At a brief meeting on April 28, 2004, five members of the Securities and Exchange Commission met in a basement hearing room to consider an urgent plea by the big investment banks. Bear Stearns, Goldman Sachs, Merrill Lynch, Lehman Brothers and Morgan Stanley. This meeting was attended by just a few members, lasted less than an hour and had no media coverage.
In letters to the commissioners, senior executives at the Big 5 had complained about what they thought were unnecessary regulation and oversight by both American and European authorities. They primarily wanted an exemption from the S.E.C Net Capital Rule (Rule 15c3-1).
Rule 15c3-1:
focused on liquidity and was designed to protect securities customers, counterparties, and creditors by requiring that broker-dealers or companies that trade securities for customers as well as their own accounts, have sufficient liquid resources on hand at all times to satisfy claims promptly;
had firms value all of their tradable assets at market prices, and then apply a discount to account for the assets' market risk; and
required that broker dealers limit their debt-to-net capital ratio to 12-to-1 limit (meaning that for every $12 of debt, the banks were required to have $1 of equity). although they must issue an early warning if they begin approaching this limit, and are forced to stop trading if they exceed it.
If the Big 5 were given an exemption to Rule 15c3-1 it would free up billions of dollars held in reserve as a cushion against losses on their investments. Those funds could then go to the parent company, enabling it to invest in the fast-growing world of mortgage-backed securities; credit derivatives and other securities.
However, a few months before this meeting, a two-page letter of opposition came from Leonard D. Bole, a software consultant from Valparaiso, Indiana who said the computer models run by the firms — which the regulators would be relying on — could not anticipate moments of severe market turbulence. Mr. Bole, who earned a master’s degree in business administration at the University of Chicago, helps write computer programs that financial institutions use to meet capital requirements.
He was never called by anyone from the commission.
One commissioner, Harvey J. Goldschmid, questioned the proposed exemption. It would only be available for the largest firms, he was told — those with assets greater than $5 billion. “We’ve said these are the big guys,” Mr. Goldschmid said, “but that means if anything goes wrong, it’s going to be an awfully big mess.”
The vote at the meeting was unanimous to allow the exemption.
The Consolidated Supervised Entities (CSE) program was now alive and would eventually affect the lives of many Americans.
The CSE stipulated that participating banks allow their broker-dealer operations and holding companies to be subject to oversight. Yet like many government regulations, this program had a flaw to it, it allowed investment bank holding companies to withdraw from this oversight at their discretion.
The next part of this creation was having the oversight done by the S.E.C. Because it is a relatively small agency, the S.E.C. relies heavily on self-regulation by stock exchanges, mutual funds, brokerage firms and publicly traded corporations. The CSE program now required substantial S.E.C resources for complex oversight. SEC supervision would include recordkeeping, reporting and examination requirements.
Christopher Cox, the head of the Securities and Exchange Commission, was a longtime proponent of deregulation. (Note that in 2004 the S.E.C. Commissioner was William H. Donaldson.) Cox had been a close ally of business groups in his 17 years as a House. He had led the effort to rewrite securities laws to make investor lawsuits harder to file. He also fought against accounting rules that would give less favorable treatment to executive stock options. Under Mr. Cox, the commission responded to complaints by some businesses by making it more difficult for the enforcement staff to investigate and bring cases against companies. The commission has repeatedly reversed or reduced proposed settlements that companies had tentatively agreed upon. While the number of enforcement cases has risen, the number of cases involving significant players or large amounts of money has declined.
Supervision of the CSE program under was a low priority for Cox. Seven people were assigned by the S.E.C. to examine the parent companies. Since March 2007, the office had not had a director. And as of October 2008, the office had not completed a single inspection since it was rearranged by Mr. Cox in 2006.
In essence the banks were now regulating themselves.
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