A Regulation Derailed
Money Market Meltdown – A Case Study
When the then-chairman of the Securities and Exchange Commission (SEC) was asked in early 2012 what kept her up at night, she pointed to money market funds, the supposedly safe investment vehicles that played a role in the financial crisis of 2008 and today manage $2.7 trillion for investors.
As Mary L. Schapiro tells it, money market funds remain so vulnerable to sudden waves of withdrawals that they “pose a significant destabilizing risk to the financial system.” At the height of the 2008 crisis, Schapiro has testified, a $300 billion run on money market funds ended only when the federal government put taxpayer money on the line to backstop the industry. Since then, the kind of federal guarantee used to stop the run has been outlawed, making any future meltdown harder to contain, she said.
Investors in money market funds “have been given a false sense of security,” Schapiro said in a February 2012 speech. “Today, the money-market fund industry...is working without a net,” she added, comparing the situation to “living on borrowed time.”
Schapiro was not alone in sounding the alarm. A council of federal regulators headed by outgoing Treasury Secretary Timothy F. Geithner unanimously called for additional reforms, noting that money market funds are still susceptible to the kinds of runs that made the financial crisis more severe. Former regulatory leaders, including Sheila C. Bair and Paul Volcker, have echoed the call for reforms.
But when Schapiro tried to tighten regulation of money market funds, she encountered powerful resistance. In August 2012, without even bringing her proposal to a vote, she acknowledged that she was blocked. There was no point in calling a vote, she said, because three of the SEC’s five commissioners had stated their opposition.
Many of the people who lobbied the SEC on this issue on behalf of the investment industry had traveled a familiar path: they once worked at the SEC but had gone through the revolving door to join the industry.
There was Justin Daly, formerly a counsel to an SEC Commissioner. He became a registered lobbyist and represented the Investment Company Institute, an industry association that fervently opposed the regulatory proposals. Daly met with Congress and the SEC to discuss “[i]ssues relating to investment companies, particularly money market funds,” according to a federal lobbying disclosure filed in July 2012.
There was Karrie McMillan, a former official in the SEC’s Division of Investment Management, which oversees money market funds. She became general counsel at the Investment Company Institute, represented the group in meetings with Schapiro and other senior SEC officials, and sent several letters to the agency objecting to the proposals.
There was Susan Ferris Wyderko, who once held the top job in the SEC’s Division of Investment Management. She became president and CEO of an industry group called the Mutual Fund Directors Forum, which argued that the SEC could “harm the markets and the economy more broadly” by making money market funds—a type of mutual fund—less attractive to investors. Wyderko and another former SEC employee, David B. Smith, Jr., expressed the group’s views in letters to the SEC, and they had a meeting on the subject with an SEC Commissioner in March 2012.
There was Fran Pollack-Matz, a former Investment Management attorney who “did work on money market related issues” before leaving the SEC in 2009, according to agency records. She became a vice president at T. Rowe Price Associates, Inc., which, as of December 2012, managed approximately $32 billion in money market fund assets. Her name appeared on a January 2011 letter from the firm arguing that one of the regulatory proposals would “substantially reduce the attractiveness of money funds to investors, and potentially cause serious disruption in the short-term credit markets.”
And, among others, there was Laura Unger, who had served as an SEC Commissioner and as acting chairman of the agency. She became a special adviser at the consulting firm Promontory Financial Group. In a February 2012 visit to the SEC, she accompanied a delegation from Fidelity Investments, a giant of the industry that opposed Schapiro’s regulatory effort. An SEC memo about the visit doesn’t explain what Unger might have said or done at the meeting. But her bio on Promontory’s website says she “provides clients with strategic advice about matters relating to the SEC, regulatory and legislative process.” Unger is also featured in a Promontory brochure highlighting the “[s]enior regulatory experience” of the firm’s professionals. The brochure states that Promontory has advised a “leading industry trade association” on how to “best influence government agencies and regulators.”
POGO made attempts to contact Unger, as well as other SEC alumni and businesses discussed in the body of this report and in Appendix B. We have included comments of those who responded.
It’s hard to know how much any of these alumni contributed to the at least temporary derailment of Schapiro’s money market fund initiative. “I imagine you could find alumni on all sides of this issue, but…matters are decided on their merits,” SEC spokesman John Nester told POGO.
