SEC Commissioner Gallagher Takes A Cheap Shot At Former Chair Schapiro

June 7, 2013

About a year ago, published "SEC Chair Schapiro Fears Future Runs On Money Market Funds But Offers Hope" (June 21, 2012), which discussed then-SEC Chair Schapiro's Congressional testimony concerning money market funds. As I stated in that article:

On a modestly positive note, Schapiro allows that during the Summer of 2011 market stress, various money market reforms instituted in 2010 seemed to have held up in the face of another spate of heavy redemptions, which were, thankfully, substantially less severe than those of 2008.  For example, during the three-week period beginning June 14, 2011, investors withdrew approximately $100 billion from prime money market funds versus the two-day panic in 2008 in which over $300 billion was redeemed.

From her perspective, Schapiro seems to have concluded that money market funds remain vulnerable to investor psychology that prompts redemption runs.  In explaining some of the elements that have fueled such panics, she cites the "Misplaced Expectation" of a stable $1.00 NAV, which, when broken or fears arise of that event, fuels the investors' rush to the doors. Pointedly, Schapiro observes that a domino effect is likely to occur when one fund's NAV comes into question, leading investors at other funds to assume the worst and try to get out before it's too late.

In tandem with this expectational issue is what Schapiro sees as the perception by investors that there is a benefit to be among the first to redeem - the expectation that you will at least get the buck rather than something less if you wait too long. Unfortunately, the understandable human response to smell smoke and not wait for signs of fire, may cripple otherwise stable funds caught up in the whirlwind. In an interesting aside, the SEC Chair notes that since institutions tend to have access to more timely market news than the average retail investor, the advantage of getting out first would likely go to the big boys, putting the small fry at a disadvantage during such a critical time. . .

[A]ddressing the scary history of 2008 and 2011, and apparently aware of the lack of effective reform, Schapiro underscores the need to meaningfully address the weakness in the regulatory scheme for money market funds.  First, she notes the option of requiring money market funds to abandon the $1 NAV and to act more like traditional mutual funds, which peg valuation on a floating basis.  Second, she muses as to whether the implementation of an enhanced capital buffer would offer another sound response. Finally, Schapiro raises the prospect of some limits on redemptions, which I suspect may not prove particularly welcome among investor advocates but is, nonetheless, an appropriate topic to raise for consideration.

Tempus Fugit-aboutit

As with far too much of what passes for regulation these days, time flies without any meaningful progress. 

Nearly five years after the 2008 market crash with its attendant run on money market funds, nearly two years after the Summer of 2011 meltdown, and nearly one-year after Schapiro floated a proposed money market reform --- well, you know, the good commissioners at the SEC are still talking about getting the show on the road. As the hotly hit groundball of money market reform was tossed around the horn from SEC Chairs Schapiro to Walter to White, we are still trying to turn an effective double play on the diamond of regulation.


Once again, money market reform is on the SEC's plate.  In "Opening Statement at the SEC Open Meeting by Chairman Mary Jo White" (U.S. Securities and Exchange Commission, Washington, D.C., June 5, 2013), the new SEC Chair offers this retrospective, which comes off as redux:

[A]s many people know, money market funds are investment vehicles that hold a pool of high-quality, short-term securities. In the early 1980s, the Commission provided money market funds with an exemption making them distinct from mutual funds and certain other investment products. That exemptive rule (Rule 2a-7) allowed these funds generally to maintain a stable share price of $1.00 instead of changing their share prices according to the market value of the securities held by the fund. . .

While money market funds have thus long served as an important investment vehicle, the financial crisis of 2008 highlighted the susceptibility of these products to runs. In September of that year - at the height of the financial crisis - a money market fund called the Reserve Primary Fund "broke the buck" - a term used when the value of a fund drops and investors are no longer able to get back the full dollar they put in. 

Within the same week of that occurrence, investors pulled approximately $300 billion from other institutional prime money market funds. The contagion effect was rapid. The short term credit market dried up, and corporations had trouble borrowing to run their businesses. This reaction contributed to the significant disruption that already was consuming the financial system. 

To stop this run, the government stepped in with unprecedented support in the form of the Treasury temporary money market fund guarantee program and Federal Reserve liquidity facilities. . .

Here we go again. Yet another recap. We've been there and done that before -- the comments of White were largely voiced previously by Schapiro.  Surely there must be a far more effective use of the SEC's time and resources than regurgitating old preambles; however, to the new SEC Chair's credit, White quickly transitioned from prologue to setting forth her agenda:

Today's proposal contains two alternative reforms that could be adopted separately or combined into a single reform package to address run risk in money market funds.

Floating NAV

The first proposed alternative would require that all institutional prime money market funds operate with a floating net asset value (NAV). That is, they could no longer value their entire portfolio at amortized cost and they could not round their share prices to the nearest penny. The set "dollar" would be replaced by a share price that actually fluctuates, reflecting the changing values in these money market funds.

This floating NAV proposal specifically targets the funds where the problems during the financial crisis occurred: institutional, prime money market funds. 
Retail and government money market funds - which have not historically faced runs in even the worst of times - would be exempt from the proposed floating NAV requirement. 

