At Long Last, A Merger of the SEC and CFTC

Last week, the House Financial Services Committee's Subcommittee on Oversight and Investigations issued a report about the demise of MF Global. The report provided a fascinating chronology of the sad events, shepherded by CEO Jon Corzine, that harmed so many unsuspecting MF Global customers. The report also included a number of recommendations.

The recommendation that has drawn the most attention is a call for Congress to consider merging the Securities and Exchange Commission and the Commodity Futures Trading Commission, two of MF Global's regulators. The lack of coordination with respect to MF Global is characteristic of the manner in which these agencies work. A merger of the SEC and CFTC, although politically difficult to engineer, would be a reasonable step towards much-needed regulatory consolidation.

MF Global was active in both the securities and futures markets, which are regulated, respectively, by the SEC and the CFTC. Despite the agencies' shared responsibility for the firm, the two agencies did not effectively coordinate their regulatory activities. The Subcommittee's report notes that "even when the SEC and CFTC finally began communicating with one another during MF Global's last week of operations, the agencies often worked at cross-purposes."

A tense jurisdictional rivalry historically has discouraged healthy interactions between the two agencies and has created regulatory distortions in the markets as innovators sought to fit their products within one regulatory regime or the other. Dodd-Frank could have changed all that by creating a joint regulatory unit to regulate the over-the-counter derivatives market.

Instead, Dodd-Frank directed the agencies to coordinate loosely and, with a few exceptions, write two sets of rules. The agencies talk a lot about how well they are working together. Their rules, however, don't reflect much coordination and, as with respect to MF Global, sometimes it seems as if they are working at cross-purposes.

There is a danger that merging the two agencies would simply create an agency that embodies the worst traits of both. The merged agency might adopt the CFTC's careless, but quick approach to rulemaking, along with the SEC's press-driven enforcement strategy. In the past, both agencies have struggled to produce good economic analyses to guide their rulemaking, but the SEC has shown a recent interest in integrating solid analysis into the rulemaking process. A merged agency might abandon the SEC's nascent efforts and revert to the shared historical tradition of treating economic analysis as an afterthought.

Another worry is that merging the two agencies would end the opportunity for competition between the two regulators. The existence of two regulators allows for more regulatory experimentation. The CFTC, for example, has - until recent years - prided itself on principles-based regulation, while the SEC has taken a more rules-based approach. A merged agency would find it harder to experiment with different regulatory approaches.

On balance, however, a merger of the SEC and CFTC would conserve regulatory resources, produce a simpler set of regulations, and better protect investors. Financial firms would be able to focus their attention on understanding and complying with one set of rules, rather than disentangling two potentially inconsistent sets. Coordination with foreign regulators would be easier, because there would only be one set of rules coming out of the United States. Because a merged agency would find it harder to avoid responsibility for regulatory failures, there likely would be fewer failures.

A merged financial markets regulator would not be perfect. It would undoubtedly suffer from the standard regulatory maladies. Nevertheless, the failures that both the SEC and CFTC have experienced in recent years, together with their massive new responsibilities under Dodd-Frank, make the case for rethinking their independence from one another.