Obama's Nominations Signal Regulation By Enforcement

Last week was a big one in the federal financial regulator shuffle. On Thursday, President Obama nominated Mary Jo White to head the Securities and Exchange Commission, and renominated Richard Cordray to be director of the Consumer Financial Protection Bureau. These two nominations are a paean to regulation by enforcement.

Ms. White has an impressive resume built on many intense years as a high-profile prosecutor and defense attorney. Yet, her extensive litigation experience is not a natural precursor to the job for which she was nominated. The SEC is fundamentally a regulatory agency, not a law enforcement agency. The SEC has plenty of enforcement lawyers and a tendency to tout enforcement statistics as a measure of success, but enforcement is supposed to be subordinate to the rulemaking function. The agency's heart is regulatory.

Contrary to what many assume, the SEC does not have the authority to lock up securities law violators. The SEC is limited to civil remedies, such as penalties and barring people from the securities industry. Responsibility for doing anything more lies with Ms. White's former colleagues at the Department of Justice.
The SEC serves the American public best when it focuses on maintaining a clear, easy-to-understand, effective, and relevant rulebook that fosters the healthy functioning of the markets. Most firms are committed to following these regulations, and the SEC has a compliance staff to assist firms in improving their compliance programs. Enforcement staffers are only supposed to be called in to deal with the recalcitrant market participants-the ones who know the rules but choose not to comply.

By selecting a former prosecutor to lead the agency, President Obama expressed a preference for an enforcement-centric SEC. This preference responds to calls for heads to roll on Wall Street, but Ms. White won't have time to run the SEC's enforcement docket. That's what her enforcement director will do. She'll have to figure her way around the internal workings of the SEC and make difficult policy calls on a long rule-writing agenda. These tasks would be tough for someone with a regulatory background. But they will be even more difficult for someone who has spent much of her career pursuing murderous thugs, not working through the intricacies of securities regulations.

To make matters harder for Ms. White, the SEC's regulatory agenda is overflowing. The agency is not even half-way through its Dodd-Frank rules. The JOBS Act also imposed rulemaking obligations on the SEC. Along with these two statutory rulemaking task lists, the SEC has pledged to work on money market fund and market structure reforms. These are both complex regulatory problems that will demand considerable attention from the SEC's new chairwoman.

The CFPB also has a heavy rulemaking agenda and an enforcement-focused director. A ruling on Friday by a federal court about the constitutionality of recess appointments called into question Mr. Cordray's current status as director of the CFPB. If the President is successful in convincing the Senate to confirm him this time around, he will likely continue his enforcement-centric approach.

Like Ms. White, Mr. Cordray, former Ohio Attorney General, comes from a litigation background and was first brought in to the CFPB to run its enforcement program. When he became director, he made it clear that he would regulate through enforcement. Shortly after he took over as director, he was asked the following question at a congressional hearing: "You have enforcement powers and you have regulatory powers. In the gray areas, would you probably proceed straight to enforcement or would you probably turn to rulemaking and apply that rule prospectively, so everyone would know what the rules were?" Mr. Cordray's telling response was that "I think that there could be situations where we might do either." A well-functioning government needs to define the rules before enforcing them. When regulators look at the world through enforcement lenses, they forget this important principle.

Let's hope that the approach taken by another federal financial regulator who announced her resignation last week-Commissioner Jill Sommers of the Commodity Futures Trading Commission-will rub off on the President's latest nominees, despite their litigation bent. As she explained in a recent speech, "I cannot express how disheartened I am by the number of people who have reached out to me with the same message: ‘We want to comply, we just need clarity.' It is our job as regulators to set out clear rules of the road."