Peeling away financial reporting issues one layer at a time

“Going Public” is More than a Memoir by an SEC Staffer — Which is Unfortunate

There is more to the securities laws and their administration by the SEC than just the ’33 and ’34 Acts.  The Investment Company Act of 1940 focuses on disclosures by mutual funds and similar entities; and the Investment Advisers Act of 1940 requires registration of certain investment advisers, and subjects them to inspection by the SEC. I think it is more than fair to say that administration of these latter statutes may have occupied more of the commissioners’ bandwidth than the financial reporting statutes over the last decade, especially since the 2008 Financial crisis, and the Madoff and Stanford mega-Ponzi schemes.

In 2010, Norm Champ took time off from private law practice to work at the SEC.  His first position was in the Office of Compliance Inspections and Examinations, which had recently whiffed in relatively short order on Madoff and Stanford. Champ was hired to head the examinations of investment firms in the New York metropolitan area. After two years, he was named Director of the Division of Investment Management by chair Mary Schapiro, where he served for three more years.  At IM, he led rulemaking that arose out of the financial crisis and the Dodd-Frank Act.

The subject of Champ’s memoirs of his time at the SEC are somewhat of a diversion from the financial reporting topics that are my meat and potatoes on this blog.  I was nonetheless eager to read them as few have written about the inner workings of the SEC staff in any great detail.  I was inside the SEC myself, as an academic fellow, and had formed my own (largely positive) opinions of how the SEC staff went about their jobs.  But, that was a long time ago (1992 – ’93), and things change.  When I was at the SEC, the staff had not yet unionized and morale among the professional staffers was very good.  I was singing right along with Champ early on:

“…[T]he surprising truth is, for all the challenges, my time there [at the SEC] will always be the epitome of my professional career…. I served with many dedicated individuals who devoted their lives to public service and the preservation of the U.S. capital markets…. It was an honor that I will cherish for the rest of my life.” [p. 21]

But soon thereafter, I would become a captive audience for clumsy interpolations of conservative talking points, which were far afield of Champ’s core competencies.  The topics ranged from tax policy, budget deficits, monetary and fiscal policy.  None of these have anything to do with the SEC.   Generalizations, inaccuracies and inapt analogies were rampant.  For example, on at least two occasions, Mr. Champ makes the risible claims that the Democrats controlled Congress for two years, when in fact it was only for a little more than two months; and that Dodd-Frank was enacted by a Democratically-controlled Congress.

Yet, for all of the policymakers who come and go in the recounting, I don’t think that Champ mentioned even once Christopher Cox, the last conservative SEC chair, who had a lot to do with the condition of the SEC as Champ found it when he started working there.  Cox was the SEC Chair from 2005 to 2009, which was not very long before Champ came aboard.  Cox, like Champ, was educated at elite schools, studious, a hard worker, and a conservative.

Cox could have prioritized the types of reforms that Champ had identified as low-hanging fruit: organizational restructuring and implementation of early-warning systems.  But, he didn’t.  If Champ found evidence of dysfunction and indifference at the SEC, he should have apportioned at least some of the blame to Cox:

“Under the leadership of Chairman Christopher Cox, the commission took deliberate steps to disable the SEC’s enforcement apparatus and impede its enforcement lawyers from doing their job.  For example, in 2006, Chairman Cox instituted a new policy prohibiting the agency from assessing civil money penalties against corporations except in ‘egregious’ cases.  To keep the SEC’s lawyers on a short leash, Cox issued a further decree requiring the agency’s lawyers to get prior approval from the full commission before they could negotiate civil money penalties against public issuers.  The results were disastrous… Not long after, the New York Times reported that ‘demoralized [SEC] staff members had been watering down proposed settlement in enforcement cases out of the fear that the commission would reject them.’

…Cox shelved investigation requests from the staff unless the commission gave unanimous consent.  Not surprisingly, [Commissioner Raul] Aguilar later noted, the result was a ‘logjam.’”

[The Subprime Virus: Reckless Credit, Regulatory Failure, and Next Steps,  p. 217, emphasis supplied]

Even some Republicans wanted Cox to resign in the wake of the financial crisis.  Still, while plenty of criticism was directed toward liberal politicians, nary a word from Champ about Cox.  (Some of my own views are here and especially here.)

I also didn’t need, or much care, to know that Mr. Champ was deprived of attention as a youth by his wealthy, politically-connected, alcoholic father — who took the “party” aspect of “Democratic Party” literally.  I suppose Champ was trying to explain motivations to right wrongs through public service.  Yet, I am left to wonder whether the wide-ranging pro-conservative commentaries are Champ’s way of exacting a measure of revenge against his father.  Ironically, Champ needed a lot of outside support to be in a position to serve the public while not sacrificing his family’s lifestyle.  He was fortunate to have a supportive uncle who stepped up to pay his college and law school tuitions — not a government charity, but charity just the same.

And as long as he mentioned it, just how much did Champ personally benefit from the generous “carried interest” tax loophole he is against eliminating?  Since he used income from family assets accumulated over generations, what are his views on estate taxes?  Just to be clear, I don’t care much about the answers to the questions, and only wish to point out the selectivity of his digressions from the book’s main topic.

Indeed, this post is somewhat of a digression from the main topic of The Accounting Onion. But Champ’s book did stimulate my thinking about financial reporting in a number of respects.  Here are two:

First, Champ seems to take it for granted that current valuation should be the standard of measurement of investments by mutual funds (with the possible exception of money market funds) in both equity and debt securities.  He recognizes that measurement can involve subjectivity, but that one of the jobs of Investment Management was to make sure that the measurements by reporting entities of their assets were consistent and transparent.

Yet, for some reason, what is natural for investment companies is a struggle for companies reporting under the ’33 and ’34 Acts.  Just recently, for example, issuers fought tooth and nail against the requirement added by ASU 2016-01 to broaden the set of equity investments that would be measured at fair value.  The ’33, ’34 and ’40 Acts are all administered by the SEC, yet when it comes to financial reporting, they are in their own silos.

Second and relatedly, I really didn’t appreciate until now (but maybe I should have) just how much of the Commissioner bandwidth was being used by the ’40 Acts. While I remain resentful that successive SEC Chairs (Schapiro, Walter, White) dodged accounting policy matters, I have a new appreciation of the constraints they were facing.

Congress made a mistake when it designated the administration of the ’40 Acts to the SEC.  It has made the SEC too big and too broad in its mandate.  As Champ found out, lots of stuff falls through the cracks.  There should be two agencies: one to regulate ’33 and ’34 Act registrants, and a separate SEC to regulate the markets, investment companies and advisers.  I see a lot of benefits to that kind of structure, mainly increased focus and efficiency, because there is very little overlap today across these statutes.

* * *

I don’t doubt that Champ did good work while at the SEC.  I enjoyed reading the half of the book describing the successes and failures, and he is generous about giving credit to others.  For the other half, I’ve already told you how I feel.


1 Comment

  1. Reply Charlene Budd June 13, 2017

    Thanks. This is a neat review and allows me to avoid having to read it. I appreciate your work.

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