AGA Today

SEC Chief Strives To Rebuild Regulator
Scrutiny Intensified In Financial Crisis

By Zachary A. Goldfarb
Washington Post Staff Writer
Thursday, June 4, 2009

On the morning of Feb. 4, the chairman of the Securities and Exchange Commission, Mary Schapiro, sat in a confidential meeting reviewing financial crime cases when an assistant handed her a note. Schapiro read it and then asked everyone in the room to leave, except for her fellow commissioners and their aides.

She learned that top SEC officials had just been pilloried at a House committee hearing on the agency's failure to detect Bernard Madoff's massive fraud. When the officials refused to answer questions about the case, one lawmaker lamented that the SEC had acted like it had been "anointed by God to be all righteous."

With the room cleared, Schapiro asked whether, before her arrival eight days earlier, the agency had placed legal limits on what officials could tell Congress. It had not. Then, she immediately phoned the committee leaders and wrote a letter promising "a full accounting, both of Mr. Madoff's activities and why we did not detect the fraud."

Schapiro's rapid response offers a window into her strategy to rebuild what was once the nation's premier financial regulator and preserve the agency as the Obama administration and Congress set out to shape the future of financial regulation.

Inside the agency, Schapiro is working to step up enforcement efforts, pushing cases linked to the financial crisis and freeing investigators to more vigorously pursue financial wrongdoing. She is also pursuing regulations to govern hedge funds, derivatives, short-selling, money managers, corporate disclosures and governance.

The agency has been under enormous pressure to change. Besides the fallout from the multibillion-dollar Madoff fraud, the SEC has been hamstrung by years of bureaucratic infighting and wounded by a series of internal investigations into suspicious trading and other potential misconduct by employees. Now, the agency is fighting to protect its domain as Obama administration officials discuss stripping key powers.

Schapiro's efforts to reform the agency are still getting off the ground and have yet to gain the prominence of actions taken by the Treasury Department and Federal Reserve to stabilize the financial system. But by taking so many actions so quickly, Schapiro is trying to send the message that the SEC is an aggressive and relevant regulator.

"I wanted to be very clear almost from my first day -- not just with words, which are pretty easy to string together, but with actions -- that this is a new SEC that is moving in a decidedly different direction and at a decidedly different pace," she said in one of a pair of lengthy interviews.

Since 1934, the SEC has been writing rules for companies that participate in the financial markets and penalizing firms that break them. It is the agency's job to ensure that investors have honest and timely information, that funds and investment firms don't abuse their clients and that public companies give investors accurate data about their financial condition. But its recent past has been troubled. It oversaw the investment banking industry that all but collapsed last year, dragging down the market. The SEC leadership has appeared missing in action during moments of crisis. And the agency's pride -- enforcement -- has suffered.

"Our markets are vulnerable if we're not able to restore confidence," Schapiro said. What investors "need to see is that the rules that are in place and will be in the future are enforced and aggressively enforced. If they don't see that, their reluctance to engage the capital markets will be pretty significant."

But the messaging only goes so far. More than three months after she promised a full accounting of the Madoff fraud, neither Congress nor the public has received one.

Crisis Drives Change
Schapiro sat down in February in the agency's ceremonial conference room for a private meeting with a dozen enforcement division leaders.

In her first days, she had selected a new enforcement director, former federal prosecutor Robert Khuzami. Schapiro ended policies that had demoralized the division, including requirements that it appear before the full commission before subpoenaing documents or approaching companies about settlements.

Now it was time to lay down her view of what enforcement needed to do. She told the division leaders that some investigations seemed stale, such as ones into illegally backdated options. She urged them to move fast on cases with ties to the financial and economic crisis, "even if that means you have to stop focusing on the 100th backdating case, so you can look at subprime investigations."

Some enforcement division leaders were reluctant to drop cases. And just a few years ago, the SEC was under pressure to take a lighter touch, with reminders that the nation could lose business if U.S. regulators were tougher than those abroad.

"That philosophy started to permeate and led people to a sense of complacency abut the need for aggressive enforcement," Schapiro said in the interview. "All the changes in enforcement are really geared toward fast, important, significant enforcement cases."

Schapiro set her eyes on a single case: an investigation into the breakdown last fall at Reserve Primary Fund, a $60 billion money-market mutual fund, that spurred massive government programs to prevent broader fallout.

SEC investigators suspected that Reserve's management deceived investors about their willingness to stand behind the fund if it were to wobble. But the case could take years. "You need to speed it up to light speed," Schapiro told investigators. Three months later, the SEC filed the case, and Reserve is now fighting the charges in court.

