The ERM Current™

What has happened to the promise of transparency and accountability?  According to a recent article in the New York Times, it has become a real-world example of “doublethink” – a term coined by George Orwell, the author of the famous novel 1984.  On the heels of one of the most serious financial crises of the past 100 years, the U.S. Congress is working against providing greater transparency and accountability.  Here is what the Times reported.

It took just five weeks after the WorldCom accounting scandal erupted in 2002 for Congress to pass, and President George W. Bush to sign, the Sarbanes-Oxley Act. That law required public companies to make sure their internal controls against fraud were not full of holes. It took three more years for Bernard Ebbers, the man who built WorldCom into a giant, to be sentenced to 25 years in prison for his role in the fraud.

Mr. Ebbers will be 85 years old before he is eligible for release from prison. He may be freed, however, before the law is ever enforced on the vast majority of American companies. A Congressional committee voted this week to repeal a crucial part of the law. Other parts are also under attack. Sarbanes-Oxley was passed, almost unanimously, by a Republican-controlled House and a Democratic-controlled Senate. Now a Democratic Congress is gutting it with the apparent approval of the Obama administration.

The House Financial Services Committee this week approved an amendment to the Investor Protection Act of 2009 — a name George Orwell would appreciate — to allow most companies to never comply with the law, and mandating a study to see whether it would be a good idea to exempt additional ones as well. Some veterans of past reform efforts were left sputtering with rage. “That the Democratic Party is the vehicle for overturning the most pro-investor legislation in the past 25 years is deeply disturbing,” said Arthur Levitt, a Democrat who was chairman of the Securities and Exchange Commission under President Bill Clinton. “Anyone who votes for this will bear the investors’ mark of Cain.”

Restoring investor confidence in the financial system is the most effective path towards long-term economic recovery. These actions may remove a short-term burden from some companies, but the long-term impact to investor confidence will be severe – just ask the former stockholders of WorldCom.

A recent op-ed article in the Wall Street Journal by professors from Columbia and Harvard Business Schools provides a view on the political impact on financial regulatory reform in the United States.  Here what they had to say about the missed opportunity in the current proposal by the Obama administration.

For political reasons the administration has decided not to upend the current system. Instead it proposes four federal entities—Financial Services Oversight Council, the Office of National Insurance, the Federal Consumer Coordinating Council, and the Consumer Financial Protection Agency—on top of the current alphabet soup of regulatory agencies. This is a shame. We need fewer, not more, regulators. The Committee on Capital Markets Regulation, a private, nonpartisan organization on which we serve, recommended in its May report that serious consideration should be given to the creation of a unified supervisor, such as a U.S. Financial Services Authority, modeled on the approach of the United Kingdom. Our financial system has had a complete meltdown and our outmoded regulatory structure is partially responsible. This is the time to redesign the system for the future, not for politics as usual.

Reduced complexity and more accountability will result from a streamlined regulatory system.  The professors should take their case to Capitol Hill.

The much anticipated regulatory reform proposal from the new Obama administration is nearing completion according to a report today in the Wall Street Journal.  The aim of the proposal is to streamline the byzantine regulatory framework within which U.S. financial institutions have been operating for many decades.  Here is what the WSJ had to say.

Top Obama administration officials are close to recommending that Congress create a single regulator to oversee the entire banking sector, people familiar with the matter said, a departure from the hodgepodge of federal agencies that failed to contain the financial crisis as it ballooned out of control last year.

The new agency is expected to be a major plank in a proposal that Treasury Secretary Timothy Geithner and White House officials send Capitol Hill in a few weeks with the goal of overhauling supervision of financial markets.

The new bank regulatory agency could prove controversial because it would consolidate the Office of the Comptroller of the Currency and the Office of Thrift Supervision and strip supervisory powers from the Federal Reserve and the Federal Deposit Insurance Corp.

The Fed and the FDIC would gain other powers, though, as White House officials want the Fed to be able to oversee systemic risks in the economy. They also want the FDIC to have new powers to take large financial companies that aren’t banks into receivership.

