Whither the sec now?

Virginia Law Review

Volumn 95, Issue 4, 2009, Pages 1085-1104

  Cartwright, Brian G ^a  

^a NONE

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EID: 69249093897     PISSN: 00426601     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (83)

1. The Federal National Mortgage Association.
2. The Federal Home Loan Mortgage Corporation.
3. Press Release, Fed. Hous. Fin. Auth., Statement of FHFA Director James B. Lockhart (Sept. 7, 2008), available at http://www.ofheo.gov/newsroom.aspx (follow "July-September" hyperlink under "2008"; then follow "Statement of FHFA Director James B. Lockhart" hyperlink).
4. Press Release, Lehman Bros. Holdings Inc., Lehman Brothers Holdings Inc. Announces It Intends to File Chapter 11 Bankruptcy Petition (Sept. 15, 2008), available at http://www.lehman.com/press/pdf-2008/091508-lbhi-chapterl 1-announce.pdf.
5. Press Release, Merrill Lynch & Co., Inc., Bank of America Buys Merrill Lynch, Creating Unique Financial Services Firm (Sept. 15, 2008), available at http://www.ml.com/index.asp?id=7695-7696-8149-88278-106886-108117 (follow "Newsroom" hyperlink; then follow "More Press Releases" hyperlink; then follow "2008" hyperlink).
6. That is, its shares had a net asset value of less than one dollar.
7. Press Release, The Reserve, A Statement Regarding the Primary Fund (Sept. 16, 2008), available at http://www.reservefund.com/pdfs/Press%20Release%202008- 0916.pdf. Ironically, the affiliated Reserve Fund had been the first money-market fund to be established in the United States in 1970. Diana B. Henriques, Money Market Fund Warns its Customers Face Losses, N.Y. Times, Sept. 17,2008, at C1.
8. At the end of 2007, the net assets of money-market funds were $3.1 trillion. See Inv. Co. Inst., 2008 Investment Company Fact Book 144 (48th ed. 2008), available at http://www.icifactbook.org/pdf/2008-factbook.pdf.
9. See Fed. Reserve Bd., Commercial Paper Outstanding (2009), http://www.federalreserve.gov/releases/cp/outstandings.htm.
10. The Federal Reserve later responded by creating a Commercial Paper Funding Facility. Press Release, Fed. Reserve Bd. (Oct. 7, 2008), available at http://www.federalreserve.gov/newsevents/press/monetary/20081007c.htm.
11. Press Release, Fed. Reserve Bd. (Sept. 16, 2008), available at http://www.federalreserve.gov/newsevents/press/other/20080916a.htm.
12. Id.
13. See Robert Barnes & Michael D. Shear, Obama, McCain Trade Shots Over Responses to Financial Meltdown, Wash. Post, Sept. 19, 2008, at A3.
14. Compare Market Gauges, N.Y. Times, Sept. 13, 2008, at C7 (showing that Morgan Stanley closed at $37.23 per share on Friday, Sept. 12, 2008), with Market Gauges, N.Y. Times, Sept. 19, 2008, at C12 (showing that Morgan Stanley closed at $22.55 per share on Thursday, Sept. 18, 2008).
15. See, e.g., Vikas Bajaj et al., Markets Soar, But New Rules Upset Traders, N.Y. Times, Sept. 20,2008, at A14.
16. See, e.g., Patrice Hill, Treasury, Congress Craft Loan Plan, Wash. Times, Sept. 19, 2008, at Al.
17. Press Release, Sec. & Exch. Comm'n, SEC Halts Short Selling of Financial Stocks to Protect Investors and Markets (Sept. 19, 2008), available at http://www.sec.gov/news/press/2008/2008-211.htm.
18. Press Release, Fed. Reserve Bd. (Sept. 21, 2008), available at http://www.federalreserve.gov/newsevents/press/bcreg/20080921a.htm; see also Andrew Ross Sorkin & Vikas Bajaj, Democrats Set Conditions on Bailout as 2 Firms End Investment Banking Era, N.Y. Times, Sept. 22, 2008, at Al.
19. Glass-Steagall Act of 1933, ch. 89, § 20, 48 Stat. 162, 188 (1933), repealed by Gramm-Leach-Bliley Act, Pub. L. No. 106-102, § 101, 113 Stat. 1338, 1341 (1999).
