Your humble blogger has to confess to having called Mary Jo White’s appointment incorrectly, based on enthusiastic readings on her from people who’d worked with her as a prosecutor, such as Neil Barofksy. But the default assumption for Obama appointees, that he’d never give anyone who’s rock the status quo a serious role, was the right assessment. White’s ten years in the private sector at Debevoise seems to have reinforced habits that aren’t serving her well, even in her role as Potemkin fixer-upper of an agency that is widely seen as timid and floundering. Not only is she failing to move regulatory measures forward quickly enough, but she’s also engaged in an unseemly amount of turf warfare with other agencies.
An article yesterday in ProPublica by Jesse Eisenger was tame in its criticism of Mary Jo White. Yes, the headline does state that she hasn’t turned around the agency, and points out early on that “opinions of Ms. White’s performance range from dissatisfied to infuriated.” But the article has a handwringing tone, as if Eisenger is puzzled as to why this sorry turn of events has come to pass.
Part of the problem is Eisenger fails to appreciate why the SEC was once a feared and respected agency, and why it has fallen. He unwittingly gives the impression that it was seen as competent recently. In fact, the neutering of the agency started in the 1980s, and has continued even under chairmen who had modest ambitions for the SEC. We’ve repeatedly discussed the account of the longest-serving SEC chairman, Clinton appointee Arthur Levitt. As a non-attorney and former head of the American Stock Exchange, Levitt no doubt was expected to be pro-business and not very interventionist. But while Levitt thought that large institutions could more or less fend for themselves, he was very serious about trying to protect retail investors. And even with those limited aims, he ran into considerable opposition from Congress, which threatened to cut his air supply by slashing the SEC’s budget. Eisenger cites Bush appointee Christopher Cox as responsible for crippling the agency, when Cox’s immediate predecessor, Harvey Pitt, was a bit of a horrorshow.
So if you put aside the matter of Mary Jo White’s true ambitions and loyalties, why was it reasonable to believe that she might have been able to turn around an agency that was a shadow of what it had been in the 1970s? The answer: her prosecutorial chops. White is widely respected by the people she worked with, and is seen as a tenacious litigator. And what led the SEC to be feared and respected in its heyday? Its head of enforcement, Stanley Sporkin. From a 2012 post:
When I worked on Wall Street, the SEC was feared, and it was feared because it had an effective enforcement department, the legacy of the legendary Stanley Sporkin. A reader provided some corroborating detail in comments on a post over the summer:
I was an SEC enforcement attrorney during the generally-regarded halcyon days of the Sporkin era, and I can tell you, we kicked ass and took names. I myself was involved in many cases involving some of the biggest names on Wall Street, and was instrumental in several cases that eventually resulted in the enactment of the Foreign Corrupt Practices Act. We had a trial unit back then that was quite busy actually trying, and, more often than not, winning cases. We referred many cases for criminal prosecution (including for perjury), not having prosecutorial authority ourselves.
Back then, the industry quaked in its boots when we came calling. The only partially apocryphal story about Stanley is that, during an investigation he was leading (before he became the head of enforcement), he had a group of witnesses waiting to give on-the-record testimony. When the witness he had been deposing had a heart attack during the deposition (a not-infrequent occurrence), the ambulance attendants wheeled the stricken witness out of Stan’s office on a gurney, with Stan close behind, announcing to the waiting group of witnesses, “alright, who’s next.”
So the real tell as to whether Mary Jo White was serious about her job was who she appointed to be head of enforcement. When Neil Barofsky wasn’t nominated to lead the SEC, there were calls for him to be named head of enforcement, which meant he set the standard for what the public hoped for. Instead, White chose a colleague from Debevoise, meaning a litigator who represents corporations. While a Pauline conversion was possible, it wasn’t something a rational person would bet on. Mary Jo White’s pick wasn’t as obvious a repudiation of the promise of reform as Obama’s choice of Timothy Geithner as Treasury Secretary, but it lowered expectations of her among the cognoscenti big time.
