SEC Commissioner: More Financial Regulation Not Needed
The recent volatility in the investment markets has revealed the effects of a boom in unregulated investments such as hedge funds, derivatives, and commercial paper. Some observers say the failure of some bonds backed by subprime mortgages has roiled many distantly related investments only because investors don't have enough information to see just how serious the mortgage problems are—something a little regulation could fix. Even Christopher Cox, the Republican chairman of the Securities and Exchange Commission, and no fan of overregulation, asked Congress this summer for the power to make municipal bond issuers provide more information. But in an interview with U.S. News, SEC Commissioner Paul Atkins, also a Republican, argues against more intrusion into the markets. The markets will get over these troubles on their own, he believes.
Are you worried about the market today?
Obviously, there's been some volatility in the marketplace lately. That's part of what makes it interesting. It's not like putting money into a bank. The risks are higher, and so are the potential rewards. We like to preach around here, as do a lot of people, that people should invest for the long term. If you look over any long stretch of time, the equity markets, at least, have been producing a return that is better than other alternatives. So that's what you have to keep in mind.
So do you think this is just sort of a short-term ripple, and this will work itself out?
Well, one never knows, but if you look at the recent actions of the Federal Reserve and some of the other central banks, and the reaction of our marketplace, yeah, I think the marketplace has taken it more or less in stride. There will be changes of business models. People will start to react to what has happened in how they allocate their investments.... But I think we on the regulatory side and elsewhere can't become panicked. We have to look at the long term as to how we set policy and how we react to the market's ups and downs.... This will work itself out, ultimately.
One of the complaints from investors is that all kinds of investments are getting beaten down because people don't know where the risks really are. Do you think there is a lack of transparency in the market, and if so, is that a problem?
That's a complicated question. First, if you are looking at the retail market, if you are a normal investor, corporations are required to disclose to you in a prospectus [if it's a new issue], and then in their Management Discussion and Analysis, about how the business is doing, where they think the opportunities are, where the risks are, and how they are going to try to manage those risks. Now, of course, people aren't perfect, so they could be wrong. And there could be some nefarious aspect, too. But by and large, people are honest, and they are trying to do the right thing.
But we're hearing about hedge funds going down. And companies can't sell commercial paper to raise money right now because investors are not willing to front the money.
The people who invest in hedge funds know they are taking a risk. They tend to be savvy.... Yes, maybe a pension fund is investing in a hedge fund, but they are not risking their last dime—they are restricted in how much they can invest in products like hedge funds. They are trying to boost their return by diversifying and taking calculated risks. As a pension fund manager, you can't just put your money in treasuries and then expect to meet your obligations 30 or 40 years down the road. So pension funds, insurance companies, and others have to try to balance their risks and expected returns.
But hedge funds aren't regulated, and there have been some sort of noticeable failures. Is it just caveat emptor?
Well, it is not entirely caveat emptor because there are a lot of rules that apply to hedge funds. Many of them voluntarily register with the SEC. No hedge fund can lie, cheat, or steal. And, to make sure everything is covered, we just promulgated a new hedge fund rule that says, basically, "Thou shalt not rip off thy limited partners."
If big investors are going to be plunking down $100 million into a hedge fund, they have a huge amount of leverage over that hedge fund manager. There are accountants coming in to kick the tires, look at valuations. If they suspect a rat, we have authority to go in to check up on what's going on, which we have done in the past. So it is not the Wild West at all. There is a sheriff in town. The investors have the ability to blow the whistle. The main question is: Where should the SEC as the cop on the beat be devoting its limited resources? To mutual funds, where more than 90 million mostly retail investors have their money? Or to hedge funds, where mostly professional money managers with their accountants and lawyers are investing a limited portion of their assets?
In fact, one of the fears is of a building moral hazard, of investors thinking, "This hedge fund is registered with SEC. So it must be safer than something that is not." But that is absolutely not the case. For example, the two Bear Stearns subprime hedge funds that failed were registered with the SEC. We are not in the business of vetting investment strategies. Just like if you look back at Long-Term Capital Management, which failed back in 1998. That fund was run by Myron Scholes, a Nobel Prize-winning laureate in economics, and others. Just imagine an SEC examiner walking in and saying, "I really question your model. I think it is heading for a crash." [Laughter.] You know, if I were an investor, I would be outraged at that because I am risking my money, and if their strategy doesn't pan out, then, OK, I tried, and it didn't work.
In July, SEC Chairman Christopher Cox told Congress about his concern about the lack of information for municipal bond investors. Is that something we should be worried about?
There have been some problems over the years in the muni bond area. The SEC has brought some cases. And you have all sorts of levels of competence and risks out there. There probably could be better disclosure.
Chairman Cox asked Congress for more power to regulate municipal bonds. Do you support that?
One major issue is federalism. That is a huge hornet's nest. But I do think that when we look at some of the people who are engaged by the various governmental organizations to help them issue the paper—this goes for underwriters, bond counsel, tax counsel, that sort of thing—they do have an obligation to try to get accurate disclosures to investors.
But given the fact that the market isn't doing that naturally, does the SEC need the power to force issuers to do that?
Well, I will leave that up to Congress.
Could there be such a thing as too much transparency in the markets?
That's a great question. You do have to have a balance. We have a rule that says if you have more than $100 million in the marketplace, you have to file your positions with the SEC every quarter. There is an understandable reluctance for someone, especially if you are a hedge fund manager or something like that, to disclose your strategy so that people could figure it out. So there is a lot of window dressing toward the end of the quarter: Mutual funds and hedge funds change their investments to try to not give away too much information to competitors. We get requests all the time for exemptions, which we usually turn down.
But it is a global marketplace. There are alternatives. People can go abroad. They can go into other sorts of instruments to get out of the equity market and have pretty much of an equity equivalent through derivatives, so I think we have to be very careful. Look at some of these new proprietary trading systems that are promising anonymity. If a mutual fund's portfolio manager is interested in buying a million shares of IBM, for example, making that public can be bad for the fund's investors. If that is your mutual fund buying IBM, and if everybody knows what it is going to do, the price is going to change—against you.... We are all trying to strive for a fair market. You have to get a balance because, if it loses its balance, then it could really disrupt this huge, great engine of a marketplace that we have in the United States that is really the envy of the world.
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