B. Carton
As I argued in this column last month, the Securities and Exchange Commission budget has been well below where it should be for several years. This shortfall has caused the SEC to suffer a 10 percent reduction in staff and a cut of more than 50 percent in its new technology investments since 2005, a period during which the securities markets it regulates have continued to see explosive growth. Most recently, of course, the agency has had to operate in this weakened state in the pressure-cooker of the current economic crisis.
The SEC has now asked Congress for a 20 percent increase in its budget for 2011 (to $1.2 billion), and early indications are that lawmakers may go along with this request. Despite these positive signs, however, SEC Chairman Mary Schapiro and some of her fellow commissioners such as Luis Aguilar now are pushing for what they believe is an even better way for the SEC to secure the resources it needs to perform its role: self-funding.
Self-funding can take various forms depending on how much flexibility Congress gives an agency in using the fees it collects. Congress has provided permanent budget authority to certain banking agencies, such as the Federal Reserve, the Office of Thrift Supervision, and the Federal Deposit Insurance Corp., allowing these agencies to use the funds they collect and removing them from the annual appropriations process. This type of authority is what Schapiro and Aguilar appear to be seeking.
In the SEC’s case, it could easily fund itself through the registration and transaction fees it collects from issuers and regulated entities. The agency reportedly expects to collect $1.3 billion in fees in 2009 and $1.5 billion in 2010. By contrast, Congress has appropriated only $960 million to the SEC in 2009 and is expected to approve the Obama administration’s proposed budget of approximately $1.026 billion in 2010.
A move to a self-funded model has been one of Aguilar’s priorities since joining the SEC in July 2008. He points to the FDIC as a prime example of a regulator that can nimbly respond to changing market conditions and demands because it is self-funded and controls its own budget. Schapiro has also jumped on board; in an interview in August, she stated that self-funding has “been discussed over the years, but I think it may now well be the moment.” Referring to the SEC’s flat budget of the past few years, Schapiro added that “self-funding will help us to avoid periods of drought. Think about what the markets were doing in terms of growth and innovation at the same time the SEC was in a hiring freeze.”
Is self-funding the right choice for the SEC? What are the pros, cons, and implications of such a fundamental change in the SEC’s funding mechanism? Those questions have been percolating for years. Indeed, when Congress passed the Investor and Capital Markets Fee Relief Act of 2002, it included a mandate that the U.S. Government Accountability Office study the implications of converting the SEC to a self-funded basis.
The GAO report had two main conclusions. First, under self-funding, the SEC would have more control over its own budget and funding level, which might better enable the SEC to address its increasing workload and evolving market issues. Second, a move to self-funding would require the SEC to establish a system of internal controls to ensure fiscal discipline, and reduce or eliminate Congressional control over the SEC.
Several events in recent years have underscored the need for more flexibility and responsiveness from the SEC. The collapse of Enron and other major corporations at the beginning of the decade, for example, was an unexpected, game-changing event requiring a new type of response by the SEC. As the GAO report noted, those corporate failures stimulated an intense debate on the need for broad-based reform in securities regulation. In response, the SEC requested approval for 100 additional staffers who would help review corporate filings, enforce securities laws, and provide accounting guidance. Congress and the executive branch still had to approve those increases in the SEC’s staffing allocation, of course, and despite general agreement on the need for these increased resources, the SEC’s request got lost in the shuffle of other Congressional priorities for an extended period.
Likewise, the massive turmoil facing world and U.S. markets in 2009, coupled with the intense scrutiny resulting from the Bernard Madoff Ponzi scandal, has placed the SEC in an unprecedented regulatory environment that could never have been contemplated by the budget process. But the agency can’t respond to the current challenges by hiring new staff and ramping up its technology, because it has no money to do so. Congress is expected to approve a modest increase in 2010, but the additional $200 million that Schapiro is seeking to fund 375 additional full-time positions and $30 million in needed technology will not arrive until 2011—if those monies arrive, under the current appropriations model.
Many former SEC staffers agree that self-funding would be a good move. Broc Romanek, a former attorney in the Office of Chief Counsel of the SEC’s Division of Corporation Finance, agrees that self-funding is long overdue for an independent agency like the SEC. “By being beholden to Congress for its funding, the SEC is able to be politicized, and has been for the past decade,” he said.
Michael MacPhail, a former deputy assistant director in the Enforcement Division now with the law firm Holme Roberts & Owen, also believes that self-funding is a “great idea.” He says that from the fees it collects from registrants, “the SEC is a profit center for the government and should be allowed to benefit from its activities,” and that “there is no reason to treat the SEC any differently from the FDIC, which is allowed to be self-funded.”
Along with the obvious benefits of self-funding, however, come challenges. Giving the SEC control of its own billion-dollar budget means requiring the agency to have effective internal controls in place; it also strips Congress of its primary means of controlling the SEC. Under the SEC’s current funding structure, the Office of Management and Budget and the appropriations process provide this fiscal discipline for the agency. The SEC’s annual budget process is now a “reactive” one based on the previous year’s appropriations, rather than on what may be actually needed to fulfill its mission. A self-funded SEC would need to be able to review its staffing and resource needs independent of the budget process.
Bill Thomas, a former branch chief in the Enforcement Division now with SEC Intelligence, notes that the GAO itself has faulted the SEC several times in the past for weaknesses in this very area. And Pat Conti, another former branch chief in the Enforcement Division now in private practice, says the notion of a regulator having a stake in the penalties it collects is a bit unsettling. He says that “it was always a point of pride for me while on the staff that what we collected went to the Treasury or to victims.”
Moreover, the SEC has been under withering criticism in the past year, which will no doubt be fueled further by the report from the Commission’s own inspector general chronicling the SEC’s failure to identify Bernard Madoff’s Ponzi scheme as far back as 1992. A recent poll showed the SEC is now viewed even more unfavorably than the Internal Revenue Service; that doesn’t help efforts to get Congress to provide so much power and autonomy to the SEC.
My own take on the subject is that Schapiro is correct: The time for self-funding the SEC has arrived. It seems clear to me that the challenges and demands imposed by the markets the SEC regulates change so quickly and significantly that the SEC is routinely left hanging by the current appropriations process. I say let the SEC be self-funded like the FDIC and other regulators, and see if it can better execute its mission with the funding and flexibility it believes it needs.
Originally published in Compliance Week. Reprinted with permission. © 2009 Financial Media Holdings Group, Inc. All Rights Reserved. Compliance Week can be found at http://www.complianceweek.com. Call (888) 519-9200 for more information.
