors' attention is directed to the important, balanced, complete, and (hopefully) reliable information in prospectuses - stay relevant when investors are bombarded with information coming through sources that issuers often cannot control and that we never could have foreseen when the rules were written?
  • Is a "quiet period" for a registered IPO realistic today, and are we helping investors by limiting information in these offerings?
  • If more communication is better, as many would advocate, how can we assure that investors are protected and that those who communicate with the goal of encouraging investors to invest are held appropriately accountable so that they take care in deciding what to say?
  • With pre-IPO companies widely trading in private company markets, widespread use of equity to pay employees, longer periods between formation and IPO, ever-expanding OTC markets, and securities ownership increasingly shifting to indirect forms, what are the characteristics that should determine whether a company should be subject to registration and reporting under the Exchange Act?

Commission staff have been thinking about these questions, and working to bring recommendations to the Commission to address at least some of the concerns raised by these questions. As part of this effort, we are thinking about whether there are ways to make going public easier and whether the ban on general solicitation is still necessary and workable. . .