In the end, the balance was tipped not by a former official, but by a current one: Luis A. Aguilar, one of the five SEC commissioners. Aguilar, a Democrat, has often been the toughest of the commissioners when it comes to regulation, and has frequently chastised the agency for not doing enough to protect investors. But, at a pivotal juncture on the money market fund issue, he sided with the two Republican commissioners and the investment industry.
As it happens, Aguilar previously worked in that industry. He had been executive vice president of Invesco, a money management firm, and worked as a corporate attorney at law firms where his practice involved, among other things, mutual funds.
In March 2012, Invesco sent a team to meet with Aguilar at the SEC and tell him why tightening rules for money market funds was a bad idea. In its presentation, Invesco called the regulatory plan “extreme” and “not warranted.” One of the Invesco team members also participated in a larger meeting with representatives from other companies and officials from various SEC offices, according to a memo posted on the SEC’s website. But Aguilar was the only commissioner with whom the Invesco team had an exclusive meeting, according to the SEC’s website.
Explaining his opposition to Schapiro’s initiative, Aguilar issued a statement that closely tracked arguments made by industry—including arguments advanced by Invesco and SEC alumni. The statement shows how much convergence there was between his thinking and that of the industry in which he once worked.
Before writing new rules, Aguilar argued, the SEC should determine whether rules adopted in 2010 had solved the problem. “A critical analysis of the efficacy of the 2010 Amendments would be a necessity to analyze what, if any, additional steps are required,” he said.
Members of industry made a similar point. “Prior to proposing fundamental changes to money market funds, the SEC must first fully analyze the effects of the 2010 amendments,” the Mutual Fund Directors Forum said in a letter to the SEC. “Reforms from 2010 are working,” Invesco said in its March 2012 presentation.
Further, Aguilar argued, the proposed changes could make matters worse by prompting investors to move assets from money market funds to other investment vehicles that regulators are unable to track or oversee. “I remain concerned that the Chairman’s proposal will be a catalyst for investors moving significant dollars from the regulated, transparent money market fund market into the dark, opaque, unregulated market,” he said.
Aguilar also expressed concern that the proposed changes “could be needlessly harmful” given the “fragile state of the economy.”
Here again, a similar view was expressed by Aguilar’s former employer and by SEC alumni representing the industry. For example, in a letter to the SEC, Invesco warned: “Large investors, in particular, may be prone to transfer funds currently invested in...money market funds to other, less regulated vehicles.”
Aguilar also expressed concern that the proposed changes “could be needlessly harmful” given the “fragile state of the economy.” Likewise, in its presentation, Invesco warned that “unnecessary regulation” could “damage a fragile economic recovery.”
Did Aguilar’s past relationship with the mutual fund industry make him more receptive or sympathetic to its point of view?
In a November 2012 interview with POGO, Aguilar said the answer was no. “It gives me a level of knowledge,” he explained. “I think my background gives me the ability to understand and put into context both the...pros and cons of their arguments.”
Aguilar told POGO that he follows the public interest as he sees it. “I don’t think I’m anybody’s puppet,” he said. He pointed out that he opposed the mutual fund industry on an earlier, unrelated SEC initiative, and that the leadership of Invesco has changed since he left the company a decade ago.
A spokesman for one mutual fund company argued that the revolving door actually helps investors. “We strongly believe that having people with industry experience work for a regulator and having people with a regulatory background work in the industry benefits both sides as well as investors,” T. Rowe Price spokesman Brian Lewbart said in an email to POGO. Before signing the January 2011 letter on behalf of T. Rowe Price, former SEC official Fran Pollack-Matz consulted with the agency’s ethics office, Lewbart added.
Treasury Secretary Geithner and other regulators haven’t given up on tightening the regulation of money market funds, but they could be hard-pressed to do so without the SEC’s support. Indeed, they turned up the pressure on the agency.
In December 2012, the SEC released a staff report taking a closer look at the issue. In a December 5 statement on the report, Aguilar reiterated his view that the “outflow of money fund assets to an unregulated market is a significant systemic risk concern,” and added that he welcomed the “serious consideration” the issue was receiving.
The SEC could revisit the issue this year, and news reports suggest that the backing that eluded Schapiro may yet coalesce around at least part of her initiative. According to those reports, Aguilar and another commissioner have been warming to the possibility of certain regulatory changes. (As of this writing, President Obama’s new nominee for SEC chairman has not publicly taken a position on the issue.)
