What is the SEC?

The Securities and Exchange Commission (SEC) is a federal agency responsible for regulating the securities industry and for enforcing federal securities law. It is meant to protect the public against fraudulent and manipulative practices in the securities markets. While this is a simplification, you can think of them as the group that polices (or is supposed to police) Wall Street.

The SEC was created by the Securities Exchange Act of 1934 to regulate the securities industry. This law was passed in the wake of the 1929 crash, which led to the Great Depression. As Investopedia writes, in the time before the crash, “commercial banks were accused of being too speculative in the pre-Depression era…. Unsound loans were issued to companies in which the bank had invested, and clients would be encouraged to invest in those same stocks.“ The spirit of the Exchange Act was to address the abuses of the past.

The authority this Exchange Act gives the SEC includes “the power to register, regulate, and oversee brokerage firms, transfer agents, and clearing agencies as well as the nation’s securities self regulatory organizations (SROs).”  The SEC does not have criminal authority, and primarily enforces its rules through the imposition of fines. It can refer cases to the Department of Justice for criminal investigation.

What are the maximum fines the SEC can charge for violations?

Fines against individuals are capped at $150,000 per violation. Penalties for firms are capped at $725,000 per violation.

At the end of November, SEC Chairman Mary Schapiro requested that these caps be raised to $1 million per violation for individuals, and $10 million per violation for firms, but these requests have not yet been addressed by Congress.

How is the SEC funded?

The SEC is funded each year by Congress.

You might think the SEC could be self-funded, given that “in some years, the agency has taken in almost twice the regulatory fees as Congress has provided it in funding.” But the SEC is not allowed to keep the fees and fines it receives through settlements or through the courts. Instead, any fees in surplus of their expenses go to the Treasury.

What are the laws the SEC enforces?

Read more at: http://www.sec.gov/about/whatwedo.shtml#laws

How many people work at the SEC?

The SEC has approximately 3,500 employees and 11 regional offices in the United States.# For context, the NYPD employs 34,500.

Criticisms of SEC’s Effectiveness

Many argue that the SEC is under-staffed and under-funded, leaving them unable to adequately police the US financial system. Bartlett Naylor of Public Citizen, a consumer rights advocacy group, pointed out back in March 2011 that:

”The SEC also deals with a more basic asymmetry in the cat-and-mouse game against market fraudsters: Veteran staff enforcement attorneys at the SEC may earn $125,000, whereas first-year attorneys at elite private firms begin at $160,000. The lure of such huge compensation adds an additional challenges for the SEC as astronomical paychecks siphon many talented people into the business of perpetuating frauds and fomenting financial crises.”

Prior to Dodd-Frank’s Wall Street reform law, the SEC oversaw some 6,400 public companies.
 The Dodd-Frank Wall Street reform law adds to the SEC’s responsibilities, requiring it to oversee an additional 30,000 institutions.

For additional comparison purposes, here are the total number of employees at just five of the 6,400 U.S. companies the SEC oversees:

New Powers Under Dodd-Frank

Section 922 of the Dodd-Frank Act includes a new whisteblower program, which intends to “reward individuals who act early to expose violations and who provide significant evidence that helps the SEC bring successful cases.”

This whistleblower program includes a bounty:

“The Commission is authorized by Congress to provide monetary awards to eligible individuals who come forward with high-quality original information that leads to a Commission enforcement action in which over $1,000,000 in sanctions is ordered. The range for awards is between 10% and 30% of the money collected.”

Settling vs Going to Court

The SEC has been criticized for routinely settling out of court with the banks that violate securities law. These settlements are often presented to judges for their approval.

Judge Rakoff’s Rejection of the November 2011 SEC/Citigroup Settlement

At the end of November, Judge Jed S. Rakoff of United States District Court in Manhattan threw out a proposed settlement between the SEC and Citigroup for $285 Million.

The settlement was over a case where Citi allegedly bundled up low-grade mortgage-backed securities, sold them off to investors, and then simultaneously shorted (i.e. bet against) the same securities. Citi made $160 million off the deal, and investors lost $700 million.

Settling would have allowed Citigroup to avoid admitting any guilt at all. All the SEC charged them with was “negligence.” The SEC did NOT charge Citigroup with outright fraud. This is despite the SEC having referred to Citigroup in a memo as a recidivist (a habitual criminal). Judge Rakoff states in the ruling: “By the S.E.C.’s own account, Citigroup is a recidivist.”

Settling also would have allowed Citi to avoid going to court, where the case would be argued out in public and put before a jury. Had Citi lost in court, it would have been subject to FAR more in fines than the $285 million that it settled for.

Judge Rakoff threw out the settlement, insisting that the case must go to trial.

