Bill Singer Comments on Mary Schapiro's CNBC Interview -- veteran lawyer calls for regionalization of SEC

July 21, 2011

The other morning (July 20, 2011), I listened to Securities and Exchange Commission ("SEC") Chair Mary Schapiro's interview on CNBC. In the end, Schapiro's explanations, excuses, and sometimes feisty insistence come down to her perception that the SEC needs more money and more staffing.

That's one view. And it's also one that I reject as discredited by history and pragmatism.

Congressional Investigation

Congress is presently investigating the SEC's conduct in entering into a lease for 900,000 square feet of new office space, which would have obligated the SEC to a ten-year expense of over $556 million. As a result of that lease, the SEC is now embroiled in a $93 million dispute with the landlord.  Purportedly, the obligation was taken on in anticipation of hiring over 2,000 additional staffers - although Congress has yet to approve funding for that expansion. Sort of like kiting a check on a grandiose scale - you know, you're always supposed to make sure that the funds have first cleared before you sign your name.

An internal report by David Kotz, SEC inspector-general, slammed the lease and urged consideration of disciplinary action against two Office of Administrative Services ("OAS") employees who managed the leasing process.

In his written testimony to Congress on June 16, 2011, Kotz stated:

The OIG investigation found that the circumstances surrounding the SEC's entering into a lease for 900,000 square feet of space at the Constitution Center facility in July 2010 were part of a long history of missteps and misguided leasing decisions made by the SEC since it was granted independent leasing authority by Congress in 1990. .
. . .
The OIG investigation further found that a "closed" and "rigid" atmosphere within OAS may have contributed to the irresponsible decisions made with respect to the Constitution Center lease. In the course of this OIG investigation, several witnesses who sought to remain anonymous came forward to the OIG to provide information concerning the environment and the decision-making processes within OAS. These witnesses described an environment in which inexperienced senior management make unwise decisions without any input from employees who have significant knowledge and experience. We found that questioning of upper management decisions by the staff is "not allowed" and that OAS Executive Director Sheehan surrounds herself with "yes-men" and "does not want to hear what [experienced staff] will tell her." . . .

No Mas

During Chair Schapiro's recent Congressional testimony: Testimony on the Lease of Constitution Center, Before the Committee on Transportation and Infrastructure, Subcommittee on Economic Development, Public Buildings, and Emergency Management, U.S. House of Representatives (July 6, 2011), she made the following comment:

The SEC currently employs approximately 3,900 permanent staff and more than 700 contractors. Approximately 60 percent of the permanent staff work out of the agency's headquarters, principally the Station Place buildings adjacent to Union Station in Washington, DC. The agency's remaining 1,500 employees (mainly enforcement and examination staff) work in our 11 regional offices.

As a 30-year veteran of Wall Street and a former regulatory lawyer with the American Stock Exchange and the NASD (now known as FINRA), Schapiro's comment sort of says it all for me - it crystallizes so much of what is wrong with those now setting federal regulatory policy. Frankly, after having fought in the trenches for some three decades, I think I have a pretty good idea of what works, what doesn't, and why. 

Regulation and prosecution are most effective when handled locally and on a relatively small scale - and are often at their worst when the command-and-control structure is a ponderous bureaucracy situated remotely in Washington, DC. 

For example, the Department of Justice is often at its best through the local US Attorneys offices located in numerous local districts around the country.  Each US Attorney largely sets his or her own agenda, hires and controls a local staff, and jealously guards their turf and tend to aggressively prosecute their cases.  In contradistinction, what comes out of DOJ in Washington, DC is largely little more than endless announcements of promotions, self-congratulatory awards, broad-brush "visions" for new enforcement programs, and notices of senior executives taking trips to far-flung, international seminars (which I see as little more than junkets). 

The advantage of the localized US Attorney system is that it allows for more effective neighborhood policing - cases are developed in your hometown, handled by local investigators and attorneys, and tried in front of juries from communities that you know. 

Is such a homegrown approach always perfect? Absolutely not - too often it is abused by wunderkinds seeking little more than a splashy stop on their resumes.  Too often the goal is not for a career as a prosecutor but to establish a stepping stone for elective office or the cushy partner's suite at a white shoe law firm. 

There is an even darker side to going local.  In some communities, local prosecutions reflect the worst prejudices of the day and may be little more than legally sanctioned lynchings or show trials predestined to free the guilty.  Vigilance and prudence demand that we not forget the racist trials of the Civil Rights Era.  Nonetheless, lately, the best results have come from local offices.  Perhaps this is nothing more than the inevitable ebb and flow of society.  However, in 2011, over-broad and over-board Washington, DC-centric bureaucracies are failed institutions and we must opt for something more effective, which I think is now local.

Up until the 1990s, Wall Street was largely regulated on a far more local basis than today.  There were local self-regulatory stock exchanges and the old NASD.  The SEC's regional offices were left to develop a more local docket with less interference from Washington, DC. 

Was the old way effective?  Again, to avoid hypocrisy and the tendency to oversimplify complex issues, the answer is "not always." Frankly, the old, more localized regime had significant problems.  Among the worst faults of the pre-90s regulatory scheme was that the self-regulatory organizations were little more than the lap dogs of the powerful member firms, as was revealed during the NASDAQ price-fixing investigation of the late 90s. 

