“Cop on the beat,” “broken windows,” and bringing “the swagger back.” These are some of the more colorful catchphrases SEC Chairman Mary Jo White and Co-Enforcement Director Andrew Ceresney have used to describe the Commission’s new focus on enforcement.
While it would be easy to dismiss such language as flashy showmanship, substantive shifts in enforcement policy can be discerned from these remarks.
One such shift is the SEC’s insistence on accountability. In her now infamous “Deploying the Full Enforcement Arsenal” speech, White discussed her prosecutorial experience and her development of the first corporate deferred prosecution agreement (“DPA”). Shortly thereafter, the SEC announced its first use of a DPA with an individual.
According to Associate Enforcement Director Scott Freistad, the DPA rewarded cooperation while also requiring accountability. In a November 14th speech White explained trials are important because they make both the plaintiff and defendant accountable. All litigants must meet their burden of proof and the public has the opportunity to hear the facts. But a regulatory “no admit/no deny” settlement lacks the necessary measure of accountability which may sometimes be required. White therefore changed the SEC’s settlement policy “because I believe that in certain cases, more may be required for a resolution to achieve public accountability and to be, and viewed to be, a sufficient punishment to send a strong message of deterrence. Not a trial, but some extra measure of public accountability.”
Even Commissioner Daniel Gallagher has noted the need for accountability. Although Gallagher expressed dismay with the aggressive language used by his fellow senior officials, he too believes that the agency “should take every opportunity to bring regulatory cases for violations of even the most technical rules.” As part of that effort, he called for an increased use of the failure-to-supervise theory for non-scienter based fraud cases.
The SEC’s era of accountability has begun.
We’ve long offered item-level searching for Forms 10-K and 8-K. Yesterday, we rolled out this functionality for two other major filing types, forms 10-Q and 20-F.
Item-level searching is most commonly used to limit your text-search to certain items (sections) of a filing. It also allows you to view your results as single items –one item per result — rather than as full filings. In addition, for form types in which only certain items are included in a given filing (such as the 8-K), you can use item-level searching to filter your search to only those filings that include the selected item.
Note that because redline comparison capability is part of item-level searching on Knowledge Mosaic, this feature is now available for 10-Q and 20-F items.
Yesterday we sent out our quarterly newsletter apprising customers of what’s been happening and what’s in the works for the Knowledge Mosaic product. You can access that newsletter here.
And here’s an update on one of those “What’s on the horizon” features. We expect to release item-level searching for Forms 10-Q and 20-F before the end of this month — and likely before the Thanksgiving holiday. Note that because redline comparison capability is part of item-level searching on Knowledge Mosaic, this feature will be available for 10-Q and 20-F items as well as for the current 10-K and 8-K items.
If you ever want to see what’s new on Knowledge Mosaic — not to mention what was new last year, the year before, and going back four years — visit our What’s New archive at http://www.knowledgemosaic.com/net/public/WhatsNewArchive.aspx.
It was a long time coming. After a mere 37 months of pondering, the SEC finally released its proposed rule implementing the Pay Ratio Disclosure Rule, Section 953(b) of the Dodd-Frank Act. No wonder it’s taken the agency three years to release its proposal: For such a small provision, Section 953(b) has generated a lot of heat.
Inserted into Dodd-Frank at the last minute by Senator Robert Menendez, the 140 word section requires companies to disclose their CEO’s pay as a ratio to the median pay of all the company’s employees. The legislative history gives no indication why the Section was added to the bill. But it doesn’t take a Ph. D. in political history to figure out that it was in response to public outrage at the bloated rewards being raked in by America’s corporate titans – especially on Wall Street.
Inflated executive pay is the great white shark circling below the surface of American politics. Populist anger is as potent on the Tea Party right as on the Occupy left. As president Obama recently pointed out, the average American CEO has gotten a nearly 40 percent raise since 2009, while the average American worker earns less than they did in 1999. According to the AFL-CIO’s authoritative annual Executive Paywatch review, the ratio of CEO-to-worker pay at the 500 largest companies was 42 to one in 1980. By 2011 it had swollen to 380 to one. In France, by contrast, the ratio is 104 to one. In Japan it is only 67 to one. Read more…
Little Did They Know: Responses to the Office of Financial Research’s Report on the Asset Management Industry
Thirty-five days ago the Treasury Department’s Office of Financial Research (“OFR”) fired a warning shot across the bow of the asset management industry. It delivered a report to the Financial Stability Oversight Council (“FSOC”) which, according to the Treasury Department press release announcing the report, “identifies industry activities that could pose risks to the financial stability of the United States.” OFR Director Richard Berner said “The report is an example of how the OFR serves the needs of the Council and collaborates with its member agencies.”
The SEC, one such “member agency,” might beg to differ. It took the unusual step of creating a webpage through which comments could be submitted in response to the OFR report. All Saints’ Day was the deadline for submitting comments and by the close of business, the SEC had posted 15 comment letters, a small number when compared to the thousands it has received in response to other opportunities to comment.
But while small in number the comments carry a substantial punch. Striking at the heart of the matter, commenters reminded the FSOC that its mandate is to guard against the moral hazard of “too big to fail.” But since asset management firms do not have a balance sheet requiring support, their failure cannot present the risk of a government bailout. As BlackRock notes in its comment letter, “Portfolio gains and losses accrue to investors, who may take their assets elsewhere with little market disruption if managers fail to perform. This may cause certain asset management firms to go out of business or be acquired over time, but this is not of systemic concern.”
And the academics agree. George Mason University’s Mercatus Center noted the report’s failure to distinguish between asset managers and the asset classes they manage. It also comments on the absurdity of trying to treat a $50 trillion industry as a cohesive whole in a thirty-page report.
Dechert LLP commented that FSOC reliance on the OFR report may actually backfire since it “will taint the administrative record” and provide “a basis for companies to challenge designation and other regulatory actions that attempt to rely on the Report.” Dechert identifies a number of the report’s fundamental legal and logical defects noting, for example, that investors purchase shares of a fund knowing that poor investment performance, including the loss of principal, is a natural and understood risk; that volatility and fluctuation of a fund’s net asset value are normal market features, not inappropriate risks that require extraordinary regulation and supervision; that the report treats a diverse industry in a one-size-fits-all manner; and that it fails to consider the role of existing SEC regulation.
The superficial approach the OFR took to analyze the industry was explored by Mayer Brown, which noted, “In the nearly 18 months it took OFR to produce its 30-page Report, OFR refused to make more than a show of consulting with asset management industry participants to learn the facts.” The law firm cites Reuters as reporting that although OFR shared a draft of its report with the SEC, it ignored the SEC’s feedback.
The asset management industry has returned fire.
Take a moment to ponder the distinguished looking gentleman in the photo above. He’s a trader on the floor of the New York Stock Exchange. We’ve all seen pictures like this. Every other news story about the stock market seems to have some variation of the generic theme: stock photos of stock traders waving their hands in the air in a frantic scrum of buying and selling. This guy just looks a bit more elegant than usual. And this picture was taken a half century ago. The vibe is a bit quaint and genteel.
The truth is that this fellow’s modern counterparts, with their blue jackets and lanyards, frantically shouting out quotes on the trading floor are just as archaic as he is. Floor traders have about as much relevance to market trading today as the costumed inhabitants of Colonial Williamsburg. Actual flesh-and-blood humans handle only a tiny fraction of all the trades made every day around the world. Like everything else, the securities business has become automated. (Even Ferraris, so beloved of stock brokers, are now assembled by robots.) Where traders used to bellow and elbow each other on the stock market floor, banks of computers now duel with each other, buying and selling stocks at lightning speed, executing enormous instantaneous trades based on proprietary algorithms, and moving billions of dollars in mere fractions of a second.
The life blood of modern markets is now pumped by automated systems executing trades at ever increasing speeds. Some of the finest mathematical minds in the world devote their energies to devising software with which to squeeze profits out of the tiniest increments of time. Market advantage is now measured in milliseconds, and the lag between matching and executing orders is being relentlessly whittled away. High frequency trading accounts for 90 percent of all exchange-traded derivatives, which Warren Buffet so famously described as “financial instruments of mass destruction.”
No doubt, modern electronic trading is efficient. But what social value does the inexorable race to shave nanoseconds off trading time provide? And how do we prevent the sudden, precipitous market crashes that can occur when machines furiously bet against each other? What happens when Allen Greenspan’s “irrational exuberance” arises out of robotic tenacity rather than extraordinary popular delusions and the madness of crowds? What threats do these autonomous trading systems pose to market stability and society at large? Are the markets being controlled by SkyNet?
Regulators have been struggling to come to grips with the technological arms race underway between traders. In September, the Commodity Futures Trading Commission published a Concept Release on Risk Controls and System Safeguards for Automated Trading Environments.
Prompted by the 2010 “flash crash”, the $440 million “errant trading” glitch at Knight Capital Group, and the recent Nasdaq breakdown, the Commission is trying to wrap its institutional brain around automatic trading systems in general and high speed trading in particular. As the commission notes, traditional risk controls and safeguards that relied on human judgment and speeds, and which were appropriate to manual and/or floor-based trading environments, must be reevaluated in light of new market structures. The genie won’t go back in the bottle. In the CFTC’s words, the evolution from manual trading in open-outcry pits to electronic trading platforms is substantially complete. Now the Commission wants help from the public in finding a way forward to a new regulatory environment.
The CFTC’s release is no run of the mill-of-the-mill request for comment – it is seeking public input on a total of 124 questions. The questions the Commission is posing fall largely into four groups: risks related to high frequency trading; latency-related risk; the risks posed by interconnected markets; and the continuing importance of manual controls and safeguards. The Commission is particularly interested in better understanding high frequency trading and determining whether it should receive different regulatory attention than automatic trading systems in general.
The complexity of the task facing the CFTC was underscored this last week by the Securities and Exchange Commission with the release of its much-anticipated MIDAS (Market Information Data Analytics System) website.
MIDAS collects and processes data from the various exchanges as well as from the separate proprietary feeds made individually available by each equity exchange. According to the SEC, these individual exchange feeds are typically used by only the most sophisticated of market participants such as market makers and high-frequency traders. The SEC tells us that most institutional investors, retail investors, and academics, generally do not consume this data – it is extremely voluminous, challenging to process correctly, and requires specialized data expertise. Hence, the introduction of MIDAS.
The SEC has done a terrific job of taking an immense amount of data and lassoing it into a number of eye-catching interactive graphs. (There’s also the obligatory Excel charts for the old schoolers out there.) Two things became immediately apparent when I started playing around with the MIDAS tools. The first is how much high speed trading is going on out there. The second is just how tiny the time parameters are. The MIDAS tools let you zoom in to see orders and cancellations executed in the merest fractions of a second. Mary Jo White describes MIDAS as a game changer, and says that it should spur innovation by unlocking the power of data and research to unlock a wealth of ideas from investors, market participants, and academics. White might not be engaging in hyperbole. MIDAS could prove to be a very powerful tool.
While ordinary market participants might not find themselves spending hours on end pushing and pulling the MIDAS charts like teenagers lost in World of Warcraft, I suspect analysts at the CFTC will.
The CFTC faces a daunting challenge, even with the SEC’s lovely new toy to play with. If you want to offer your thoughts on their 124 questions, you have until December 11, 2013 to pass them on.