Whether the 2012 regulatory stalemate—which former SEC Chairman Arthur Levitt called a “national disgrace”—was a defeat or merely a delay for Schapiro’s money market fund initiative, the episode illustrates a conspicuous feature of the SEC: the pervasiveness of the revolving door. The constant spinning blurs the lines between the regulatory agency and the world it regulates.
This blurring is hardly unique to the SEC. The phenomenon is so familiar that economists and political scientists have a name for the most extreme cases: “regulatory capture,” when an agency is effectively taken over—culturally, if not literally—by the industry it regulates.
The potential stakes of regulatory capture are particularly far-reaching at the SEC because the agency is responsible for regulating a vast swath of American business, including the investment and brokerage industries, stock markets, accounting firms that audit public companies, and information that publicly traded corporations disclose to investors. It’s the agency’s job to protect investors.
Currently, the SEC is bogged down in the biggest overhaul of the nation’s financial markets since the 1930s: a long-delayed and heavily lobbied effort to write rules implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), which Congress passed and President Obama signed in 2010 to reduce the risk of future crises.
The SEC also continues to investigate whether additional individuals or corporations should be charged with law-breaking for contributing to the last crisis. The agency points to a long list of enforcement actions it has taken so far; federal judges and other observers have criticized some of the biggest settlements as too weak to make a difference.
Meanwhile, the revolving door keeps turning.
In September 2012, the Alternative Investment Management Association—a global hedge fund group—announced a new chairman: former SEC Commissioner Kathleen Casey, who left the agency in 2011. She is expected to enhance the dialogue between the association and industry regulators, the group’s chief executive said in a press release.
In December 2012, Deloitte—one of the “Big Four” global accounting firms that cater to big corporations—announced that it had hired James L. Kroeker, a former SEC chief accountant who left the agency in July. He will be reporting directly to Deloitte’s CEO, who, in a press release, praised Kroeker’s “unique perspective” and “experience as a regulator.” The move completed a round-trip for Kroeker; he had been a partner at Deloitte before joining the SEC in 2007.
And in January 2013, President Obama nominated Mary Jo White—a partner at the law firm of Debevoise & Plimpton—to serve as the next SEC chairman. “You don’t want to mess with Mary Jo,” President Obama remarked, referring to her work from 1993 to 2002 as the U.S. Attorney for the Southern District of New York, where she “built a career the Hardy Boys could only dream of” prosecuting white-collar criminals.
At Debevoise & Plimpton, however—where White has worked since 2002—she has routinely defended clients before the SEC. For instance, she defended JPMorgan when the SEC charged the company with misleading mortgage investors, according to The Washington Post. In a separate matter, Morgan Stanley’s board hired White to explore if a prospective CEO was in danger of being charged in an SEC insider trading probe. After reviewing how the SEC handled White’s inquiries, Senate investigators criticized the agency for “providing prominent individuals selective access to senior SEC officials.”
This report—POGO’s second in-depth study of the SEC’s revolving door—examines many manifestations of the phenomenon. It also explores the question: Are concerns about the revolving door much ado about nothing?
A widely noted study by several academics dismissed the notion that the revolving door weakens SEC regulation. Robert Khuzami, the head of the SEC’s Enforcement Division from 2009 until early 2013, cited the study as evidence that the agency has been unfairly maligned.
But, as this POGO report explains, the academic study does not settle the issue. For a more detailed analysis of that study, see Part V.
The revolving door is deeply embedded at the SEC and throughout the federal government. The problem transcends the thoughts and actions of individual government employees; it is both subtler and more powerful. The close linkage between the regulators and the regulated can influence the culture, the values, and the mindset of the agency—not to mention its regulatory and enforcement policies—both from the bottom up and from the top down. To be sure, many employees may be immune to its influence and may explicitly reject it. But when so much of a regulatory agency’s world view can be shaped by the industry it oversees, consciously or otherwise, the public has reason to be concerned.
As matters now stand, the public has only limited ability to see through the revolving door. With this report, POGO attempts to shed additional light.
Follow this link to view a full copy of POGO's report, Dangerous Liaisons: Revolving Door at SEC Creates Risk of Regulatory Capture, including endnotes with explanatory text and citations.