While the outcome of the proposal is far from certain, one thing is certain – major regulatory change is on the horizon. Is your company prepared to manage this change?  Wheelhouse Advisors can help.  Visit www.WheelhouseAdvisors.com to learn more. 

The Wall Street Journal commented on the state of the U.S. Securities & Exchange Commission (SEC) today in an article by David Weidner.  The article also provided some interesting perspective on the effectiveness of regulatory bodies as they age.  Here is what Mr. Weidner had to say.

Just ask Harry Markopolos, the whistleblower who waged a decade-long, ultimately unsuccessful battle to persuade the SEC to prosecute Mr. Madoff. The commission was clearly reluctant to pester an established Wall Street force. However, the SEC also showed itself to be shockingly incompetent.

Consider Linda Chatman Thomsen’s response to a recent congressional inquiry on the Madoff case. Ms. Thomsen, the SEC’s enforcement director from 2005 to 2009, was asked why the SEC didn’t respond to Mr. Markopolos’ mountain of evidence against Mr. Madoff. “If we knew that it was provable fraud, it (investigating) would be easy,” she said. This is what we can expect when a regulatory body has become too enmeshed with the industry it monitors, according to John Kenneth Galbraith, the late economist.

“Regulatory bodies, like the people who guide them have a marked life cycle,” Galbraith wrote. “In their youth they are vigorous, aggressive, evangelistic and even intolerant. Later they mellow, and in old age – in a matter of 10 or 15 years – they become, with some exceptions either an arm of the industry they are regulating or senile.”

In the U.S., we have not only the elderly SEC, but many other aging regulatory bodies that have lost their effectiveness over time.  It is time to host retirement parties for some of these agencies and streamline our regulatory structure for the 21st century.

This week, the U.S. Senate Committee on Banking, Housing and Urban Affairs held a hearing into the lessons learned in risk management oversight at federal financial regulators.  Not surprisingly, all of the representatives from each regulatory agency agreed that risk management practices in the institutions they regulate must be strengthened.  Here is what Mr. Timothy Long from the Office of the Comptroller of the Currency had to  say.

The unprecedented disruption that we have seen in the global financial markets over the last eighteen months, and the events and conditions leading up to this disruption, have underscored the critical need for effective and comprehensive risk management processes and systems. As I will discuss in my testimony, these events have revealed a number of weaknesses in banks’ risk management processes that we and the industry must address. Because these problems are global in nature, many of the actions we are taking are in coordination with other supervisors around the world. 

More fundamentally, recent events have served as a dramatic reminder that risk management is, and must be, more than simply a collection of policies, procedures, limits and models. Effective risk management requires a strong corporate culture and corporate risk governance. As noted in the March 2008 Senior Supervisors Group report on “Observations on Risk Management Practices During the Recent Market Turmoil,” companies that fostered a strong risk management culture and encouraged firm-wide identification and control of risk, were less vulnerable to significant losses, even when engaged in higher risk activities.

Hindsight certainly is clearer given the magnitude of the recent economic meltdown.  However, these views must remain with us as we emerge from this downturn and inevitably enter better economic times.  

Last week, the U.S. Chamber of Commerce published a declaration of their regulatory reform principles for consideration by the Obama Administration and the U.S. Congress.  Among other things, the declaration calls for greater transparency within the regulated entities as well as the regulatory authorities.  Here are their views.

Important elements for improving transparency and market integrity include:

1. Fostering information flow among all significant financial institutions and credible, effective regulators;
2. Enhanced risk management practices and disclosure thereof within regulated entities;
3. Improved and timelier risk modeling, particularly in times of stress;
4. Improved timely cross-border and cross-institutional information sharing among regulators; and
5. Oversight of credit rating agencies that promotes greater transparency, adherence to best practices, and initiatives to minimize conflicts of interest. Improved self-regulation should be supplemented by responsible and more internationally consistent government regulation of the industry.

As stated in previous blog posts, a crisis such as the one we are currently experiencing can lead to positive change.  These principles set forth in this declaration are certainly a step in the right direction.