Run With All of Donaldson's Rules, Mr. Cox
August 15, 2005
There was a good reason why former Securities and Exchange Chairman William Donaldson chose as his last official act a vote to reapprove controversial mutual fund governance reforms.
Faced with a narrow 3-2 voting margin on some of his biggest initiatives, Donaldson may well have calculated that his successor could turn the SEC into a very different place - where the 3-2 margin would shift to the other, less-restrictive side on contentious regulatory issues.
Donaldson, ever the independent-minded pragmatist, was right on the money as usual.
When the Senate confirmed Christopher Cox as the new chairman on July 29, it also confirmed Roel Campos and SEC staff veteran Annette Nazareth as the Democratic members of the five-member Commission.
Cox, bringing a pro-business reputation and voting record as a California Republican Congressman, is much less likely than was Donaldson to side with the Democrats, thus shifting the balance of power - particularly on those close votes - toward the Republican majority of Cox, Paul Atkins and Cynthia Glassman.
Early Acid Test
An early test could come on those mutual fund governance reforms.
Although they are now in effect, with a compliance date of 2006, the U.S. Chamber of Commerce has filed suit for the second time to block them (see MME 5/16/05, 6/13/05, 7/4/05). If the court remands the rules to the SEC again, which happened at the U.S. Court of Appeals last Wednesday, the Commission under Cox could vote them down.
There will, before too long, be other ways for Cox's SEC to show its colors on major reform initiatives. Still in limbo is the anti-late-trading "hard close" proposal, which would require purchase or redemption of mutual fund shares by 4:00 p.m. in order to receive that day's price.
As a centerpiece of Donaldson's operational reform efforts, the hard close has been hobbled in part by its complexity. A technology-assisted alternative for preventing late-trading abuses was reported to be under consideration at the time Donaldson stepped down.
Point-of-sale disclosure is another unresolved issue. This deals with the obligation of a broker/dealer to provide information to customers at the point of sale about fees and conflicts of interest. There have been proposals and redrafts, with the SEC indicating an expectation that the information be provided in writing - which the fund industry, led by the Investment Company Institute, opposes.
Get Thee to the Web
"We are not in favor of hard copy," says ICI General Counsel Elizabeth Krentzman. "The solution is that it be posted on the Internet."
There is no requirement that the Commission act on its proposals, so the SEC under Cox might choose to do nothing at all. Or it could act selectively, addressing issues such as late trading and leaving others on the back burner. Krentzman, who has served at the SEC as an assistant director, points out that the chairman traditionally has a significant impact on the policy agenda. Mutual fund reform may or may not be given a high priority.
There have been some dire warnings that Cox could sell out hard-won investor protections. "Cox has repeatedly demonstrated a preference for sacrificing investor protection," said an editorial in the Washington Post, adding that installing Cox at the SEC "signals the return to pliant directors, misleading financial statements, disenfranchised shareholders and runaway executive salaries."
But however much of a pro-business cheerleader Cox may have been in the past, the choice of whether or not to be a vigorous regulator might not rest entirely in his hands.
To roll back fund rules or slow the momentum of a reinvigorated SEC could send the wrong signal at a time when regulation and compliance have of necessity become top corporate priorities.
As Senator Paul Sarbanes, (D-Md.) - he of the Sarbanes-Oxley Act - pointed out at Cox's confirmation hearing, the scope and scale of recent corporate transgressions has exceeded anything the U.S. has witnessed since before the Great Depression. First there were the accounting, disclosure and governance problems at Enron, WorldCom and other big public companies. Then there were major financial institutions issuing misleading and fraudulent analyst reports, resulting in the Wall Street global settlement. There were also systemic problems with the functioning of stock exchanges, leading, for example, to censure, fines and reform of regulation at the New York Stock Exchange.
Last but not least, mutual fund scandals involving market timing and late trading implicated some of the biggest and best-known investment firms in the world.
It is in the interest not only of investors, but also of the securities markets, for the SEC to maintain the strong regulatory framework established by Donaldson as a response to these unprecedented scandals.
Completing the Commission's mutual fund reform agenda is an important milestone on that road.
Cox seemed to be moving in this direction at his confirmation hearing, telling members of the Senate Banking Committee that his top priority as SEC chairman will be "vigorous enforcement of the securities laws," followed by "respect for the rule of law in our capital markets [and] continuity, clarity and consistency" in the Commission's rulemaking and enforcement responsibilities.
We hope this is an early indication that the SEC, which Sarbanes calls the "crown jewel of federal regulatory agencies," will continue to excel with effective leadership at the top. That more than one in every two households are invested directly or indirectly in the markets only underscores how vital is the SEC's mission to protect investors and maintain the integrity of the securities markets - and how critical is this moment of leadership transition.
As Cox himself said: "The number of Americans who are directly invested in securities has reached a record level. As a result, the work of the SEC is now more important than ever."
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