Mary Schapiro Puts SEC Back in Business

Chairman Mary Schapiro is working to rebuild the SEC into a forceful investor advocate.


When Mary Schapiro arrived at the Securities and Exchange Commission in January, the agency’s morale and reputation were at rock bottom. The collapse in December 2008 of the Bernard Madoff Ponzi scheme, which the SEC had failed to detect despite years of warnings, unleashed a torrent of attacks against the commission from investors and politicians.

A few months earlier the SEC had been little more than a bystander to the debacle of Lehman Brothers Holdings, which it supervised, as the Federal Reserve Board and the Treasury allowed the firm to fail and then engineered a massive bailout of the financial system. Political interference had slowed activity in the SEC’s Division of Enforcement, the core of the agency, even as financial market turbulence created conditions ripe for investor abuse. Some critics questioned whether the agency could ever regain its relevance.

Stepping Up SEC's Enforcement

Stepping Up SEC’s Enforcement

Sensing the urgency, Schapiro moved quickly to shake up the SEC. Less than two weeks after taking over as chairman, she publicly announced she was abandoning the policy of her predecessor, Christopher Cox, that had required the enforcement division to seek approval from the SEC’s five commissioners before negotiating fines with companies accused of violating securities laws. She also gave enforcement staff the power to open investigations without commissioner approval. By loosening the bureaucratic handcuffs, Schapiro hoped to give her staff a much-needed morale boost and signal a new activism at the agency.

“I wanted to do things that were visible and quick, so the staff could see we were headed in a new direction,” says the 54-year-old lawyer and veteran regulator.

Schapiro has also moved swiftly to give a clear sense of purpose to that activism. Within days of taking office, she and her staff promptly drew up a list of hot-button issues that they aimed to tackle within a year. In subsequent months they have proposed new or revised rules in ten areas, including measures to impose restrictions on short-selling, facilitate shareholders’ ability to nominate directors and ban so-called flash trading, which allows some professional traders to see buy and sell orders a fraction of a second ahead of mainstream investors. The chief has made a number of high-profile appointments, most notably recruiting Robert Khuzami, a former federal prosecutor and Deutsche Bank lawyer (see sidebar), to take over the enforcement division. And drawing a lesson from the financial crisis, Schapiro has created a new Division of Risk, Strategy and Financial Innovation designed to help the agency anticipate potential problems stemming from financial innovation.


“We felt we had a lot of things to do right away,” Schapiro told Institutional Investor in a recent interview in her office. “We felt the most important thing we could do is lay out an agenda and get to work on it. It became a popular expression around here to act like our hair is on fire.”

Schapiro’s efforts have yet to bear much fruit, but her determination and energy have quieted many of the SEC’s critics, who no longer talk about shutting down the agency or merging it with the Commodities Futures Trading Commission. “That is one of her great successes — she changed the focus of the conversation,” says Richard Ketchum, who has known Schapiro since they worked together at the SEC in the 1980s and who replaced her as CEO of the Financial Industry Regulatory Authority, or Finra, an industry body, earlier this year.

“She effectively made the case that no other agency can be an investor advocate,” says John Olson, a partner in the Washington, D.C., office of Los Angeles–based law firm Gibson, Dunn & Crutcher and a former chairman of the American Bar Association’s Committee on Federal Regulation of Securities. “Mary is so politically astute,” adds Stephen Cutler, general counsel at JPMorgan Chase & Co. and a former SEC enforcement chief from 2001 to 2005. “She understood at a gut level that she had to basically turn the place upside down in order to save it.”

SEC Top Cop Robert Plaze

SEC Top Cop Robert Plaze

Schapiro has been particularly active in wooing the SEC’s erstwhile critics on Capitol Hill, which her office overlooks. She has testified frequently before congressional committees that are considering legislation to overhaul financial regulation and has met with key lawmakers who control her agency’s budget. Her overriding message: The SEC is on track to restore its mission as an investor advocate and defender of fair and efficient markets. Her efforts have won appreciation from key members of the House and Senate.

“I am very impressed with her understanding of the problems,” says Representative Barney Frank, the Massachusetts Democrat who is shepherding financial reform legislation as chairman of the House Committee on Financial Services. “She hit the ground running and hasn’t stopped,” adds Senator Jack Reed, a Rhode Island Democrat and senior member of the Senate Banking, Housing and Urban Affairs Committee.

Yet for all the plaudits Schapiro has won so far, the SEC boss has suffered some notable setbacks. A federal judge in September threw out one of the most prominent enforcement actions taken on Schapiro’s watch when it rejected the agency’s proposed $33 million fine of Bank of America Corp. to settle charges that it misled investors about bonus payments at Merrill Lynch & Co. before it acquired the securities firm last year. Judge Jed Rakoff said the decision to fine the firm — rather than executives who allegedly acted improperly — thereby penalizing shareholders violated “the most elementary notions of justice and morality.” The issue is set to go to trial early next year. “It is an incredible setback for the SEC,” says Senator Edward Kaufman, Democrat of Delaware.

Closing the books on the Madoff affair will also take time. In August the SEC’s own Office of the Inspector General issued a scathing report criticizing the agency for failings on the case dating back to 1992, saying officials had received six substantive complaints between June 1992 and December 2008 “that raised significant red flags concerning Madoff’s hedge fund operations and should have led to questions about whether Madoff was actually engaged in trading.” The Inspector General recommended 58 changes in the agency’s Office of Compliance Inspections and Examinations and its enforcement division, including new protocols for handling tips from outsiders and identifying red flags about potential securities law violations. Schapiro, who has until the middle of this month to provide a written plan for implementing those recommendations, vows to address the Inspector General’s concerns.

The SEC chief is also running into stiff industry resistance to one of her key initiatives — a crackdown on a variety of electronic trading techniques that have transformed U.S. and global equity markets. In September the agency proposed a rule change that would ban flash trading, which Schapiro contends may create a two-tiered market in which only certain investors have access to the best available prices. The following month the SEC proposed new rules to require many users of dark pools, which allow investors to trade securities without the disclosures of public stock markets, to report trading intentions and transaction prices. Schapiro is also considering imposing curbs on high-frequency trading, in which firms use powerful computers to generate rapid-fire orders in milliseconds to reap profits.

Schapiro fears that the combined effect of these trading practices gives an unfair advantage to the largest, most-sophisticated brokerages and investors at the expense of the multitudes. In challenging these practices, she is seeking to block technological advances developed and controlled by some of the most powerful players on Wall Street. Goldman Sachs Group, which operates its own dark pool, recently submitted a 55-page comment letter to the agency that claimed that dark pools and other technological tools benefited institutional and retail investors. “Proliferation of faster and less expensive hardware has leveled the playing field, enhanced competition and increased liquidity,” it said.

Fulfilling her reform plans, and restoring the SEC’s clout and respect, won’t be easy. But Schapiro — who defines her mission with a sign over her door that reads, “How Does It Help Investors?” — vows no letup in pursuit of her goals.

“If our compass is truly set on protecting investors and ensuring the markets are operating with integrity, then far more often than not we will get it right,” she says. “We will do what needs to be done to restore confidence in the securities market, which will be very important to the economic recovery. I know we are capable of being the kind of regulatory agency the American people deserve.”

A creature of the last great financial crisis, the SEC is struggling to redefine its place in the U.S. regulatory framework following the turmoil of the recent panic. Established in 1934 as part of a wave of reforms during the Great Depression, it was charged with ensuring that publicly traded companies disclose accurate information and that investors are treated fairly and honestly by brokerages, dealers and stock exchanges. For much of its history it did that job well, earning a reputation as one of the most feared and respected of federal agencies. More recently, though, its clout withered from the deregulatory ethos of the boom period and ideological divisions between the agency’s Republican and Democratic commissioners.

Earlier this decade, it was New York State’s then–Attorney General, Eliot Spitzer, and not the SEC, who set the agenda in financial policing. Spitzer cracked down on conflicts of interest in financial research by negotiating a $1.4 billion settlement with major brokerage firms, took the lead in investigating mutual fund late trading and market timing, forced Maurice (Hank) Greenberg to resign as chairman of American International Group over alleged accounting improprieties and took on former New York Stock Exchange chairman Richard Grasso over his huge severance package.

The SEC receded even further into the background under the chairmanship of Christopher Cox, whom former President George W. Bush appointed to head the agency from August 2005 to January 2009. Deregulatory sentiment was running high, and Cox, responding to pressure from critics who claimed that regulatory measures such as the Sarbanes-Oxley Act were making American business and markets uncompetitive, reined in the agency by requiring a unanimous vote for virtually every new policy and rule and insisting that the Enforcement division get the commissioners’ approval before issuing subpoenas or negotiating settlements. The impact on enforcement activities was dramatic. The number of formal orders of investigation steadily declined from 272 in 2005 to 233 in 2008, according to a 2009 report by the Government Accountability Office, the congressional watchdog agency. Penalties plummeted 84 percent during the same period, from a peak of $1.59 billion in the fiscal year ended September 30, 2005, to $256 million in fiscal 2008.

