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Breaking windows at the SEC

Bill Coffin | January 9, 2017

When I was a kid, while my dad was driving us through town, I spotted some graffiti on a city wall. It wasn’t a random tag of somebody’s name; it was a mural that featured some pretty nice artwork. But it was still graffiti, and it had still been painted on somebody’s property without their consent. And it was surrounded by a whole lot of other sprayed paint that wasn’t trying to express something artistic; it was just vulgar slogans and boasting. I saw the art. My dad saw the criminality. He told me to look around at the part of town through which we traveling. It was a mess. Boarded up buildings, neglected property, crime … the works. My father said that the graffiti was the start of it. Once a neighborhood accepts the presence of that, it soon begins to accept the presence of much worse things.

I thought of that as we look toward a new era in the history of the Securities and Exchange Commission. If all goes well for President-Elect Trump, his nomination to run the SEC will be Jay Clayton, a renowned Wall Street lawyer who has some pretty strong opinions on how the nation’s top financial cops go about their business. In particular, Clayton takes issue with the “broken windows” enforcement philosophy championed for years by former SEC Chair Mary Jo White. The idea behind that strategy is simple: enforce smaller transgressions quickly and forcefully enough so that everybody won’t even think about committing really large transgressions. It’s kind of like how sticking gum underneath a park bench in Singapore will get you caned. No wonder why nobody tries to sell drugs on the street corner.

There is a point to be made here. Those who have felt the sharp end of the SEC’s “broken windows” approach note that the agency’s many successes here encourage it to enforce ever more enthusiastically. And that’s fine when you have folks who are actually committing wrongdoing. Where this metastasizes, however, is in areas where the SEC isn’t so sure if a company is breaking the law or not. As companies use emerging technologies and novel market strategies to innovate, they run the very real risk of gaining the SEC’s attention, which might just go ahead and drop the hammer on the company first, and figure out if it was actually doing wrong later. At this point, the SEC isn’t so much about going after broken windows, or building-side graffiti, but it’s about piking heads at the city gates as a warning to all others. And that isn’t exactly the best way to enforce the law. It might be very effective, sure. Tyranny usually is. But it isn’t just.

The trick is whether a Chairman Clayton would simply shift the focus of the SEC from low-severity offenses to high-severity offenses, or whether he would start there and usher in an era of a significantly depowered SEC that doesn’t just stop going after people for financial jaywalking, but is rendered so toothless that it will allow another Bernie Madoff scandal or another AIG fiasco to unfold. After all, if you stop going after broken windows, those windows will keep on breaking, and what happens when it’s suddenly a lot safer to commit low-level offenses? We won’t really know until it’s too late. And in the meantime, there will be a whole lot of compliance officers looking at a strangely quiet SEC and trying to figure out how to convince their C-Suites and boards of directors that even without the imminent threat of enforcement actions, robust compliance programs are still worth the investment.