However, perhaps as an over-reaction to such failures, the pendulum swung far too extremely in the direction of a centralized bureaucracy in Washington, DC, where there is no stock exchange, no meaningful business center, and little more than the corrupting influence of lobbyists.  It would be hard to imagine a worse site for an effective national regulatory/prosecutorial organization.

We must always be careful when holding up what once was as a paragon of virtue.  The mists of time can dangerously produce a nostalgic memory that is not supported by the facts. We arrived at the debacle of Madoff and the Great Recession because of failed regulation.  We proceed haphazardly from that point because of failing regulation.  Prior, failed regimes may serve as little more than the mirror image of an equally failed response.  For all the shortcomings and failures of the old days of Wall Street regulation, what we have now is merely a reverse image replete with its own grievous shortcomings and failures. 

Consultants and Contractors

In Schapiro's Congressional testimony, she explains that the SEC has a permanent staff of 3,900, which is augmented by 700 contractors, for a gross total of 4,600.  I wonder if the SEC's Chair has done the math - over 15% of her total staff are contractors, dare I say "consultants."  Oh, how Washington, DC loves to hire politically connected, unqualified consultants/contractors, who often provide half the work for twice the compensation, and sometimes screw things up to such a degree as to require even more contractors to undo their mess. 

60/40 Mix

Of course, in my calculus, Schapiro's staffing presents an even more dire problem.  By her own admissions, about 60 percent of the SEC's permanent staff work out of the agency's headquarters, and the remaining 40% (some 1,500 employees, who are mainly enforcement and examination staff) work in the SEC's 11 regional offices.  That doesn't add up.  That is a prescription for continuing disaster.

The solution to ineffective government bureaucracy is not more money or staff.  Sometimes there is addition by subtraction.  Then there is the entire benefit of constructive destruction.

Talk to enough career federal regulators or prosecutors and you will learn (albeit largely "off the record") that they detest the abyss that they see as the home office in Washington, DC.  Ask them why and you'll frequently hear the same refrain. It's inefficient. It adds too much delay. It's too much about politics. They think all of us in the local offices are idiots.  They have no idea about the guts of our case.  I lost four weeks waiting to get my charge memo back and the only changes were some semicolons for commas and some stylistic revisions. I'm fed up having to call the Deputy to the Assistant to the Deputy Assistant to the Assistant Deputy, who soon announces that he or she is leaving in a month to go work for our adversary. 

So, Ms. Schapiro, here's an idea. Fire about 25% of your Washington, DC staff.  Offer another 50% of your DC staff reassignment to a regional office. Slash the Washington budget and use the savings to pump up the autonomy of your regional staff.  Go smaller. Go local. Encourage more nimble, quicker investigations and prosecutions.  It's time for bare bones in DC and a beefed-up presence where it truly counts: in the field.  Moreover, the local communities surrounding your regional offices will greatly appreciate the demand for new leased space and increased employment.  However, please, always remind yourself of this sage critique by your own Inspector General Kotz, as more fully cited above: 

[I]nexperienced senior management make unwise decisions without any input from employees who have significant knowledge and experience

US Chamber of Commerce Report

Finally, the U.S. Chamber of Commerce issued a report:  U.S. Chamber Report Offers Fixes to Five Major Holes that Remain One Year After Dodd-Frank  (July 19, 2011) , which set forth five areas where the present Wall Street regulatory structure and processes are viewed as reducing the quality and efficiency of the U.S. capital markets.  While I have some reservations and disagreements with many aspects of the proposal, by and large it adds to the necessary debate.  Moreover, it presents a sane counterbalance to the drumbeat from Schapiro and other career regulators that it's always about more money and more staffing.  I commend these bullet points to your consideration:

Rationalizing the Regulatory Structure- The current structure is a result of years of layering and Dodd-Frank only exacerbated the situation, increasing duplicative and conflicting regulators. The Financial Stability Oversight Council (FSOC) should address the most egregious conflicts and duplications among the plethora of existing and new regulators.
Reforming Regulatory Agencies - Without fundamental reform of individual regulators, the system will not improve. Agencies have not kept pace with markets and technology. Regulators need to be overhauled to ensure they have the right operational capability and technology infrastructure to regulate today's markets.
Making Nongovernment Policymakers Accountable - The lack of transparency and accountability surrounding nongovernmental policymakers can undermine innovation, competition, and operation of the capital markets. Where nongovernmental policymakers receive extraordinary grants of authority from government explicitly (e.g., FINRA) or implicitly (e.g., ISS) they should also be required to adhere to the same basic due process and transparency rules the law requires from other regulators.
Restoring Integrity to Litigation and Enforcement- Strong, reliable capital markets depend on the ability to identify and stop wrong-doers from undermining confidence in the financial system. However, in many cases litigation and enforcement practices are used as an alternative to transparent and open rulemaking.
Improving U.S. Competitiveness and Engagement - The U.S. should seek to reach agreement in many areas where the markets operate globally. However, the United States should delay implementation and consider alternative approaches in areas where the rest of the world has already indicated it is unlikely to follow our approach, such as the Volcker Rule

Also see these prior articles by Bill Singer on the state of regulation: