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SEC Chief Defends His Restraint
Cox Rebuffs Criticism of Leadership During Crisis

By Amit R. Paley and David S. Hilzenrath
Washington Post Staff Writers
Wednesday, December 24, 2008; Page A01

Christopher Cox, the embattled chairman of the Securities and Exchange Commission, is defending his restrained approach to the financial crisis, saying he has provided steady leadership as Wall Street's main regulator at a time when other federal regulators have responded precipitously to upheaval in the markets.

During his tenure, the SEC has watched as all the investment banks it oversaw collapsed, were swallowed up or got out of their traditional line of business. The agency, meanwhile, was on the sidelines while the Treasury Department and Federal Reserve worked to bail out the financial sector. And the SEC, by its own admission, failed to detect an alleged $50 billion fraud by Bernard L. Madoff that may be the largest Ponzi scheme in history.

But in his first interview since the Madoff scandal broke, Cox said he was not responsible for the agency's failure to detect the alleged fraud and that he had responded properly to the broader financial crisis given the information he had. Confronted with a barrage of criticism from lawmakers, former officials and even some of his staff, Cox said he took pride in his measured response to the market turmoil.

"What we have done in this current turmoil is stay calm, which has been our greatest contribution -- not being impulsive, not changing the rules willy-nilly, but going through a very professional and orderly process that takes into account unintended consequences and gives ample notice to market participants," Cox said. This caution, he added, "has really been a signal achievement for the SEC."

Taking a swipe at the shifting response of the Treasury and Fed in addressing the financial crisis, he said: "When these gale-force winds hit our markets, there were panicked cries to change any and every rule of the marketplace: 'Let's try this. Let's try that.' What was needed was a steady hand."

Cox said the biggest mistake of his tenure was agreeing in September to an extraordinary three-week ban on short selling of financial company stocks. But in publicly acknowledging for the first time that this ban was not productive, Cox said he had been under intense pressure from Treasury Secretary Henry M. Paulson Jr. and Fed Chairman Ben S. Bernanke to take this action and did so reluctantly. They "were of the view that if we did not act and act at that instant, these financial institutions could fail as a result and there would be nothing left to save," Cox said.

Although Cox speaks of staying calm in the face of financial turmoil, lawmakers across the political spectrum counter that this is actually another way of saying that his agency remained passive during the worst global financial crisis in decades. And they say that Cox's stewardship before this year -- focusing on deregulation as the agency's staff shrank -- laid the groundwork for the meltdown.

"The commission in recent years has handcuffed the inspection and enforcement division," said Arthur Levitt, SEC chairman during the Clinton administration. "The environment was not conducive to proactive enforcement activity."

Cox, 56, a former Republican congressman from California, became chairman in mid-2005 and plans to step down early next year before his full five-year term expires. President-elect Barack Obama has nominated Mary L. Schapiro, a former SEC commissioner, to replace him.

In a 90-minute conversation in his 10th-floor corner office last week, Cox said the SEC's emphasis on enforcement is as strong as ever. "We've done everything we can during the last several years in the agency to make sure that people understand there's a strong market cop on the beat," he said.

"That's why Madoff is such a big asterisk," he added. "The case is very troubling for that reason. It's what the SEC's good at. And it's inexplicable."

Cox argued that the agency has carefully defined responsibilities and that it was unfair to blame it for every problem on Wall Street.

"The public might not understand that that wasn't the SEC's job," he said, adding that the agency was not responsible for preventing investment banks from collapsing but rather for sheltering their securities trading units from problems in the broader corporation. "The SEC is not a safety and soundness regulator," he said.

Cox said that when he first took office he emphasized the importance of simplifying the rulemaking process and increasing transparency. Outside experts say he has succeeded.

"He's made it lot easier for the public to get information and made strong attempts at better disclosure," said Lee A. Pickard, a former director of the SEC's division of market regulation. "He unfortunately has had a couple of hurricanes that have evolved on this watch, like the credit crisis and the Bernie Madoff situation. But I'm not sure you can point to him as responsible for either one of those."

But former officials said enforcement has suffered during his tenure. A pilot program begun last year required enforcement staff to meet with the commissioners before beginning settlement talks in certain cases involving non-financial firms. Some former officials said the change was just one example of new bureaucratic impediments that slowed enforcement work. The commissioners also made clear that they thought staff members were being too aggressive in some cases, the officials said.

"I think there has been a sentiment communicated to rank-and-file staff, lawyers and accountants that you don't go after the establishment," said Ross Albert, a former special counsel in the enforcement division.

