Just days after the Republicans took control of the House, threatening even greater legislative gridlock, leaders of the financial industry urged caution in the way in which government moves forward with financial reform.
While there was widespread consent at yesterday's Securities Industry and Financial Markets Association's annual meeting in New York that passage of the Dodd-Frank bill was essential to stabilize markets, many worry that the time frame in which Congress has mandated reform is emphasizing speed over efficacy.
"We're talking about the most significant industry reform in 70 years," says Walter Robertson III, senior managing director of Virginia-based Scott & Stringfellows, a regional brokerage and investment banking firm, "and the risk is in acting too quickly."
Chet Helck, COO of Raymond James, agrees regulatory reform has been long over due. But he also believes recovery is stalled by the lack of clarity about future regulation. "I think businesses are holding back on big capital commitments to grow and expand their operations until they know what the regulatory costs and taxes are going to be."
James Gorman, CEO of Morgan Stanley, sounded more sanguine in the conference's opening remarks. He believes the march toward reform-starting with the bank stress tests here and then in Europe, followed by Dodd-Frank and Basel III, "should give investors, rating agencies, consumers and issuers confidence that the institutions they're dealing with are materially safer and sounder then they were before. And that's precisely what the regulators were after."
But Gorman warns that reform doesn't guarantee that we've moved past the notion of too big to fail. He personally doesn't believe any company should be shielded from failure due to poor management, idiosyncratic risk taking, and recklessness. Such operations, he said, "should be allowed to fail regardless of their size."
He does believe, however, that adoption of a new systemic regulator to ensure coordination of the "alphabet soup of regulators" and the creation of a resolution authority to deal with troubled companies will vastly improve transparency--akin to bankruptcy-assuaging market stress. As Gorman sees it, the new reforms can better control--not prevent--such failures.
Gorman agrees with Raymond James' Helck that the subsequent rule making supporting Dodd-Frank will ultimately determine whether the law will be effective or counterproductive. To achieve the desired end, he urges patience among all players affected by reform.
"Action is always preferred over thoughtfulness," concedes Gorman. "And there is a desire to have immediate results on everything that you do on a linear fashion. That's simply not the way the world works. We have to be very careful to think through the unintended consequences of a structure that could end up hurting job and capital creation."
SEC Chairman, Mary Schapiro, also highlighted the theme of change when describing her agency's transformation from no longer approaching the industry with a so-called, "light touch." This regulatory style, she explained, had been borne out of the belief that the industry was self-correcting and that bureaucrats don't know how to effectively address the increasing complexity of financial markets.
But since returning to head the agency nearly two years ago, she's been hiring directly from the industry: hedge funds, trading desks, analysts, credit raters, and derivative specialists. And the agency is reaching out to the industry, market participants, and investors to inform the rule making process.
Schapiro believes she's reinvigorating the agency by making it feel more relevant. To her, no recent event better drove home that point than the agency's failure to detect Madoff's fraud--an extraordinary example of just how crucial regulation and enforcement are in protecting investors and market confidence.
She also highlighted the urgency of preventing future flash crashes. "May 6th revealed the frailty of our system," she exclaimed, and "we cannot tolerate if the integrity of the market place is in question."
Toward that end, she spoke of the new circuit breakers that are in place when a stock moves--either up or down--by more than 10% in five minutes. Trading is halted for five minutes to restore liquidity and rationale pricing.
To prevent erroneous trades, Schapiro announced that last week the SEC passed a rule that prohibits broker-dealers from allowing customers to directly access the market without orders initially going through firms' risk management checks.
Schapiro also says the SEC is focused on algorithms--a key component of programmed trading--that can cause very serious market disruption. "We had a circuit-breaker trigger when an algorithm tried to sell 10% of a stock's daily volume in 2 seconds," recalls Schapiro.
In the reforming the market, she has found the financial industry input has been quite constructive. But she may find that lacking in her plans to reign in certain compensation schemes. In concert with fellow regulators, Schapiro announced the SEC will be seeking ways for industry compensation to encourage the right kind of behavior and conduct. Some observers felt that could be as challenging as clearly defining all forms of proprietary trading.
Schapiro was explicit, however, in what she thought needed to be stopped: "Compensation programs that incentivizes people to take short-term risk at the expense of the long-term franchise and investors. Whether it is how brokers who deal with retail customers are paid with big upfront bonuses, or high levels of compensations for high levels of portfolio turnovers, or senior management that are compensated solely on the short-term numbers--these are things that absolutely have to change."
Pointing to the Goldman Sachs case, Schapiro thinks the industry needs to think about the profound conflicts of interests that exist and the importance of putting the customer first.
On this point, Raymond James' Helck firmly agreed. What's not changing, he explains, is his firm's commitment not to take on too much risk or leverage, to be conservative in money management, and to stick to a disciplined process to help ensure more predictable outcomes. "It's common sense," he observes, "and it seems the world is again recognizing the value of thinking this way."