Reforming the SEC: The Humbling of a Proud Agency

Bureaucracies, over time, become, well, bureaucratic.  As William O. Douglas, the third chairman of the SEC, wrote in a speech only four years after the creation of the SEC (the SEC only came into existence with the adoption of the Exchange Act; the Securities Act of 1933 left to the FTC the initial obligation to enforce the securities laws):  “Flexibility in any institution is difficult to obtain. Special vested interests acquire their strongholds. Habit and the ease of inaction dissipate constructive endeavors. Tradition exacts its toll.”

In short, federal agencies fight a constant struggle against vested interests, capture by the industry they regulate, the elevation of habit over thoughtfulness and, frankly, a declining sense of mission.  Rampant risk aversion creates an impediment to change.  Even the most dedicated agency can succumb to these forces after decades and decades of operation.

In some respects, the SEC has been luckier than most.  The Agency has had a relatively clear mission -- the protection of investors -- and has traditionally attracted a staff who believes in the mission.  The definition of investor protection has varied from administration to administration, but the core concern has always been there.  Indeed, the top echelons of the agency has traditionally been full of dedicated personnel who could easily parlay their experience into a much higher paid private sector position but prefer to work on a mission they believe in.  The structure of the Commission, particularly the requirement that both parties be represented on the body (its actually phrased as a requirement that no more than three members can be from the same political party) and the tradition of decision by consensus, likewise has contributed to the focused nature of the Agency.

But like all agencies, even the Commission can succomb to a creeping inertia and sense of ossification, relying on practices not because they are the best but because they are comfortable.  Moreover, the last Commission likely accelerated the trend by ending the reliance on consensus and undermining the investor protection mission of the Agency.  Certainly overturning the Second Circuit's decision in AFSMCE that allowed access bylaws placed the Commission squarely in opposition to the interests and views of most shareholders (the position wasn't helped by the attempt to justify the position by demonizing another group of shareholders, offshore hedge funds). 

Similarly, requiring pre-approval of corporate penalties by the Commission suggested that the Agency had lost some of its concern with investor protection.  The practice suggested that the Commission wanted the chance to reduce or kill efforts to impose meaningful punishment on corporate violators.  Indeed, corporate penalties fell off (the staff got the message) and the number of investigative attorneys in the Division of Enforcement dropped by 11%.  See GAO Report 09-358 March 2009 at 4 ("While overall Enforcement resources and activities have remained relatively level in recent years, the number of non-supervisory investigative attorneys, who have primary responsibility for developing enforcement cases, decreased by 11.5 percent, from a peak of 566 in fiscal year 2004 to 501 for fiscal year 2008."). 

At the same time, there was a sense that the market was out pacing the agency.  Complicated products and fast timelines required a more nimble response and greater expertise, both in short supply. 

With this background in mind, we will devote a series of posts to the future of the SEC, with most of the emphasis on the current efforts at reinvention, a process given particular immediacy with the problems surrounding the failure to detect the Madoff ponzi scheme.