This approach would thus preserve the stable value fund product for those retail investors who have found it to be convenient and beneficial. It also would allow municipal and corporate investors to have access to government money market funds - a stable value product - if they need it, although it would be a product that holds federal government securities as opposed to the higher-yielding investments of a prime fund. 

We are soliciting commenters' views regarding the impact of targeting the floating NAV reform to institutional prime funds and whether government and retail money market funds also should operate with a floating NAV, as well as commenters' views regarding whether today's proposal would effectively differentiate retail funds from institutional funds by imposing a $1 million redemption limit. These and other important questions are specifically posed in the proposal. 

I believe the floating NAV reform proposal is important for a number of reasons: 
First, by eliminating the ability of early redeemers to receive $1.00 - even when the fund has experienced a loss and its shares are worth somewhat less - this proposal should reduce incentives for shareholders to redeem from institutional prime money market funds in times of stress.

Second, the proposal increases transparency and highlights investment risk because shareholders would experience price changes as an institutional prime money market fund's value fluctuates.

And, third, the proposal is targeted, by focusing reform on the segment of the market that experienced the run in the financial crisis.

Fees & Gates 

The second proposed alternative seeks to directly counter potentially harmful redemption behavior during times of stress. 

Under this alternative, non-government money market funds would be required to impose a 2 percent liquidity fee if the fund's level of weekly liquid assets fell below 15 percent of its total assets, unless the fund's board determined that it was not in the best interest of the fund. That determination would be subject to the board's fiduciary duty, and we believe it would be a high hurdle. After falling below the 15 percent weekly liquid assets threshold, the fund's board would also be able to temporarily suspend redemptions in the fund for up to 30 days - or "gate" the fund. 
This "fees and gates" alternative potentially could enhance our regulation in several ways: 

First, it could more equitably allocate liquidity risk by assigning liquidity costs in times of stress (when liquidity is expensive) to redeeming shareholders - the ones who create the liquidity costs and disruption.

Second, this alternative would provide new tools to allow funds to better manage redemptions in times of stress, and thereby potentially prevent harmful contagion effects on investors, other funds, and the broader markets. If the beginning of a run or significantly heightened redemptions occur, they would no longer continue unchecked, potentially spiraling into a crisis. The imposition of liquidity fees or gates would be an available tool to directly counteract a run.

And, third, this approach also is targeted, focusing the potential limitations on a money market fund investor's experience to times of stress when unfettered liquidity can have real costs.

The two alternative approaches in today's proposal target the common goal of reducing the incentive to redeem in times of stress, albeit in different ways. 

Accordingly, the proposal requests comment on whether a better reform approach would be to combine the two alternatives into a single reform package - requiring that prime institutional funds have a floating NAV and be able to impose fees and gates in times of stress, and that retail funds be able to impose fees and gates. We specifically solicit and I am interested in commenters' views on this combined approach. 

Another False Start?

Will Chair White forge a consensus among the SEC's commissioners concerning proposed money market fund reforms?  In recent years, the SEC has proven itself to be little more than a debating society of dueling commissioners, each of whom speechifies and publishes their observations and thoughts Wall Street, the ebb and flow of societal change, life in general, and the price of beans in China.  Of course, one wonders how much time is diverted by such pronouncements from the actual work of securities regulation.

If My Aunt Were A Man, She'd Be My Uncle

Consider this lovely tidbit from SEC Commissioner Gallagher. "Statement at SEC Open Meeting - Proposed Rules Regarding Money Market Funds" (SEC Open Meeting, Washington, D.C., June 5, 2013) [Ed: emphasis supplied in bold]:

[T]he path to today's proposal has been a long and winding one.  Indeed, as I sit here today, it's hard to believe that we have produced such an excellent proposal given where this agency stood last August. For me, it is important to explain the evolution of this proposal and how I ultimately became comfortable moving forward with amendments to our money market fund rules. 

Far too much has been said and written - with far too little accuracy - about the fundamentally flawed draft proposal on money market fund reform that was championed last year by the then-Chairman.  In contrast with today's proposal, last year's proposal - through no fault of the staff's - was drafted without the input of the Commissioners and presented to the Commission as an inviolate fait accompli.  Indeed, we were given the proposal only after it had been fully baked and blessed by other agencies. 

Moreover, despite requests from three Commissioners for our economic experts to conduct a study examining several key issues prior to drafting a rulemaking proposal, the staff was not directed to do so.  Only after last year's fundamentally flawed draft proposal had been rejected by a majority of the Commissioners, and after the decision had been made to abdicate responsibility for MMF regulation to the FSOC, did the staff receive such authorization.  If the staff had been authorized and directed to study these issues earlier and to engage the full Commission in the drafting process as it should with every rulemaking proposal, we could have issued today's proposal last year and might be discussing its adoption today.  Any claims to the contrary are disingenuous.  Indeed, given the substance of today's proposal, it appears that the Commission could have pursued the floating NAV reform much earlier.  My predecessor Commissioner Kathleen Casey voted against the 2010 amendments because, in part, they did not make structural changes such as including a floating NAV requirement. . .