As Adam Sorensen noted in Time:

“Monday’s decision could have implications beyond Citibank. Settling out of court with no admission of wrongdoing has frequently been the SEC’s modus operandi in cases like this. If political momentum built in the wake of Rakoff’s ruling and other judges picked up his banner, Wall Street could face a level of scrutiny it has so far avoided.”

Notable SEC Employees

The current chairman of the SEC is Mary Schapiro. She was a Commisioner at the SEC from 1988-1994, and has worked at another regulatory agency, the CFTC, as well as FINRA, which is one of the self-regulatory organizations that oversee the banks. Schaprio worked at FINRA (then named NASD) from 1996-2008.

Schaprio, during her time at FINRA, was an example of a regulator who made nearly as much as a Wall Street execuitve. In her final year at FINRA, “Schapiro earned a regular compensation package of $3.3 million; on departure from FINRA, she received additional lump sum retirement benefit payments that brought her total package in 2008 to $8,985,334 (about the same as Goldman Sachs CEO Lloyd Blankfein made in that year).”

Robert Khuzami is the current Director of Enforcement at the SEC. Prior to working at the SEC, Khuzami worked at Deutsche Bank as the global head of litigation from 2002-2004, and as the General Counsel to the Americas from 2004-2009. His history as General Counsel at Deutsche Bank makes him a controversial figure at the SEC, as Deutsche Bank was a major issuer of CDOs, a type of mortgage derivative central to the 2008 crisis. As noted by the Wall Street Journal, “Deutsche Bank has faced allegations of inadequate disclosure over its creation of CDOs.

Richard Bookstaber is a senior policy advisor at the SEC’s Division of Risk, Strategy, and Financial Innovation. Bookstaber had a long career on Wall Street before joining the SEC, including serving as the head of firm-wide risk management at Salomon Brothers and as the first market risk manager at Morgan Stanley. Bookstaber is the author of Name Your Link

What is the Volcker Rule?

What is popularly referred to as “The Volcker Rule” is actually Section 619 of the Dodd-Frank Act, which was passed in 2010 and aims to regulate Wall Street. Its official title is “Prohibitions on Proprietary Trading and Certain Relationships with Hedge Funds and Private Equity Funds.”The Volcker Rule bans proprietary trading (i.e. speculation) and investments in hedge funds at government backstopped banks.

The concern behind the Volcker Rule is that banks have used depositors’ funds from FDIC-insured checking and savings accounts, as well as access to virtually free money from the Federal Reserve, in order to take extremely risky bets in the financial markets.  When these bets fail, they leave bank depositors and the American taxpayer holding the bag.

Similar concerns arose during the Great Depression of the 1930’s, leading to the passage of the Glass-Steagall Act, which required retail banks to be separate from investment banks.  Unfortunately, in the 1990’s, federal regulators and Congress buckled under pressure from the banking lobby and gradually repealed Glass-Steagall.  The final death-knell of Glass-Steagall came in the form of the Gramm-Leach-Bliley Act.  The proposed Volcker Rule attempts to approximate the restrictions of Glass-Steagall. However, there are a large number of exceptions to the rule in the current draft, which we believe has the potential to be abused by the banks.

Why is it called “The Volcker Rule”?

The Volcker Rule is named after Paul Volcker, who served as the Chairman of the Federal Reserve from 1979-1987. Following the financial crisis of 2008, Volcker wrote a three-page memo to President Obama where he argued that to avoid a similar crisis in the future, one approach would be to eliminate proprietary trading at and ownership of hedge funds by the big banks.

Is the Volcker Rule in effect now?

The Volcker Rule is not currently in effect. That is because Section 619 passed the task of writing the actual implementation of this new rule on to the regulators (the SEC, the Federal Reserve, and others). The regulators released their draft in October 2011, and the public has until January 13th, 2012 to submit comments on this draft. All comments become a part of the public record, and can be viewed online. After the comment period, the regulators will create the final rule, taking into account the comments received. The final rule is scheduled to go into effect on July 21st, 2012.

What does the Draft Volcker Rule Say?

The Draft of the Volcker Rule that the SEC and the banking regulators have prepared does ban proprietary trading at banks, and prevents them from owning hedge funds, but it makes many exceptions to these broad bans. Here are just a few:

  • Banks are still allowed to perform underwriting and market-making.
  • They are allowed to have up to a 3% ownership interest in a hedge fund.
  • In the first year of a hedge fund, that 3% limit does not apply.
  • The trading of repurchase agreements (called repos for short) is given a blanket exemption.

These exceptions, in their current form, are so broad that they have the capacity to essentially nullify the Volcker Rule’s main restrictions.