SEC has its cleanup work cut out for it

Normally, agencies avoid controversial decisions in an election year

By STEPHEN LABATON

New York Times

Friday, January 2, 2004

Washington — Defying a quadrennial tradition here, the Securities and Exchange Commission enters this presidential election year with a remarkably ambitious and contentious agenda.

Every four years, most federal agencies all but go underground when it comes to making controversial decisions, hoping to avoid issues that could create difficulties for the White House or engage Congress as lawmakers and the president face the voters.

But for a variety of political, financial and policy reasons, 2004 is certain to be one of the commission’s busiest years in recent history. That is the expectation of both commission officials and occupants of the White House and of Capitol Hill. They all agree that the plans of the commission’s chairman, William H. Donaldson, to address some Wall Street and corporate issues are necessary to assuage the huge numbers of voters who are also investors.

“We’re in the cleanup period from the obviously well-publicized malfeasance of the decade of the 1990s,” said Donaldson, who became chairman of the agency last year after the political missteps that forced his predecessor, Harvey L. Pitt, to announce his resignation in November 2002 on the same day as the midterm congressional elections.

“Investor confidence has been severely diminished — confidence not just in Wall Street and the financial markets, but in the industry generally and in the mutual fund industry.”

The primary force compelling the commission to move forcefully is the more than two years of scandals that have yet to abate and have plagued public companies, the accounting profession, the New York Stock Exchange and the mutual fund industry. With so many Americans invested in the markets — one in two households owns at least one mutual fund — politicians have been pressing the regulators to continue to bring enforcement cases and to issue new rules. That is a clear exception to the prevailing climate of deregulation that has taken hold with both ends of Pennsylvania Ave. controlled by Republicans. Regulators and politicians fear the potent force of voters, should they encounter more Enrons and WorldComs.

Several lawmakers and Democratic presidential candidates, including Sens. Joseph Lieberman of Connecticut and John Edwards of North Carolina, have been clamoring for a more visible commission, urging it to move more swiftly in cleaning up the mutual fund industry in particular.

“Whether due to a lack of resources or other pressing priorities, mutual fund abuses simply did not receive adequate attention from the SEC,” Sen. Richard Shelby (R-Ala.), the chairman of the Senate Banking Committee, said at a hearing late last year. “Although recent enforcement actions indicate that priorities have changed, we need to understand how the SEC will revise compliance programs to detect and halt future fund abuses.”

Other lawmakers have announced that they intend to push for legislative solutions to the problems in the mutual fund industry, but some commission officials say those efforts could lose steam if the agency takes vigorous action first.

The commission also finds itself under considerable pressure from state officials — most notably the attorney general of New York, Eliot Spitzer — who have repeatedly discovered problems on Wall Street and in the mutual fund industry and, in the process, exposed the SEC to criticism that its inspectors, rule makers and prosecutors have not been diligent enough.

SEC has been busy

In the last year, the commission has approved significant changes in the governance of the New York Stock Exchange, including making the board more independent from Wall Street, insulating the Big Board’s regulatory apparatus from its business operations and requiring the exchange to split the jobs of its chairman and its chief executive. The commission has selected William J. McDonough to lead the new Accounting Oversight Board. And the commission has begun to reinvigorate its oversight of the mutual fund industry, adopting rules to eliminate late trading and trying to curtail abusive market timing.

But there is much more on the table. In the coming months, Donaldson and other officials say, the agency plans to rewrite the governance rules of mutual funds to force a large number of fund companies to find more independent directors and chairmen. They say they will redraw the proxy rules to permit large institutional investors to nominate alternative directors to troubled companies. And they say they will impose rules that reshape the structure of the stock markets, making fundamental decisions that will favor either the emerging electronic trading networks or the incumbent exchanges.

They also plan to impose a new regulatory framework on the hedge fund industry, which is scarcely regulated now. The commission proposes to require the funds to register and to make disclosures and to subject them to the possibility of greater government scrutiny.

In addition, the officials have announced they will overhaul the commission’s own byzantine structure as the agency undergoes its most significant growth in staff — by more than 25% — in decades. At the same time, they will be overseeing the first major efforts of the new Accounting Oversight Board to inspect and regulate the accounting firms that do work for publicly traded companies. The board has just begun its operations and inspections, taking over regulatory functions from the American Institute of Certified Public Accountants. That group, which is sponsored by the profession itself, failed for decades to ferret out any significant industry problems.

“It is amazing to think about how big the commission’s agenda is,” said Joel Seligman, a leading SEC historian and dean of the Washington University School of Law in St. Louis.

To the commissioners favoring the new regulations, the agency has little choice but to act.

“There’s a national need and a national anger,” said Harvey J. Goldschmid, a Democratic commissioner who has worked closely with Donaldson in fashioning many of the regulations of the last year and the agenda for action on the proposed ones. “The country’s future is based on some level on the decency of our financial markets. With all these people in the market, we cannot let this agency or the markets be left unguarded.”