20. Fed. Reserve Bd., supra note 18.
21. Donald C. Langevoort, The SEC, Retail Investors, and the Institutionalization of the Securities Markets, 95 Va. L. Rev. 1025 (2009).
22. Or those that followed, such as the revelation that Bernard L. Madoff Investment Securities LLC had operated a Ponzi scheme of unprecedented proportions. See Press Release, Sec. & Exch. Comm'n, SEC Charges Bernard L. Madoff for Multi-Billion Dollar Ponzi Scheme (Dec. 11, 2008), available at http://www.sec.gov/news/press/2008/2008-293.htm.
23. Brian G. Cartwright, General Counsel, Sec. & Exch. Comm'n, The Future of Securities Regulation, Address at the University of Pennsylvania Law School Institute for Law and Economics (Oct. 24, 2007) (transcript available at http://www.sec.gov/news/speech/2007/spch102407bgc.htm). Professor Langevoort eschews my coinage of "deretailization" in favor of "institutionalization," which is, of course, his prerogative. Terminology can subtly influence thinking, however, and so I continue to prefer "deretailization," since it places the emphasis both on the retail investor and on the retail investor's diminishing role in some markets and absence in others. As the primary focus of the SEC should, in my view, remain protection of the retail investor, I prefer to retain this linguistic emphasis.
24. Langevoort, supra note 21, at 1026.
25. Cf. Marshall McLuhan & Quentin Fiore, The Medium is the Massage 63, 100 (1967) (discussing the need to move from an educational perspective that focuses on the rear-view mirror to one that is proactive and forward looking).
26. Leo E. Strine, Jr., Toward Common Sense and Common Ground? Reflections on the Shared Interests of Managers and Labor in a More Rational System of Corporate Governance, 33 J. Corp. L. 1, 6 (2007).
27. Langevoort, supra note 21, at 1026. See also Cartwright, supra note 23.
28. Langevoort, supra note 21, at 1026.
29. Id. at 1025.
30. Id. at 1027.
31. Id. at 1083.
32. Sec. & Exch. Comm'n, The Investor's Advocate: How the SEC Protects Investors, Maintains Market Integrity, and Facilitates Capital Formation (2009), available at http://www.sec.gov/about/whatwedo.shtml.
33. The SEC is one of the "independent" agencies, and the President's influence over the SEC is muted, at best, after his appointment of its commissioners.
34. Ralph Nader, Unsafe at Any Speed (25th anniversary ed., Knightsbridge Publ'g Co. 1991).
35. The analogy, of course, is quite imperfect: unlike a retail customer, a retail investor owns - along with others - the very business whose conduct is challenged, which leads to complications. For example, scholars have identified the many imperfections of securities class actions, whose proponents often draw their rhetoric from the consumer protection well. But the investors whose interests as a group are to be vindicated by class actions also own the enterprises and, as such, indirectly bear the burden of funding class action settlements. There is extensive academic literature examining this topic. See, e.g., Donald C. Langevoort, On Leaving Corporate Executives "Naked, Homeless and Without Wheels": Corporate Fraud, Equitable Remedies, and the Debate Over Entity Versus Individual Liability, 42 Wake Forest L. Rev. 627, 627-31 (2007).
36. Cartwright, supra note 23.
37. Through the Investment Company Act of 1940, ch. 686, 54 Stat. 789 (codified as amended at 15 U.S.C. §§ 80a-1 to 80a-64 (2006)) and the Investment Advisers Act of 1940, ch. 686, 54 Stat. 847 (codified as amended at 15 U.S.C. §§ 80b-1 to 80b-21 (2006)). These Acts are showing their age and in need of modernization. But that is a question for another day.
38. Langevoort, supra note 21, at 1081.
39. Id.
40. Id. at 1051.
41. Id. at 1055.
42. Id. at 1054.
43. For the record, I should note that I do not find myself in entire accord with all of Professor Langevoort's analysis here, though I am in agreement with its thrust - which suffices for present purposes.