Even so, White has been inept as well as unable to fake ambition. Eisenger does usefully recount many of the people she’s alienated. She has the rest of the Financial Stability Oversight Council annoyed for stymieing efforts to designate asset managers like Pimco and Blackrock as systemically important financial institutions. She’s even managed to undercut tame reform measures advocated by the not-at-all aggressive Public Company Accounting Oversight Board. And he gives a very good description of why the SEC fixes for money market funds did virtually nothing to address the real problems.
But Eisenger seems mystified that Mary Jo White does not get on well with reform-minded Democrats, including the Democratic SEC commissioner Kara Stein, Senator Carl Levin (who is unhappy about how slowly White is moving on Dodd Frank rulemaking and how weak the results have been), as well as other progressive Senators who want the agency to implement rules to bar financial firms from creating transactions that are most profitable for them if they fail, as John Paulson, Citigroup, Goldman, and most important, Magnetar did.
The real tell that White simply has no interest in making meaningful changes is its response to the Michael-Lewis-induced furor over high frequency trading. This is a long-standing abuse. Even though it’s less profitable to the perps than it once was and in the overall scheme of financial services industry rent-seeking, it’s not all that high on the list, it’s worth cleaning up. Both the flash crash and a raft of follow-on academic studies have demonstrated that HFT has had adverse effects on market structure. Not only does it produce junk liquidity, as in more when markets don’t need it, it drains liquidity when participants need it most, when trading is thin and volatile.
The SEC is singularly responsible for the rise of HFT by allowing traders to have advantaged access to orders by co-locating servers at exchanges. This was an obvious move to front-run trades that the SEC permitted and still refuses to roll back. Similarly, the agency has failed to address the failing of its Regulation NMS, which was meant to create a modern, electronic market structure but has in fact made markets less stable and more failure prone than before. From a post earlier this year:
The old exchange system was a hub and spoke model, which was a stable system architecture. The internet was an outgrowth of a DARPA project to make a communication system so decentralized that it could not be taken out by a nuclear strike. Hub and spoke models are stable, but subject to an outage, say by a nuclear bomb or electrical failure. What chaos theorists have found is that highly decentralized networks are stable, as are single node networks (like exchanges), but that slightly decentralized networks are fragile. And that is what we have now thanks to the SEC’s misguided efforts to “modernize” the stock market via Regulation NMS.
So regulators have left investors with the worse possible market structure. We no longer have liquidity obligations to make orderly markets as we had with the old model. Our current system is more complex due to some decentralization, but it is not so decentralized that it is robust (in technology-speak, a synchronized mesh network). The complexity of keeping the slightly decentralized model synchronized is what makes the system unpredictable and more fragile. This is not just an academic network construct. It is why we saw some exchange crashes recently (like Nasdaq) that were due to code changes in the linkages and feeds between exchanges.
Similarly, the value high speed traders provide is reestablishing the integrity of a single price in a centralized market after Reg NMS fragmented the market. But in reality, the buy side and all brokers are already sophisticated enough to use electronic routing to reestablish that centralized market, but not at sub-second speed. So the only service HFT time-based arbitrage provides is a sub second service. We’ve yet to see anyone make a credible case for the social utility whatsoever of sub-one-second execution. So since sub-second order execution fails to provide any social utility, it follow that any profits they extract are a dead weight loss on stock transactors. Those strategies, with the complex order types and the payment for order flow, should be eliminated.
Bear in mind: this problem is completely within the SEC’s purview. A simple rule change like a minimum resting time for orders would do. Yet the agency has done squat to address it.
Another proof of how little Mary Jo White cares about serving the public: the SEC launched an examination of alternative mutual funds, which bring hedge-fund type strategies to lowly retail investors. Mind you, all the SEC has done is request information; the Wall Street Journal account stressed that this initiative does not appear to be a precursor to enforcement actions. But if you only skimmed articles, it would be easy to see this move as more serious than it is.
And while this data-gathering exercise is underway, NC contributor and compliance expert Michael Crimmins pointed out that the SEC is about to authorize sales of risky products to retail investors, namely “nontransparent ETFs.” As he notes: “Complexity on top of complexity. What could go wrong?”
So Mary Jo White is no doubt doing her job. It’s simply, as with Obama, not the job the public was led to think she’d do.