Tougher financial regulations not coming fast or easy for SEC's Mary Schapiro

By Zachary A. Goldfarb
Tuesday, February 16, 2010; A09

As Mary Schapiro took the reins of the Securities and Exchange Commission last year, she faced a torrent of complaints from lawmakers and bankers that Wall Street short sellers had driven down bank stocks during the financial crisis, contributing to the fear that gripped the nation.

As SEC chairman, Schapiro pledged to quickly pursue new limits on short selling. In April, just two months after she took the job, the agency unveiled a proposal to crack down on the practice.

But more than a year after Schapiro took office, the SEC has not yet written into the Wall Street rulebook the short-selling limits -- or most of the other measures that the agency has proposed to more tightly regulate the financial system.

Among the proposals that have not been finalized are new rules to make it easier for shareholders to shape the upper echelons of corporate management, an overhaul of the credit-rating industry that judges the quality of investments and measures to curb corruption in state pension plans. Each of those measures is aimed at failings that became apparent during the past two years.

Whether Schapiro can achieve more of her reform agenda will be a test of how much she can change the SEC, which gained a reputation as a weak Wall Street regulator in the years leading up to the financial crisis. The commission's poor performance in part led the Bush and Obama administrations to consider stripping it of key powers, but Schapiro's ambitious vision for the agency has helped the SEC retain its authority.

Schapiro defended the agency's progress.

"It can take more time than one might have thought at the outset," she said in an interview. "We have to understand the real-life implications of what we're doing, the unintended consequences. We need to digest all the comments and all the economic analysis. And that leads us down a path that sometimes isn't 100 percent predictable at the beginning."

Lynn Turner, a former senior SEC official who has served under three agency chairmen, gives Schapiro an "incomplete" grade. "But that's not a negative," he said. "It takes a while to get regulations done and it's just too early to tell how effective she'll be."

In the win column

The agency has recorded several achievements in the past year, finalizing three new policies striking at problems that have recently surfaced on Wall Street.

The agency put in place conditions that investment advisers be audited, a response to the massive Ponzi scheme run by Bernard L. Madoff. It tightened requirements on seemingly ultra-safe money-market funds after one of them, the Reserve Primary Fund, lost investors' money in fall 2008. And the SEC required public companies to tell shareholders more about how their pay practices could lead to excessive risk taking, reflecting widespread concern that banks pay employees based on the quantity, not quality, of the investments they sell.

"Before Mary's term, the average time for a proposal to be adopted was 10 1/2 months," said commissioner Elisse B. Walter, an ally. "Things here have been moving pretty swiftly."

Facing hurdles

But with many proposals, Schapiro has faced roadblocks.

The short-selling proposal met resistance from powerful Wall Street firms, and economists widely argued that it would have little effect. Moreover, the agency's staff is having difficulty tailoring a rule that would discourage short selling designed to manipulate stock prices while not shutting out legitimate forms of the practice.

In a short sale, a trader borrows someone else's stock and sells it, betting that its price will fall. The trader's plan is to buy back the same stock for less money and pocket the difference before returning it to its owner.

Despite increasing doubts inside the commission about the proposed limit, SEC observers say Schapiro would have trouble backing down from a proposal that she so publicly supported and has significant backing on Capitol Hill.

"As a matter of purely rational economics, the short-selling proposals are unnecessary, but they're probably politically required," said Brian Cartwright, a former SEC general counsel.

There are other barriers at the SEC, including divisions among the commissioners. Schapiro is an independent appointed by a Democrat. Two of her four colleagues are Democrats, one close to her, the other pushing for even more aggressive steps. The other commissioners are Republicans, both skeptical of many of Schapiro's proposals.

The SEC also faces the risk of a legal challenge from businesses, which have previously won lawsuits to overturn agency rules. "The commission hasn't had a perfect record in winning litigated cases and it wants to be very careful not to propose something that will be later struck down," said John Olson, a securities lawyer at Gibson Dunn in Washington.

Nor, under law, does the agency have the power its top officials want to regulate the markets. The SEC needs new authority from Congress to step up oversight of hedge funds and financial derivatives, as Schapiro would like.

Schapiro has also said she wants to overhaul the credit-rating industry, after it was blamed for giving inflated grades to many of the mortgage-related securities that went bust in the crisis. But while the commission, which oversees the industry, has adopted minor reforms, Congress must give the SEC the authority to write stricter or more sweeping rules.

Proposals on the table

The commission, meanwhile, did propose rules to ban the use by pension plans of outside, politically connected consultants after a huge pay-to-play scandal in New York came to light last year. But the agency is facing unexpected resistance from the very pension plans it is trying to protect -- they say they need the consultants for investment advice.

Despite industry opposition, the SEC has proposed three rules to keep Wall Street firms from using new technologies to get an unfair trading advantage over ordinary investors. But no deadline has been set for adoption of the measures.

One of the initiatives that Schapiro has most often touted is the "proxy access" proposal to give shareholders more power to nominate directors to serve on corporate boards. Many companies make it difficult for shareholders to band together to get directors elected. By keeping shareholders at bay, management can maintain tighter control over a range of corporate matters, including compensation.

Proxy access has been a major issue for Democratic politicians, and labor unions in particular have pressed the issue, seeking to influence management. Big business has actively fought attempts to introduce proxy access by conventional lobbying and in court.

In June, the agency proposed new rules for shareholders to nominate directors to boards. The plan received more than 50,000 public comments. The agency's goal was to put those rules in place by the end of 2009, so that they could affect the corporate voting season that begins in the spring. The deadline was breached and proxy access won't be in place until 2011 at the earliest.

"We would have liked to see a rule in place, but it's important that basically they do as good a job as they can in crafting it," said John Keenan, who works on corporate governance and public pension issues for the American Federation of State, County and Municipal Employees.

Moving slowly

The SEC is taking a long time because it faces many legal risks. In several recent cases in federal court, SEC rules have been struck down because key business interests were able to show the court that the agency failed to take their concerns into consideration before rules were issued.

A 1992 Supreme Court case looms large because the justices limited the powers of the SEC in telling companies how to run their businesses.

The U.S. Chamber of Commerce, for one, is likely to sue once the agency finally issues its proxy rules. "We continue to believe that the SEC lacks the authority and in particular this proposal is unworkable," said David Hirschmann, senior vice president. "We've sued the SEC when we felt it's important in the past and we're not afraid to do it again."

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