44. To emphasize the diminished role of banks, I might use the coinage "debankification," but given Professor Langevoort's reaction to my coinage of the term "deretailization," Langevoort, supra note 21, at 1026-27 n.6, I refrain from doing so here out of respect for his aesthetic sensibilities (though I make no promises regarding future use elsewhere). Various aspects of the trend toward securities-centric debt financing have been given various designations over time. The shift from bank deposits to money-market funds and other higher-yielding alternatives, for example, was often referred to while it was under way as "disintermediation." I find this designation inadequate for present purposes, however, because present-day alternatives often involve new intermediary entities of their own. Similarly, corporate debtors' shift from reliance on bank loans to the issuance of bonds, debentures, and other debt securities has been referred to as "securitization." I find this designation also inadequate, because the same term confusingly is used to describe the altogether different phenomenon of the issuance of securities that pass through to investors the cash flows from an underlying pool of assets.
45. For the sake of simplicity, I use the term "bank" throughout this Article not in its technical sense, but rather to refer more generally to any deposit-taking or similar financial institution. In addition, non-deposit-taking financial institutions also were involved in the traditional model. For example, individuals and businesses paid premiums to insurance companies, which then in turn invested those premiums in other businesses, often in the form of loans held to maturity (capital market participants today sometimes refer to financing of this type by insurance companies and others as the "private private market," as contrasted with the 144A market). Because I seek here to sketch the trends of interest to us only in the broadest of terms, I ignore complexities such as these.
46. Henriques, supra note 7, at C1. The first money-market fund in the United States was the Reserve Fund, established in 1970. Money-market funds, of course, have been regulated by the SEC since their inception.
47. Protecting Homeowners: Preventing Abusive Lending While Preserving Access to Credit: Joint Hearing Before the H. Comm. on Fin. Serv., 108th Cong. 61-63 (2003) (statement of Cameron L. Cowan, Chair, Legis, and Judicial Subcomm., American Securitization Forum).
48. As another asset-side example, about a decade later, the high-yield debt market developed, substituting readily transferable securities for unsecured business loans that previously would have been held to maturity by the lender. The market for newly issued high-yield debt grew rapidly after its inception from a base of only about $2.7 billion in 1983. Dwight Asset Mgmt. Co., Fixed Income Primer: High-Yield Bond Market 2 (2006), available at http://www.dwight.com/pubs/dwightHighYield2006.pdf. Here again, securities markets replaced banks and other financial institutions.
49. Inv. Co. Inst., Money Market Mutual Fund Assets (Dec. 11, 2008), http://www.ici.org/stats/mf/mm-12-11-08.html. Outstanding bank deposits were $7.25 trillion on Dec. 10, 2008. Fed. Reserve Bd., Statistical Release: Assets and Liabilities of Commercial Banks in the United States (Jan. 30, 2009), http://www.federalreserve.gov/releases/h8/Current/.
50. See, e.g., Thomas Zimmerman, UBS, U.S. Mortgage Backed Securities Market (Jan. 29, 2006), http://www.americansecuritization.com/uploadedFiles/1-29- 2006%20US%20MBS%20(tom).ppt.
51. Sec. Indus. & Fin. Mkts. Ass'n, Agency Mortgage-Backed Securities Outstanding (2009), http://www.sifma.org/research/pdf/AgencyMortgageOutstanding. pdf.
52. At mid-year 2008, the notional amount of credit derivatives outstanding was approximately $55 trillion. Press Release, Int'l Swaps & Derivatives Ass'n ("ISDA"), ISDA Mid-Year 2008 Market Survey Shows Credit Derivatives at $54.6 Trillion (Sept. 24, 2008), available at http://www.isda.org/press/press092508.html. This figure greatly exaggerates the economic significance of this market, however. The ISDA estimated the resulting aggregate net credit exposure before collateral to be only about $2.7 trillion. Id.
53. This is true even in the core banking business of secured lending to business enterprises, where the syndication of participations in credit agreements has become more and more difficult to differentiate from the distribution of bonds by underwriters.
54. Glass-Steagall Act of 1933, ch. 89, § 20, 48 Stat. 162, 188 (1933), repealed by Gramm-Leach-Bliley Act, Pub. L. No. 106-102, §101, 113 Stat. 1338, 1341 (1999).
55. Gramm-Leach-Bliley Act, Pub. L. No. 106-102, § 101, 113 Stat. 1338, 1341 (1999).
56. See Fed. Reserve Bd., supra note 18 and accompanying text.
57. Charles P. Kindleberger, Manias, Panics, and Crashes 1 (4th ed. John Wiley & Sons 2000).
58. Margin regulation, however, is one example of a regulatory measure dealing with securities-centric finance motivated by systemic considerations.
