White’s SEC departure inspires reflection, fear of ‘midnight regulations’

The past several days have looked a bit like a victory lap for Securities and Exchange Commission Chairman May Jo White.

She herself would probably never describe the week after announcing she will step down at the conclusion of the Obama Administration as such, but carefully chosen words on her accomplishments reveal no small measure of well-earned pride. Regrets? She’s had a few. They too have emerged in recent commentaries, as has her vision of where regulators and legislators should direct their efforts in the months and years ahead.

Even some of White’s toughest critics in Congress have taken the opportunity to offer praise. On Nov. 15, for the last time, she testified before the House Financial Services Committee on the agencies 2018 budget request. Although many topics were discussed in light of her departure, agency finances was not one of them.

“She has brought an incredible amount of professionalism to her position,” Financial Services Committee Chairman Jeb Hensarling (R-Texas) said. “She is known for her independent judgment, which is greatly admired and respected …The accountability and transparency that she has brought to this office is greatly, greatly admired.”

Lest she be “lulled into a false sense of security,” Hensarling did raise several concerns. Chief among them was “the SEC’s ongoing failure to develop a capital formation agenda.

“Notwithstanding two very minor rule changes approved last month, the SEC has done little to promote capital formation since Congress passed the JOBS Act in 2012 … Also languishing at the SEC is the directive passed by Congress requiring the SEC to simplify its disclosure regime,” he said. The FAST Act, which became law nearly a year ago, requires the SEC to eliminate or reduce burdensome, duplicative or outdated disclosures.

“I know you’re under enormous pressure from those who are intent on politicizing the SEC’s disclosure regime, but you have an obligation to follow the law and not appease extremists whose ideological objectives have nothing to do with the SEC’s core mission,” Hensarling said, likely referencing concerns by Sen. Elizabeth Warren (D-Mass.) that reducing disclosures as a remedy to “investor overload” would only serve to harm investors in the long run.

Hensarling, and others on the committee, expressed a more immediate concern: the likelihood of last-minute regulatory actions as the Obama Administration winds to a close.

“Whenever there is a transfer of power from one presidential administration to another, there is a temptation for federal agencies to rush pending rulemakings to completion, as a way of cementing the policy priorities of the outgoing administration,” he said. “But this type of ‘midnight rulemaking’ is neither conducive to sound policy nor consistent with principles of democratic accountability.”

“At a minimum, we should closely study the track record of the U.K.’s Senior Manager Regime for what it can teach us about implementing a broader and stronger enforcement regime in the U.S. for holding executives accountable.”
Mary Jo White, Chairman, SEC

As there are currently two vacancies at the Commission, “absent an emergency and given your current reputation and legacy, I would strongly urge you to respect the results of last week’s election and resist the temptation to finalize any regulations, including Dodd-Frank Title VII regulations, in deference to the right of the incoming administration to set its own priorities upon taking office in January,” he said.

“Do you have any requests from the administration, or do you guys at the SEC have any ideas for midnight rules you are getting ready to propose that we need to be watchful for or are going to be coming in the backdoor here that we need to be thinking about?” asked Rep. Blaine Luetkemeyer (R-Mo.).

White’s response was that she intends to stick to an agenda for 2016 that she set out in February. “I don’t see any last-minute rushes, but I do intend to carry out the agenda I outlined,” White said. When pressed, however, she refused to say that she would back away from a controversial incentive compensation rule for financial institutions.

Six federal agencies are currently reviewing public comment on a proposed rule to prohibit incentive-based compensation arrangements that encourage inappropriate risks at covered financial institutions. Their requirement to do so was established by the Dodd-Frank Act.

Rep. Bill Huizenga (R-Mich.) noted concern over reports that regulators were rushing to finalize the incentive compensation rule prior to President-elect Trump taking office. “Will you commit to us, that you will stay any Commission vote on that rule until after the inauguration?” Huizenga asked.

“I don’t think any rulemaking benefits from being rushed,” White said. “It is hard to do it right and optimally. But I can’t judge, in a vacuum, the next two to three months.” The rule, she said, is well underway, and its fate will depend more on multi-agency consensus than an inauguration-based timeline.

