Will Mary Schapiro Be An Investor-Advocate At the SEC?

Late into the news cycle last night, two Democratic officials confirmed that Mary Schapiro will be named chairperson of the SEC.  Ms. Schapiro currently serves as chief executive of the Financial Industry Regulatory Authority (FINRA), a self-regulatory entity created when both the New York Stock Exchange (NYSE) and National Associated of Securities Dealers (NASD) combined their oversight responsibilities.  She is the first person to hold the position since the creation of FINRA.

I am optimistic that Ms. Schapiro will use her new position, assuming she is confirmed, to revitalize the SEC.  She has both enforcement chops as well as experience rebuilding an outdated regulatory regime having created FINRA basically from scratch.  While I am no fan of Wall Street’s obsession with self-regulation, Ms. Schapiro has done a commendable job given the circumstances.

It is concerning that while she was in her position Bernie Madoff was able to allegedly perpetrate his Ponzi scheme and enforcement actions have slid, and I expect this to be a major issue during her confirmation hearing.  But I believe Ms. Schapiro’s experience will eventually temper those concerns.

Perhaps most importantly, Ms. Schapiro’s nomination breaks a destructive line of SEC leaders with close financial ties to the securities industry.  She has served as a regulator nearly her entire career.  She will also have the winds of reform at her back allowing her to more easily institute massive changes at the SEC.

For these reasons, Mary Schapiro is a good choice to oversee the SEC.

Change at the SEC: A Question of Who and What

Throughout his two-year presidential campaign, President-elect Barack Obama’s constant theme was a promise of change.  And nowhere are we in more need of it than in the regulation of our capital markets.  Therefore his nominee to head the SEC is naturally a focal point.

The most recent names rumored include William Brodsky, CEO of the Chicago Board Options Exchange, former SEC Commission Harvey Goldschmid, AFL-CIO Associate General-Counsel Damon Silvers and Mellody Hobson, president of Ariel Capital Management.  Others include Robert Pozen, Fidelity Investments Vice Chairman Robert Pozen and FDIC director Martin Gruenberg.

And of course no list would be complete without the ubiquitous Goldman Sachs alum.  This time it’s Gary Gensler, a current partner that also served as a Treasury Department Undersecretary.

I’ve been on record advocating that President-elect Obama’s advisors need not look any further than among a deep bench of state regulators.  Candidates that immediately come to mind are New York State Attorney General Andrew Cuomo, Massachusetts Secretary of State William Galvin and Karen Tyler, North Dakota Securities Commissioner and former president of the North American Securities Administrators Association (NASAA).

These individuals have shown an understanding of sophisticated financial instruments as well as the ability to identify problems and put into action meaningful, lasting solutions.  They have also shown that investor confidence and securities enforcement are not mutually exclusive concepts.  And they have taken on Wall Street’s legions of highly paid lawyers - and won.

President-elect Obama’s nomination needs to send a message: that the industry serves the investors, not vice-versa.  Naming any of these individuals or someone similar would be change investors can believe in.

Perhaps a more instructive conversation is to examine the issues and how a future SEC chairman can approach them from an investor’s standpoint.

However the financial regulation structure is modeled, an investor czar should be appointed who is singularly focused on ensuring proper disclosure and protection for all products sold to retail investors.  If Wall Street wants to sell ”microwave ovens” (as Merrill Lynch described its push to unload illiquid auction rate securities), they need to be regulated as such.

In addition to a czar, enforcement needs to be overhauled.  Penalties for Wall Street firms have become just a cost of doing business.  Fines and suspensions need to become meaningful enough to prevent wrongdoing.  Overhauling the securities arbitration process is another must.  FINRA must eliminate the industry arbitrator to make securities arbitration fairer for investors.

An overarching theme for the incoming SEC chair should be transparency and disclosure.  More transparency is needed in the credit default swaps market and in hedge fund transactions in particular. The SEC should regularly have the ability to examine hedge fund holdings and leverage to determine systemic risks.

Given the destruction we saw in the financial equities market, new regulations regarding short selling are also in order.  I strongly believe a short seller should be required to own a security (and not just stocks given hedge funds short any number of instruments) he or she wants to short.  And the SEC should reinstitute the up-tick rule at least until a more comprehensive understanding of its affect is reached.

Wall Street has fundamentally changed over the past 12 months and regulatory oversight must adjust as well.  If ever there was a silver lining, a great many  hucksters have been forced out and no longer pose a threat.  That’s good news for the market and the SEC.  But the incoming SEC leaders still have a monumental task ahead.

I am confident that with the right person in place, afforded with the right powers, a new and improved financial market is in our future.