59. Though, to be sure, so long as bank-centric debt finance remains systemically significant, a lender of last resort continues to be a necessity.
60. See Mark Carney, Governor, Bank of Canada, Building Continuous Markets, Remarks to the Canada-United Kingdom Chamber of Commerce (Nov. 19, 2008) (transcript available at http://www.bankofcanada.ca/en/speeches/2008/sp08-14. pdf).
61. Some nominally institutional investors, however, are also unsophisticated and perhaps should not be treated as institutional investors for some regulatory purposes. For example, at least some instrumentalities of state and local governments would seem to fall into this category.
62. As distinguished from regulations aimed at protecting the system from the collective consequences of the activities of institutional investors.
63. Securities Act of 1933, ch. 38, § 4, 48 Stat. 74, 77 (1933) (codified 15 U.S.C. §
64. Cartwright, supra note 23.
65. Professor Langevoort seeks to avoid this conclusion with three suggestions, which can be summarized, all too briefly, as follows: (1) maybe institutional investors do not in fact differ much from retail investors in the ways that matter, thereby justifying SEC interventions on their behalf;
66. maybe the point of the securities laws is not investor protection after all, but is "disconnected from shareholder or investor welfare";
67. and (3) whatever the merits, politics will intervene to maintain the status quo. Langevoort, supra note 21 at 1055-70, 1066, 1081-83. My responses to these suggestions, in equally condensed form, are as follows: (1) assuming, arguendo, that this is true, SEC interventions remain unjustified unless the SEC can be shown to have greater competence or to be more efficient in the relevant dimensions than institutional investors in the aggregate, propositions not to be accepted without convincing justification;
68. the ultimate point of the securities laws is general prosperity (with investor protection as merely a means to that end), and, in seeking general prosperity, implementing the securities laws now for purposes other than investor welfare would seem a risky distraction at a particularly inopportune time;
69. and (3) it is always folly to underestimate the possibility that politics may intervene to achieve a suboptimal outcome.
70. Langevoort, supra note 21 at 1070-80.
71. See Brian G. Cartwright, General Counsel, Sec. & Exch. Comm'n, The Role of the States (Foreign and Domestic), Speech at the Widener University School of Law (Mar. 28, 2008) (transcript available at http://www.sec.gov/news/ speech/2008/spch032808bgc.htm).
72. Id.
73. Langevoort, supra note 21, at 1039.
74. My apologies to Professor Langevoort for yet another "-ization. "
75. Eugene F. Fama, The Behavior of Stock-Market Prices, 38 J. Bus. 34 (1965).
76. Fischer Black & Myron Scholes, The Pricing of Options and Corporate Liabilities, 81 J. Pol. Econ. 637 (1973).
77. The SEC does have an Office of Economic Analysis that includes a small number of Ph.D. economists with mathematical training. The tasks for which these economists are most frequently responsible include determining the dollar amount of damages suffered by investors as a result of financial fraud in enforcement cases and assisting in the performance of cost-benefit analyses in rulemakings.
78. The SECs Inspector General currently is investigating the failure of the SEC staff to uncover the Ponzi scheme allegedly operated by Mr. Bernard L. Madoff, despite an extensive analysis provided to the staff by Mr. Harry Markopolos. Harry Markopolos, The World's Largest Hedge Fund is a Fraud (2005), available at http://online.wsj.com/documents/Madoff-SECdocs-20081217.pdf. I believe it likely a lack of familiarity with modern finance will prove to have been a substantial factor in that failure.
79. One of the SECs long-term regulatory competitors, the Federal Reserve Board, by contrast, has hundreds of Ph.D. economists on its staff.
80. Indeed, in many ways these regulatory interests conflict with the SECs focus on retail investors. Regulators concerned with restarting the flow of credit and capital may find mark-to-market accounting procyclical and counterproductive, while the SEC must unwaveringly support mark-to-market accounting as helpful to investment analysis. Further, regulators concerned with systemic risk may find it counterproductive to exact settlements in the tens of billions of dollars from reeling financial institutions, while the SEC must obtain such settlements for retail investors stuck holding auction rate securities after that market failed.
81. Cartwright, supra note 23.
82. Employee Retirement Income Security Act of 1974, 29 U.S.C. §§ 1001-1461 (2006).
83. Langevoort, supra note 21, at 1055.