Asked what rules she wants to see finalized in the next two months, White responded that her year-end goals include capital margin segregation rules required by the Dodd-Frank Act, an outstanding derivatives proposal in the asset management space that is a priority, and a proposal to allow that mutual fund reports to investors can be filed electronically. Also “pretty far along” are recommendations to expand upon a 2009 rule that requires that boards disclose diversity data regarding their composition.

Big data, enforcement, and culture

What does White herself think of her accomplishments at the SEC, the legacy she leaves behind, and what the future should hold for her successors? In the days leading up to, and following, her announced departure, clear answers have emerged.

A WARNING ON BUDGET, ‘MIDNIGHT REGULATIONS’

The following is from remarks made by Financial Services Committee Chairman Jeb Hensarling (R-Texas) during outgoing Securities and Exchange Commission Chair Mary Jo White’s final appearance before his committee.
We need to discuss the SEC’s budget request.  As I look at the disturbing national debt clock before me and to my sides, I see no need for the SEC to receive a pre-funded escrow account of more than $290 million for a potential move of its headquarters.  The SEC will have to increase its fees to pre-fund the move, which is nothing less than a tax on capital formation.
Furthermore, claims that the SEC is underfunded are not supported by the facts since the SEC’s budget has increased by a whopping 325 percent since the year 2000—and increase the American people do not enjoy.
Moreover, the SEC’s current budget of $1.605 billion does not account for money in its Reserve Fund, which can include up to $100 million – plus another $25 million in unused funds that carry over from a previous fiscal year.
Finally, Chair White, and this is most important, whenever there is a transfer of power from one presidential administration to another, there is a temptation for federal agencies to rush pending rulemakings to completion, as a way of cementing the policy priorities of the outgoing administration. But this type of “midnight rulemaking” is neither conducive to sound policy nor consistent with principles of democratic accountability.
As there are currently two vacancies at the Commission, absent an emergency and given your current reputation and legacy, I would strongly urge you to respect the results of last week’s election and resist the temptation to finalize any regulations, including Dodd-Frank Title VII regulations, in deference to the right of the incoming administration to set its own priorities upon taking office in January.
Source: House Financial Services Committee

In the category of lasting achievements, her final days as commissioner saw the approval of a long-in-the-works plan to build the SEC’s Consolidated Audit Trail. It will create a single, comprehensive database that will enable regulators to more efficiently and thoroughly track all trading activity in the U.S. equity and options markets. With it, regulators will have more timely access to a comprehensive set of trading data, enabling us to more efficiently and effectively conduct research, reconstruct market events, monitor market behavior, and identify and investigate misconduct.

White, a former U.S. attorney who once prosecuted mafia kingpins and terrorists alike, also pioneered a “broken windows” approach to enforcement at the SEC, a focus on seemingly minor disclosure and books-and-records infractions that were either an indicator of larger malfeasance or a harbinger of problems to come.

Other initiatives and a look at where they may lead after she is gone, were discussed during a Nov. 18 speech at New York University on Nov. 18, at its law school’s Program on Corporate Compliance and Enforcement.

“During my confirmation hearing, I pledged that I would pursue a “bold and unrelenting” enforcement agenda as SEC Chair,” White said. “And through the hard work and dedication of the staff of the SEC’s Enforcement Division—and the many other parts of the agency that support the Division—we have delivered on that promise. By every measure, the SEC’s enforcement program has been a resounding success.” She touted a record number of enforcement actions and “unprecedented monetary remedies.

Among the philosophies White brought to the Enforcement Division was an “investigate to litigate” approach, asking her staff to conduct all investigations with litigation in mind. “Whenever possible, we produce a trial-ready record that can be used to prevail at trial or to secure a strong settlement,” she said.

As evidenced by her focus on the Consolidated Audit Trail, White also stressed the use of data analytics to uncover and investigate misconduct. “More than ever, the SEC is developing in-house innovative analytical tools to take advantage of today’s data-rich environment,” she said. “The result is that the number of cases we are able to originate in-house has risen dramatically.” These efforts, notably, have fueled an increase in insider-trading cases.

Another milestone was an evolving focus on whistleblowers, largely fueled by a bounty program authorized by the Dodd-Frank Act. The Commission recently surpassed the $100 million mark for awards to whistleblowers and tips in fiscal year 2016. The program has had “a transformative impact on enforcement,” White said.

Holding individuals liable for wrongdoing was another approach White championed during her tenure. “Financial reporting cases, a critical priority of our enforcement program, is an area where we routinely charge both companies and responsible individuals, including senior executives,” she said.