Still weighing heavily on the SEC is how the Madoff fraud went undetected. Schapiro calls the SEC's record in the case a "failure," despite complaints from some enforcement personnel about that characterization. But the full account of what went wrong will depend, in large part, on a report being prepared by the agency's inspector general.

For now, Schapiro has taken steps to fix problems exposed by the fraud, researching new whistle-blower protections and ways to collect tips, and proposing new rules to protect people who invest with money managers like Madoff.

'Inevitable Tension'
"Are you tough enough?"

It is a question frequently asked of Schapiro by her mentor, former SEC chairman Arthur Levitt.

The SEC chairman is "a job for someone who can endure the confrontation that comes with the inevitable tension that exists between Congress, the business community, the accounting profession and investor advocates," Levitt said. "Unless you're prepared to deal with those . . . you'll get subsumed by the system."

Schapiro, 53, knows the territory well. She began her career as an enforcement lawyer at the SEC, and, in short order, was one of the agency's five commissioners, the chairman of the Commodity Futures Trading Commission and the head of Wall Street's self-policing arm, when President-elect Obama tapped her.

The first controversy of Schapiro's tenure centered on the decision by the nation's accounting board, which the SEC oversees, to relax rules on how banks value assets. The change, pushed by lawmakers and banks, enabled firms to boost earnings. Schapiro said she didn't want to interfere with an independent board, but critics faulted her for not fighting to preserve strict rules.

"When you start to undermine transparency in the marketplace . . . then you start to move to a market where investors aren't getting the information they need," said Lynn Turner, a former SEC chief accountant. "Mary's always been an inside-the-Beltway type person. I suspect she went along with the team."

When Congress has called, Schapiro has been quick to respond, in public and private.

Early in her tenure, Sen. Charles E. Grassley (R-Iowa) complained that the SEC might be ignoring a potential insider trading case at Lehman Brothers. The SEC quickly authorized staff to brief Grassley's office, saying the probe into the insider trading case was ongoing but had been interrupted by the investment bank's collapse, according to people familiar with the matter.

In late April, Schapiro was 35 minutes into an interview when her assistant walked in to say Sen. Charles E. Schumer (D-N.Y.) was on the phone.

The senator wanted Schapiro to appear at a news conference where he was planning to call for amending a bill to boost SEC funding. The next day, she was there. 

"Our success will depend in part on how well we work with Congress," Schapiro said. "They have the resources, and they can fix the law when we feel the law is broken."

Staking Out a Future
Schapiro's challenge is to distinguish the SEC when the Federal Reserve and Treasury, with their billions of dollars in resources, seem to be in the driver's seat. 

An early test came March 26. Schapiro had spent months refining her precise views on the future of financial regulation and the SEC's role. She was finally ready to air those views at a Senate hearing.

Meanwhile, Treasury Secretary Timothy Geithner was planning his own unveiling, to be delivered at the same time to a House committee. Until late the night before, Geithner hadn't told Schapiro details of his plans.

Schapiro moved to assert the SEC's relevance, arguing the agency should have authority to regulate all hedge funds, play a role in regulating derivatives and be part of a council of regulators with responsibility for spotting risks to the overall financial system.

But Geithner differed. He argued for regulation only for large hedge funds, didn't mention a role for the SEC with derivatives and supported a "single entity" to spot systemic risks, which was well known to be the Federal Reserve.

In recent weeks, similar differences have emerged over what role the SEC should have in regulating consumer financial products, a discussion that could lead to the agency losing powers, such as authority over mutual funds. Schapiro has been at the Treasury often, advocating her view.

Many of Schapiro's ideas will require legislative approval. On others, she has moved faster than any other chairman before, though these initiatives must go through the SEC's lengthy process for introducing, getting comments on and passing new rules.

The SEC has proposed limits on short-selling, tighter rules on investment advisers and easier ways for shareholders to influence corporate boards of directors. Still to be proposed are new rules on money-market mutual funds and municipal securities and requirements to boost how much companies must tell investors about how they pay top executives.

Inside the SEC, Schapiro seems to be establishing the commanding presence she'll need to build outside.

Recently, a litigator was presenting a case before the agency's commissioners at a confidential meeting. She concluded an argument by calling Schapiro "your honor."

Schapiro smiled and noted she's not a judge. A few minutes later, Commissioner Luis Aguilar concluded his comments with the same "your honor."

The chairman acknowledged: "I could get used to this."