Financial regulation a ‘bureaucratic mess’ thanks to Dodd-Frank

With the imminent departure of SEC Chair Mary Jo White and her top enforcement lieutenant Andrew Ceresney, now is a good time to review the effectiveness of the SEC and other federal enforcement entities. Indeed, the SEC is fundamentally an enforcement outfit — approximately half of the SEC’s 5,000 employees are in inspections or enforcement.   

I lay blame for the SEC’s ineffective enforcement not on the hard-working men and women of the SEC, but on Congress for creating a dysfunctional regulatory structure that does a mediocre job of protecting investors and a poor job of promoting economic growth.

We now have hundreds of different regulatory agencies at the state and federal levels, with little communication among them. The result is an excessively costly and slow-moving bureaucratic mess.

For example, the implementation of the Volcker Rule, which prohibits banks from partaking in certain investment activities with their own accounts, required four different agencies to work together over three years, resulting in a final rule release of 1,089 pages.  

{mosads}To compound the problem, our regulators are underfunded. From the SEC’s founding in 1934 through fiscal year 2016, the U.S. government has spent approximately $22 billion on the SEC – less than investor losses from one Bernie Madoff.

What makes this even more tragic is the SEC is a budget neutral agency funded by user fees on the industry. Giving the SEC the resources to do its job will not increase the federal deficit by a single penny. Indeed, preventing one Enron would save taxpayers more than we have spent on the SEC in its entire history.

After the most recent financial crisis, there was a push to punish fraudsters who contributed to the mess. However, the SEC has no criminal enforcement authority, only civil.

Criminal prosecutions belong to the Department of Justice (DOJ), which has its hands full with drug dealers and terrorists. White-collar crimes took a lesser priority.

Eric Holder’s DOJ gave up trying to prosecute individuals for their role in the financial crisis despite the massive frauds that occurred in mortgage origination and repackaging. 

Instead, the DOJ and the SEC adopted a policy of imposing massive fines on the surviving firms. This “hit ‘em in the pocketbook” strategy created a few fleeting headlines, but it mainly punished the innocent shareholders of the surviving firms.

There was virtually no personal accountability. It did nothing to deter individuals from engaging in the same frauds in the future.

For example, if an employee engages in a sleazy action this year to earn a bonus or meet a quota, there is little personal downside risk.  Maybe, just maybe, their employer will have to pay a fine later.  

This line of reasoning allowed many of the miscreants who contributed to the meltdown to walk away as millionaires, while millions of others lost their jobs and their homes. 

This fragmentation of enforcement is another artifact of the splintered nature of our financial regulatory structure. Dodd-Frank, despite its hundreds of required rulemakings, did nothing to fix our dysfunctional and disjointed regulatory system.

In contrast, the United Kingdom examined the failures of its regulatory system during the financial crisis and created a new regulatory structure. This includes a Financial Conduct Authority to regulate the operation of financial service firms and a Prudential Regulatory Authority, under the central bank, to make sure the financial system doesn’t collapse.

The U.K. wisely kept their totally separate Serious Fraud Office as a specialist enforcement agency focused only on large financial frauds. The U.S. should create such a specialist agency, so that future financial criminals do not escape justice like the recent ones did.  

Fighting financial fraud is very different from fighting drug dealers, and a specialist agency can build up the expertise needed to do an effective job without being distracted by other serious crimes.

The upcoming change in presidential administrations puts the big picture of how we regulate our financial system into focus. This is long overdue. The Republican campaign platform rightly called for repealing the McCarran-Ferguson Act and permitting health insurers to offer nationwide products.

This implies a need for, at the very least, an optional federal charter in insurance and a need for some federal entity to oversee federally regulated insurers. This opens up the whole issue of how we regulate financial firms. 

Rather than creating another addition to the alphabet soup of regulators to deal with insurance, Congress should consider a combined financial markets regulator for all financial services, including insurance, securities, banks and commodities.

This regulator should have the explicit goals of economic efficiency and growth, along with consumer protection. Solvency and systemic risk issues should be part of a separate solvency regulator under the Fed.

Despite the need for combining redundant agencies like the SEC and CFTC, enforcement failures from the recent financial crisis demonstrate the need for a separate financial enforcement entity that won’t be distracted by other law enforcement priorities. 

I urge Congress to focus on overhauling the structure of our financial regulators rather than micromanaging them as it did in Dodd-Frank. We need to streamline the unwieldy collection of overlapping entities and come up with a smarter, not bigger, regulatory system.  

If we adopt the right regulatory structure and put in the right people with the right resources, our regulatory structure will do the right things.  

There are those pundits who say it can’t be done; that certain committees will never give up their oversight of the CFTC, or that insurance companies will never permit a federal insurance regulator.  However, with financial and health care reform clearly on the Congressional agenda, there is plenty of room for quality compromises and deal-making.

James J. Angel, Ph.D., CFA,  is a professor at the McDonough School of Business at Georgetown University.

The views expressed by contributors are their own and not the views of The Hill.