As any compliance officer or risk expert can tell you, goals must be matched with budget realities. The dollars allotted to specific functions dictate efforts and underscore the need for enhanced risk assessments to prioritize them.
The workaround, when faced with financial constraints: use data to work smarter, not harder. It is a lesson the Securities and Exchange Commission is learning, based on Chairman Mary Jo White’s March 22 testimony before a subcommittee of the U.S. House Committee on Appropriations. She was there to defend the President’s 2017 budget request and the $1.781 billion earmarked for her agency, a 6 percent increase.
The crux of White’s testimony, put simply: the SEC needs a budget boost, but is capable of working within its fiscal parameters. Tied to that was a discussion of how she hopes to guide the Commission’s immediate future.
The proposed funding will allow the agency to hire an additional 250 staff in “critical, core areas,” White said. Goals are to increase examination coverage of investment advisers; improving in-house technology; bolstering economic and risk analysis functions; and hiring more market experts.
The budget request, White said, follows a very successful year. The SEC brought a record number of enforcement cases (807), secured an all-time high for penalties and disgorgement (more than $4.2 billion); and performed exams at a level not seen for the past five years (more than 2,200).
What’s ahead? White said the need to increase examination coverage of registered investment advisers and investment companies “cannot be overstated.”
The largest increase in entities registered with the SEC is among investment advisers. A decade ago, there were approximately 9,000, managing $28 trillion in assets. Current projections see more than 12,500 investment advisers managing $70 trillion in assets by fiscal year 2017. Examination challenges are posed by the increased use of new and complex products by investment advisers and broker-dealers and evolving technology that facilitates activities such as high-frequency and algorithmic trading.
A top priority in the new budget is to hire 127 additional examiners, primarily to conduct additional examinations of investment advisers, but also to improve oversight of broker-dealers, clearing agencies, transfer agents, SROs, swap data repositories, municipal advisors, and crowdfunding portals.
Planned technology investments include an expansion of data analytic tools that can detect fraudulent or manipulative trading, identify financial statement outliers or unusual trends indicative of possible accounting fraud, and money laundering. Modernizing the EDGAR filing system, part of an effort “to simplify and optimize the financial reporting process, promote automation, and reduce filer burden,” White said. Improving examinations through risk assessment and surveillance tools will help monitor for emerging fraud risks and improve the efficiency of examinations.
White underscored the importance of the economic and risk analysis functions of its Division of Economic and Risk Analysis and plans to add six new positions to focus on exchange-traded funds, microcap stocks, the derivatives markets, and asset-backed securities.
As for the growing importance of cost-benefit analysis, White called DERA, “one of the great success stories of the SEC.” It has allowed “substantive and original research” to inform rulemaking. “I don’t think you can overstate its importance to the quality of our rules,” she said.
White was questioned, by Rep. Tom Graves (R-Georgia) about reported conflicts between her agency and the Department of Labor.
Among the most hotly contested rules in the regulatory pipeline is an effort to create a fiduciary duty for brokers who offer retirement advice. Rules to do so, crafted separately by the Department of Labor and SEC, would limit broker-dealers and advisers to providing financial advice that is in the best interests of their clients.
It is likely the DoL’s rule will predate anything from the SEC by at least several months. A recent report by the Senate Homeland Security and Governmental Affairs Committee claims that the “Labor Department disregarded concerns and recommendations from…staff at the SEC,” despite public assurances to the contrary.
White was diplomatic regarding perceived discord, but did reveal it was likely the rules would differ among the agencies. “You try to make them compatible if you can,” she said of dueling rules. “You try to make them land identically, but these are separate agencies with separate mandates and they don’t always [do that].”
On other oversight of broker-dealers and investment advisers, White detailed a growing focus on repeat offenders and the firms that hire them. “They show up again at another firm, and then again at a another firm,” she said of a troubling cycle.
The markets policed by the SEC have many new registrants, Rep. Nita Lowey (D-N.Y.) explained. More than 2,300 private fund advisers have registered since the effective date of the Dodd-Frank Act and more than 800 municipal advisers are expected to be registered by 2017. The Commission also faces new examinations for swap execution facilities, swap dealers, and crowdfunding portals. How can it prioritize these efforts?
“The markets we have to police are getting smarter, more complex, bigger, and faster, all the time.
We try to make the smartest use of the resources we have,” White said. “There will be more risk-based identification of where we need to go, data reviews and smarter analytics.”
For example, a software tool, ARTEMIS, developed in-house, can be used to identify suspicious patterns among traders, connecting the dots needed to uncover insider trading. “You don’t have to wait for an event and then wait and see who traded,” White said.
With larger-than-ever data depositories, the SEC will need to continually improve its cyber-security defenses and internal controls. “We need to be able to regulate, but we also have to be able to give the requisite assurances that we will safeguard sensitive information,” White said, adding that $14.7 million of the forthcoming budget will be used to enhance internal security systems.
The dilemma: how much can the SEC say, publicly, about how it is enhancing those systems. “It is a bit of a balance, because you don’t want to be too detailed about it or you are giving a roadmap,” White said, although she conceded that, “we need to get to a point where we can say more than we have in the past.”