In fiscal years 2015 and 2016, the Commission brought over 200 issuer reporting and disclosure actions and charged over 245 individuals, nearly doubling its output for fiscal years 2012 and 2013.

White also instructed the Enforcement Division to change its longstanding policy of settling all cases that did not involve a criminal component on a no admit-no deny basis, the nearly universal protocol used in settlement of civil enforcement cases. Since the Commission instituted the admissions policy, it has obtained admissions from 77 defendants and respondents.

In what may be one of her last public speeches representing the SEC, White imparted some final thoughts on strengthening white-collar crime enforcement. “We need to sort through the political rhetoric and decide whether, and how, we want to amend current laws—civil and criminal—to more frequently impose liability on executives and officers for offenses committed by employees ‘on the watch’ of the executives and officers.”

In certain areas, such as improper sales and disclosure practices of complex products at major financial institutions, it has been much more difficult to hold senior executives responsible, “either because they do not have their fingerprints directly on the conduct or indeed are not involved in it,” White said. “There is growing frustration that current law does not more broadly impose responsibility on senior executives, either for fostering a culture that led to the misconduct or for failing to ensure the existence or proper functioning of controls that could have prevented it. If we are to hold more senior executives responsible for misconduct that occurs at their companies, we have to think outside the box of our current laws.”

Among White’s suggestions: Look to the United Kingdom’s Senior Manager Regime, designed to incentivize executives and other senior managers to take greater responsibility for their actions (or non-actions) and those of their employees. One aspect of the U.K. framework holds senior executives liable for misconduct at their institutions in their areas of responsibility if they did not take “reasonable steps” to prevent the misconduct that occurred. Another provision imposes criminal liability on a senior officer, who makes a decision that “falls far below what could reasonably be expected,” which causes the failure of the firm.

The U.K. regime was introduced for banks more than eight months ago; in 2018 it will be extended to cover all U.K. financial services firms.

“The SEC’s authority to hold executives and officers accountable under existing law is considerably narrower than our U.K. counterparts now have,” White said. “At a minimum, we should closely study the track record of the U.K.’s Senior Manager Regime for what it can teach us about implementing a broader and stronger enforcement regime in the U.S. for holding executives accountable.”

Another idea she thinks has merit is advocated by Bill Dudley, president of the Federal Reserve Bank of New York. His proposal would require financial institution compensation to include a deferred compensation component that does not begin to vest for several years. If, during that deferral period, civil or criminal actions are brought relating to the executive’s area, the deferred compensation would be used to pay a portion of any civil or criminal fine imposed on the entity.

“Given the seemingly intractable persistence of serious corporate wrongdoing, the time for deciding whether to impose greater accountability, by expanding the reach of our laws, would seem to be at hand,” White said. “If we are to strengthen deterrence and incentivize true change in the culture and behavior of our financial institutions, we need to make the difficult decision of whether to consider legislation, appropriately calibrated, to reach further into the C-suite for accountability.”

White also hopes to eventually see an increase to the penalty authority of the Commission. “Although I often wish it were otherwise, the SEC does not have the authority to send anyone to jail. So, civil penalties are one of our most important tools for punishing and deterring misconduct. But current law too narrowly limits the amount of penalties that the SEC can seek and recover.”

“I hope the next Congress makes progress in adding real teeth to the SEC’s penalty authority,” she added.

At the House Financial Services Hearing, White was asked by Rep. Gregory Meeks (D-N.Y.) for any advice she might offer her successors, or Congress, to help restore the public’s faith in regulators and the financial institutions they oversee. Her answer stressed individual liability and, in what may be music to any compliance officer’s ears, corporate culture.

“Fundamentally, a question we need to be focusing on is accountability at the senior executive level for things that may occur on their watch even if they are not involved in the conduct,” White said. “How do you infuse this ‘do the right thing’ culture throughout a big company? We have codes of conduct we have mandated for years, and that works better at some companies than others.”

Tone from the top in terms of what is said, and even what is done, is important. “When you want your employees to behave in a certain way, you really need to focus not just what you are saying but what you are rewarding and what you are punishing,” she said. “If you end up with the incentives misaligned, don’t be surprised when bad conduct occurs …There is a whole set of issues the SEC and congress need to think outside-the-box about to really raise the bar of culture and compliance.”