Another staffing shift was underway at the Office of Risk Assessment, formed by Cox's predecessor, William H. Donaldson, to spot emerging problems in the financial markets. But under Cox, the office, which once had slots for seven people, eventually dwindled to just one. "That office withered away," said Bruce Carton, a former SEC enforcement lawyer. "It died on the vine under Cox."

The agency's overall staff also began to drop during Cox's tenure, to 3,442 full-time employees in fiscal 2008 from 3,773 in fiscal 2005, according to agency data. The agency's budget over that time has increased 2 percent, to $906 million from $888 million, an amount that the National Treasury Employees Union, which represents SEC staff, says is far too small.

"There just hasn't been enough resources or staffing over the years for the SEC to oversee the number of companies it is responsible for," said Colleen M. Kelley, the union's president. "Cox needs to take responsibility that he failed as the leader of the agency to ask for what was needed."

SEC officials said the staffing cuts were required to stay within the constraints of the budgets approved by Congress.

Cox defended his record on enforcement and risk assessment. His aides said that risk assessment is done by staff spread throughout the agency and that the total number focused on it over Cox's tenure has increased from 26 to 37 people. He also said that the 671 enforcement actions brought last year was the second-highest number in the agency's history.

While the statistics look good, former SEC general counsel Ralph Ferrara said, "they put a huge bottleneck in the ability of that enforcement division to function. Cases would linger for months or years because they didn't have the guidance to get the cases done." Ferrara, now a partner with Dewey & LeBouef, added that the enforcement division "was roped to the ground like Gulliver by the Lilliputians."

An analysis by law firm Morgan, Lewis & Bockius, however, showed that the SEC's actions against broker-dealers, who serve as middlemen in financial trades, actually dropped about 33 percent, to 60 cases in fiscal 2008 from about 89 cases in fiscal 2007.

"In one of its core areas -- regulation of Wall Street firms -- its caseload was down significantly," said Ben A. Indek, a securities lawyer at the firm.
Under Cox, the SEC has taken particular heat for its oversight of the five major investment banks -- all finance titans synonymous with Wall Street.

It became the agency's responsibility to monitor them for financial and operational weaknesses under a program set up before Cox's tenure, but under his watch they got into such trouble that today they no longer exist as investment banks. Bear Stearns and Lehman Brothers failed, Merrill Lynch had to be taken over, and Goldman Sachs and Morgan Stanley converted themselves into bank holding companies.

The March collapse of Bear Stearns illustrated an array of agency shortcomings, according to a review by the SEC's inspector general. He concluded that agency officials had been aware of "numerous potential red flags" at Bear Stearns "but did not take actions to limit these risk factors."

"It is undisputable," the inspector general concluded, that the "program failed to carry out its mission in its oversight of Bear Stearns."

The SEC was aware that the firm's exposure to mortgage securities exceeded its internal limits and represented a significant risk, but the agency made no effort to reduce that exposure, the report found. The agency also knew about but failed to adequately address various weaknesses in Bear Stearns's management of mortgage risk, such as a lack of expertise, persistent understaffing and an apparent lack of independence between risk managers and traders. In violation of an SEC rule, agency officials also allowed Bear Stearns and other investment banks to entrust critical checks and balances to internal, rather than outside auditors, the report found.

Cox shut down the oversight program this year. "This voluntary regulation of investment bank holding companies was flawed from the inception," he said. Instead, he went to Congress and asked for the explicit authority to regulate investment bank holding companies. In the interview, he said he wished he had gone to Congress earlier to get the authority.

Outside securities experts and government officials said they were surprised this year to see the SEC and Cox on the sidelines after Bear Stearns collapsed in March and Lehman Brothers failed in September.

Treasury and Fed officials viewed Cox and his staff as nonplayers who had failed to foresee the brewing problems, according to people who were involved in those efforts but spoke on condition of anonymity because of the sensitivity of the matter. They said Cox was often brought in for consultation only after major decisions had been made by Treasury and Fed officials.

Cox said it was natural that the SEC would have less of a role once it became necessary to bail out the firms. "We don't have macroeconomic levers," he said. "That's not what we do."

At the moment, the agency's biggest problem is the Madoff scandal, Cox said. Last week, Cox ordered an internal investigation into the agency's failures to uncover fraud at Madoff's investment advisory firm despite multiple warnings.

Cox has declined to talk about the specifics of the investigation. He has said that concerns about Madoff's activities were never presented to the commissioners.

When Cox was asked whether he should be blamed for a culture of lax enforcement that allowed multiple warnings about the fraud to go undetected, he said: "Absolutely not. In fact, it's in the DNA here that people thrive on bringing big cases."

Staff writers Binyamin Appelbaum and Neil Irwin contributed to this report.