The commission’s decline over the past decade or so was dramatic. “It was the second worst period of dysfunction” after the late 1950s, says Joel Seligman, president of the University of Rochester and an SEC historian. “Leadership was not as committed to enforcement as previous administrations.”

In appointing Schapiro to succeed Cox, President Barack Obama was betting that a regulatory veteran experienced in the ways of the industry and Washington could turn the agency around.

Schapiro grew up in Babylon, Long Island, where her father was a printer and antiques shop operator and her mother a librarian at Farmingdale State College. She graduated from Franklin & Marshall College in 1977 with a bachelor’s degree in anthropology and then earned a law degree from George Washington University in 1980.

She stayed in the capital and began her career as a trial attorney at the CFTC. Within a year she was named counsel to Commissioner Susan Phillips, and when Phillips became chairman, she made Schapiro chief of staff. In 1984, Schapiro jumped the fence to become vice president and counsel for the Futures Industry Association, a trade group.

Four years later, President Ronald Reagan tapped her to fill one of the non-Republican seats at the commission. (Schapiro is an independent. The other four commissioners today include two Republicans and two Democrats.) She was reappointed by President George H.W. Bush and named acting chairman by President Bill Clinton before he nominated her to run the CFTC, a job she took up in 1994. In 1996 she moved to the National Association of Securities Dealers as head of regulation. At the time the SEC and the Department of Justice were investigating NASD, then owner of the Nasdaq Stock Market, for allowing market makers to generate excessive profits by allowing them to trade stocks in price increments of as low as an eighth of a dollar. A committee headed by then-Senator Warren Rudman, a Republican from New Hampshire, decided to split Nasdaq regulation from market operations in an attempt to improve governance, and recruited Schapiro as president of a new subsidiary, NASD Regulation.

“It was a place not dissimilar to the SEC when I came here,” she recalls. “It was under siege from a number of quarters.” Schapiro built a team and bolstered NASD’s technology to create a self-regulatory organization. Finra head Ketchum, who was chief operating officer of Nasdaq at the time, credits Schapiro for establishing an independent regulatory culture at NASD. “She did a spectacular job there,” says Ketchum. “She worked with the independent board to assure the independence of NASD as a regulator from Nasdaq.”

Two years ago, Schapiro led the merger of NASD with the self-regulatory arm of the New York Stock Exchange to create Finra. The combination aimed to end duplication and come up with a single rule book for equity trading in the public U.S. markets, but turf battles and different cultures threatened to impede the deal. Ketchum, who negotiated with Schapiro as CEO of NYSE Regulation, says the merger probably would not have happened if not for the trust he and Schapiro had built over the years. “She was very pragmatic,” he says. “I had trust in her to integrate the staffs. It was clear she recognized the value of my top people.” These included Susan Merrill, who today serves as Finra’s head of enforcement, and Grace Vogel, who is in charge of member regulation.

Ketchum says Schapiro takes the time to understand the gritty details of trading and clearing but doesn’t micromanage, preferring to attract strong people and give them authority. “She is involved in key decisions, but she lets underlings make decisions,” he explains.

Schapiro didn’t waste any time building her team at the SEC. She lured back David Becker, SEC general counsel from 2000 to 2002 and later a partner at Cleary Gottlieb Steen & Hamilton, as general counsel and senior policy director. She also overhauled enforcement by bringing in Khuzami as director of the division, Lorin Reisner as his deputy and George Canellos as director of the SEC’s New York regional office. Khuzami, Reisner and Canellos all worked together at the U.S. Attorney’s Office for the Southern District of New York earlier this decade. “It sent signals to investors that tough new cops are on the beat,” says Walter Ricciardi, a partner in the litigation department of Paul, Weiss, Rifkind, Wharton & Garrison and a former deputy director of enforcement at the SEC.

Those cops’ reputations may well hinge on the outcome of the trial over the Bank of America settlement. Schapiro is taking no small risk in going to trial rather than seeking to address Judge Rakoff’s concerns in a fresh settlement. She believes the trial’s discovery process will enable the agency to look deeper into the bonuses as well as other issues, and determine whether additional charges are warranted. But Congressman Frank, who is normally a Schapiro ally, criticizes her for prolonging the issue. “She ought to say, ‘You’re right,’” he says of the judge’s ruling. “They should not fight it.”

