Last August, Treasury Secretary Tim Geithner used a speech at New York University’s Stern School of Business to outline a few financial reform principles necessary to quickly and properly execute the newly passed Dodd-Frank Act. He stated that the bill will provide better regulation to the markets, and he outlined a few financial reform principles. A year has gone by since he unfurled his plan, and in reviewing the laws coming from the SEC and CFTC, it is clear that regulators cannot walk Geithner’s talk.
In adopting new laws, Geithner stated as his first principle that regulators have an obligation to move as quickly as possible to bring clarity to the new rules of finance. He noted that the rulemaking process in Washington has traditionally moved at a frustrating, glacial pace. As we all know, government breaking with tradition is sacrilege -- and this case proved no exception. The SEC was required to adopt rules on more than 90 provisions in connection with Dodd-Frank, the most of any other agency, and it was also tasked with dozens of other provisions that gave it discretionary rulemaking authority. And the survey says: as of May, 2011 the SEC had finished only six rules and had missed deadlines on 11 others. Similarly, the CFTC has thus far only adopted seven new rules. To Geithner’s credit, his goal of full transparency and disclosure has come with some success. Proposed rules from the regulatory agencies have been published and made available to the public. They have also been open to the public for comment, and those comments have also subsequently been published. Kudos.
Where the disclosure principle has failed, however, is with regards to transparency among regulatory agencies. Many of the newly adopted rules abound with the failure of agencies to consult with one another as they draft new rules. For instance, in adopting legislation pursuant to section 753 of Dodd-Frank -- which pertain to fraud-based and price-based manipulation -- the CFTC made final rules applying to swaps, commodities, and futures without consulting the SEC. When the rule was in proposal stage, Senator Carl Levin (D-MI) commented that “the CFTC and SEC should harmonize their regulatory structures for combating disruptive and manipulative activities.” He went on to “express concern that, as currently drafted, the proposed rules may not allow the CFTC to effectively regulate market activity that is intended to or actually does artificially change prices in another market or product.” The CFTC responded by saying simply that they’ll coordinate enforcement efforts when necessary.
This breakdown of coordination also illustrates the failure and gross lack of effort to carry-out Geithner’s stated goal to eliminate existing rules and laws that did not work, and to streamline and simplify existing regulation. The SEC currently has an anti-manipulation regime that is failing. By collaborating with the CFTC on section 753, the two bodies could eliminate the SEC’s existing rules on the subject and create a legitimate and effective law. Instead they chose to go at it solo to produce two separate inadequate laws that fail to acknowledge possibly the greatest culprit -- high-frequency trading (HFT).
Both the new CFTC law and those at the SEC do not address HFT. The CFTC claimed “supervision of algorithmic and automated trading systems as beyond the scope of this rulemaking.” Why the SEC chooses not to address it is most likely because of a lack of competence.
This short-coming is not exclusive to the SEC. The CFTC also lacks sufficient understanding. One of the many still-proposed rules the CFTC has been tasked with is pursuant to section 747 of the Dodd-Frank Act. This is yet another provision where the two bodies should be working jointly, and it clearly illuminates the their non-authority on HFT. Section 747 makes it unlawful to (A) violate bids or offers; (B) demonstrate intentional or reckless disregard for the orderly execution of transactions during the closing period; or (C) is of the character of, or is commonly known to the trade as, “spoofing'” (bidding or offering with the intent to cancel the bid or offer before execution).
Of course, parts A and C are essentially the entire business of HFT and address a major aspect of market manipulation. And because of the CFTC’s reliance upon the HFT community to spell out the law as they see it should be implemented, section 747 likely won’t accomplish its stated goals in dealing with high-frequency trading. Members from the CME Group (CME) and a host of other high-frequency trading firms claimed the language in the rule to be “vague” and “susceptible to constitutional challenge.” The new law most likely will be altered to reflect these claims. Had the CFTC been entertaining a larger audience of experts, and had they been working with constituents of SEC-regulated markets where this practice is rampant, it is possible that better regulation could have been attained. It also could have eliminated the waste that’s currently on the law books at both the CFTC and the SEC that do not address current market fraud.
Dodd-Frank is largely a striking out of old language from existing laws, replacing them with updated wording and often adding lengthy additions. Those laws that do happen to be brand new are ill-informed and poorly coordinated. Geithner himself stated in his speech that in this financial system, “we have accumulated layers of rules that can be overwhelming. And these failures of regulation…were in some ways as appalling as the failures produced where regulations were absent.” So, why entrust those same regulators to blanket us once again with heavy compliance costs to pay for regulation that fails to actually regulate?
This article was first published by Minyanville.com on August 2, 2011.