Bill Singer's Comment

I was no cheerleader for former Chair Schapiro, as confirmed by my comments in "Rumsfeld, Neibuhr, Lord Tennyson, Levitt, Cox, and Schapiro" (, December 18, 2008), published on the very day in 2008 when Mary Schapiro's nomination to chair the SEC was announced:

[I] am a former regulator.  I was frustrated in that role by the organizational politics that suffocated my efforts to aggressively pursue my caseload and by the entrenched cronyism that too often promoted those who were toadies and sycophants over those who came in early, went home late, and gave their all to the task of regulation. There are many good folks still in regulation. There are many industry veterans willing to do a turn in regulation.  The challenge for the SEC, for the CFTC, for FINRA, for all regulators is to promote and reward those most deserving, and to attract skilled, qualified, veteran staff, and to retain them with fair pay and rewarding work.

All of which brings us to today's announcement that Mary Schapiro will be the next SEC Chair.  At first blush, there are a lot of things I could say.  Many positives and some negatives. I heard Charles Gasparino's comments on CNBC this morning and can't say that he's off base on many of his points.  Gasparino thinks it's a bad choice--more of the same old tired crop of regulators with their now discredited approaches (and he says that she's being pushed by none other than former SEC Chair Levitt).

On the other hand, I actually know Mary Schapiro--I've met her, I talk to her, we have exchanged emails--and she is a very skilled, intelligent regulator with an amazing history of accomplishment. Unfortunately, she and I have often crossed swords during her tenure at NASD and now FINRA, and we have certainly disagreed about how her organization dealt with (and deals with) dissent within its membership. 

Is there anyone more qualified than Schapiro for the SEC's top job? Probably not--she's former CFTC, SEC, NASD, and FINRA, which will likely prove a very useful panorama. Still, are we getting yet another career regulator from the same mold that produced Levitt and Cox? Is this the much bally-hooed "change" we were told to expect from the Obama administration?

I am holding the scale before me and see it wobbling up and down as it balances Schapiro's track record against the internal politics that remains at FINRA, her professional demeanor against her hardball response to dissent, her promise of reform against the uneven FINRA history of regulatory favoritism for the big and powerful.  This is a tough call.  Let me think on it a bit more. . .

Why the need -- really -- why the need for Commissioner Gallagher to intentionally high-stick former SEC Chair Schapiro in her face? Gallagher has every right to be frustrated by the SECs glacial pace of enacting reforms. He may even have every right to be angry with Schapiro. On the other hand, the good commissioner should do the math: Four commissioners outvote one Chair.  As such the commissioners who served during the Schapiro administration surely must accept some blame for stonewalling earlier reform of money market funds.  I would suggest that Gallagher channel his frustration and anger into scoring goals rather than injuring a player who has left the ice.

The culture of non-compromise has now spread from Congress to the SEC. How lucky for the American investor!  Dissent is no longer voiced privately among the commissioners and the Chair but now spills into the media and the public forum.  Along with this apparent need to continue a fight long after the final bell has rung, we are also treated to the gladiatorial spectacle of disgruntled commissioners turning to the crowd for the sign of thumbs up or thumbs down concerning an opponent. 

SIDE BAR: As a believer in the Hegelian Dialectic, I am an unrepentant proponent of principled dissent and robust debate; but at some point, ya just gotta stop arguing. Incessant organizational infighting endangers the whole point of resorting to a commission structure rather than simply installing a single executive officer. Of course, since I do not support the construct of the SEC, I secretly relish the manifestations of its internal failings as yet another sign that this ponderous bureaucracy is a dysfunctional relic of a bygone era.

Seems to me that folks should be appointed as SEC commissioners because of their superior knowledge of the securities industry and financial markets, and that they should bring to the table their understanding and experience of the realities of the marketplace.  Seasoned industry veterans should not resort to endless studies, comment periods, and revisions of proposals.  You weren't appointed as a member of a debating society. You were appointed to enact reform, compel investigations, and further appropriate prosecutions. As such, I am puzzled that Commissioner Gallagher trumpets the "long and winding" road that has produced what he now lauds as "an excellent proposal." Does not the good commissioner recognize that a proposal is not a final rule?  The role of the SEC is not to produce proposals but to enact meaningful reforms.  

Overall, Gallagher asserts a number of fair points about money market fund reform. As industry veterans, Commissioner Gallagher and I agree on more matters of both form and substance than this single issue of disagreement about flipping off a former SEC Chair. We both likely appreciate the wisdom in the old Wall Street axiom that some of the best trades you make are those that you don't. In that regard, I understand the Commissioner's point about not wanting to vote to approve hasty and ill-considered rules.  In the past, we have paid far too dear a price for such follies.  On the other hand, Gallagher and his colleagues cannot endlessly cut bait.

We have become a nation that ponders everything without resolution. No one is in charge of anything. No one is willing to take responsibility and make a decision. Equivocation has replaced action. Our lives are run by commissions, committees, and roundtables. It is a nightmare of debates and discussions that go on endlessly. 

Also READCan The Securities And Exchange Commission Order Lunch? (, July 12, 2012)