Schapiro has also sought to address the agency’s shortcomings in failing to detect the financial crisis in its early stages or realize the vulnerability of the investment banks it regulated. She created the new risk division to identify trends in financial markets and the potential risks they can pose to financial stability. To head it up, Schapiro appointed Henry Hu, a former University of Texas Law School professor who holds a BS in molecular biophysics and biochemistry, an MA in economics and a law degree, all from Yale University. “We needed someone who is committed to thinking of risk in a different way — combined with economics and law,” she says.

In her effort to anticipate the next crisis or scandal, Schapiro has assembled task forces to study a number of critical issues. One such task force is focusing on life settlements, or the practice whereby mostly older people sell life insurance policies for more than the cash value but less than the face value. “It has issues on so many levels,” she says. For example, those who sell their policies may not realize the transactions have tax implications, will leave them unable to get life insurance again and will make their health information available to investors who buy securitized settlements.

The task forces aim to nip problems in the bud, says Khuzami: “That’s the Holy Grail. Stopping misconduct before it happens is infinitely better than prosecuting it after the fact.”

On the policy front, Schapiro has begun to reassert the SEC’s influence in the political debate on regulatory reform in the wake of the crisis. Treasury Secretary Timothy Geithner rejected calls to merge the SEC and CFTC and instead kept both agencies as part of the administration’s blueprint for revamping the regulatory system. The irony is that Schapiro, who has worked in both agencies, has publicly acknowledged strong arguments in favor of a merger at some stage, given the increasingly blurred lines between stocks, bonds and derivatives markets. But with Congress unwilling to consider a combination, which would strip some committees of their oversight duties, Schapiro is being pragmatic and looking to work more closely with the CFTC and its chairman, Gary Gensler.

After four months of collaboration, the SEC and CFTC last month issued a joint report making 20 recommendations to improve coordination between the two agencies, including creating a mechanism to decide which agency regulates derivatives and new products and establishing a joint enforcement task force. The next step: Help draft legislation and engage in rule making. “It was hard to get to this point,” she says. “Now we must work through each issue and get to resolution.” Experts like Gibson, Dunn & Crutcher’s Olson call the interagency collaboration an arranged marriage of uncertain durability. “A lot of moving parts must come together before this is smoothly operating,” he says.

Within the SEC, progress also comes slowly on Schapiro’s issues list. Consider the controversial case of short-selling. Critics of the practice, including top executives at some leading banks, believe it contributed to the pressure on stock prices at the height of the financial crisis, but advocates, including many institutions and most hedge funds, contend that short-sellers add to market liquidity. The SEC has proposed several rule changes related to short-selling, including the reinstitution of the controversial uptick rule, which prohibits short sales except when the price of a security has just risen. The proposal generated no fewer than 4,000 comment letters, prompting the commission to propose an alternative pricing test and put it out for comment. Schapiro says she hopes the agency will be ready to make a final decision within a few months.

Similarly, the commission’s proposal to revive the proxy access issue and give investors the power to nominate directors — a tougher version of a proposal the Cox commission rejected a few years ago — attracted more than 500 comments. Schapiro hopes the SEC will adopt a rule in early 2010 but stresses that she does not want to speed up the process at the expense of quality. Other proposed rule changes, including prohibitions on political contributions by investment advisers, more disclosures about how companies select rating agencies and a Madoff-inspired requirement that investment advisers safeguard assets with an independent custodian, are “amazingly on schedule” despite the lengthy consultation process, she says.

Although Schapiro has moved swiftly on many fronts, experts say she has much more work to do before she can declare success. She needs to find heads for the Division of Trading and Markets and the Office of Compliance Inspections and Examinations. More generally, she needs to attract more talented staff with nonlegal backgrounds while working within the SEC’s tight compensation guidelines. “Compensation is what it is,” she laments. “I can’t work magic. But this is a compelling time to come to the agency.”

Ultimately, the goal is to recapture the elan the agency enjoyed in previous years. “When I first came here, in 1977, the reputation was that it was one of a handful of the best places to work in government,” says Commissioner Elisse Walter, who has known Schapiro since they worked together at the SEC in the 1980s and subsequently at the CFTC and NASD. “But it became reactive, less proactive and less creative. We want to restore it to one of the pre-eminent places in government.”

For Schapiro the job is far from done.