Capitol Report: Former SEC Commissioner Stein says she’s proud of modernization effort, frustrated by lack of Dodd-Frank progress


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Former Securities and Exchange Commission Commissioner Kara Stein

Kara Stein, the departing commissioner of the Securities and Exchange Commission, told MarketWatch she was focused during her five-and-a-half years as a regulator on bringing the regulator into the digital age.

Her efforts have paid off with initiatives like the consolidated audit trail that she says will make a computerized marketplace more resilient to shocks. In the August 2010 Flash Crash, the Dow Jones Industrial Average plummeted more than 1,000 points in just seconds and then recovered almost as quickly.

Stein kept an eye on “foundational” issues to make sure markets stay fair and orderly since, “At the end of the day, we’re going to be regulating computers with computers.”

Stein, a Democrat, joined the SEC after serving as Senior Policy Advisor for securities and banking matters for Rhode Island senator. Jack Reed. As staff director of the Securities, Insurance, and Investment Subcommittee of the Senate Committee on Banking, Housing, and Urban Affairs from 2009 to 2013, she played a key role in drafting and negotiating significant provisions of the Dodd-Frank law.

Her departure leaves one lone Democrat at the SEC, former law school professor Robert Jackson. The White House hasn’t formally nominated her successor but the Wall Street Journal reported in August that the White House was vetting Allison H. Lee for the role. Lee is a corporate governance consultant, according to her LinkedIn profile, and worked at the SEC as a legal adviser to Stein from 2013 to 2015.

Stein says she will be senior research fellow at the Center on Innovation at the University of California’s Hastings College of the Law, and will also be teaching a seminar starting soon at the University of Pennsylvania Law School.

MarketWatch sat down with Stein on December 19 after her final open meeting, and right after colleagues delivered heartfelt salutes to her public service. Her last day at the SEC was January 2.

MarketWatch: How do you feel?

Stein: I’ve been getting teary.

MarketWatch: Is there a particular issue you feel you made the most progress on during your tenure or that you are the most proud of?

Stein: People might think it’s boring, but I really cared immensely about updating the technology of the SEC, getting people to submit documents and other filings in structured form. I hope that makes it easier for folks to come to the site and compare one mutual fund to another or one issuer to another. When we regulate markets we really do regulate technology companies now.

Now that the SEC is moving forward with the consolidated audit trail it will be easier to analyze what happened when we have an event like a flash crash instead of taking three months. Then we can figure out if it was “limit up/limit down” or circuit breakers and be able to do much faster analysis. The goal is to create much better remedies in the computerized marketplace, to make it more resilient. Because at the end of the day we’re going to be regulating computers with computers.

Read: Critics say SEC’s audit trail plan falls short

Stein: These are foundational issues to being a regulator in 2018 going forward. It’s something I feel is important but it was more about the SEC becoming part of the digital age.

I think I have been really focused on conduct and accountability, trying to make sure the consequences of certain actions are clear and fair, making sure we are using all the tools we have in our toolbox effectively. I am talking, of course, about automatic disqualifications.

[ At the Dec. 19 open meeting the SEC passed a rule over Stein’s ‘no’ vote that she said in a statement will provide “an automatic exception for a company that committed fraud, or engaged in the wholesale theft of assets and allow it to continue to participate in the securities swap market. There will be no application for a waiver, no hearing, no weighing of the factors, and no affirmative decision by the Commission. Companies will be automatically cleansed and be considered good actors in one procedure-less swoop.”]

If we have these automatic disqualifications because someone has committed a crime or fraud, we should have a very thoughtful process before we say you can participate in the market again.

We should not have automatic waivers. So I have been pushing for a thoughtful process where we weigh the factors, we outline the factors required to show that it’s in the public interest to allow that person to continue to participate in the marketplace. I have been focusing on the transparency around process like that.

Read: SEC commissioner calls for greater transparency in stock market

Read also: Split at SEC means swaps waiver rule likely to get big alteration

As you know, I have been pushing for five and a half years on gatekeepers related to Stanley Sporkin’s access theory, where attorneys, accountants and others who provide offerings with access to the marketplace are held strictly accountable for their own participation in such unlawful activities.

As a commissioner you are sitting in enforcement meetings every week and seeing the worst behavior in the market. With limited resources you have to figure out how to message the marketplace that certain behaviors are unacceptable. Again, we have to use all the tools and that includes penalties and disgorgement and “bad actor” bars.

Another thing I focused on, another geeky thing, is market infrastructure. It’s aligned with my focus on technology. Making sure our markets are fair and orderly in this very high-speed marketplace.

As all of our trading venues are essentially computerized and interacting with each other at light speed it’s changed the way we need to think about regulating the market. A lot of our rules were writing for human beings. That might be a trader or an investment advisor. A mutual fund is a computer program.

Also read: SEC’s Stein worried mutual funds marketing more risk to investors

MarketWatch: I wrote the story, you may have seen, about how Chairman Clayton said, “maybe” when pressed recently by Senator Elizabeth Warren about whether the SEC’s “best interest” rule proposal could be revised to use the word “fiduciary”. Do you think it might happen?

Stein: It’s going to happen when I am not here. We have to think through what fiduciary duty means in the 21st century.

I always say to my staff I am trying to make what we do clearer to the audience, to get rid of the technical stuff when I talk, since media translates it even further. People get very lawyerly around here, more than getting to be like the accountants, and missing the underlying important principles.

We just defined “companies” out of our “bad actor” rule! They are people convenient at other times but they are not people now.

MarketWatch: Is there anything since you were confirmed in August 2013 that has been incredibly frustrating?

Stein: It’s been incredibly frustrating to not get all the Dodd-Frank rules done in eight years.

MarketWatch: Like the executive compensation rules?

Stein: Yes, it’s just unbelievable. I have pushed in every possible way that I could as just a commissioner, since the chairman sets the agenda and decides how rulemaking resources are allocated. That’s been very frustrating.

More here: A decade after the crisis, the SEC still hasn’t passed executive compensation rules

MarketWatch: You got a few last words in at the open meeting. I was struck by the comment from the Public Company Accounting Oversight Board chairman Bill Duhnke [who testified on Dec. 19 on the audit regulator’s proposed 2019 budget and accounting support fee] about “reinventing” and “revisioning” the auditor inspection process.

There is an elephant in the room, the KPMG/PCAOB scandal, that is repeatedly ignored in public forums. I asked Chairman Clayton and Chairman Duhnke at the December AICPA conference about the PCAOB would report soon on any remedial actions taken in the wake of the scandal. Clayton said he can’t speak about it because of the ongoing investigation and legal action and Duhnke looked like he didn’t know what I was talking about.

See also: Regulators revive China audit dispute, but miss prime opportunity to fully explain why

Stein: I don’t know why they won’t talk about it. I had not heard the theory that they won’t talk about it because of active enforcement activities. But, of course, we are not allowed to talk about active enforcement activities. I asked [Duhnke] a version of that question twice today and it was not answered. At the end of the day, you are asking the right questions. It goes back to transparency. If you had a problem you need to make sure the market knows you worked hard and you fixed the problem as best you are able.

MarketWatch: You asked the section 10A question, too, one of my favorite issues. The GAO prepared a report at the request of Congress in 2000 and 2003 to compiled data on how often auditors reported illegal acts to the SEC.

(According to PCAOB audit standards, auditors are required, under section 10A(b)1 of the Securities Exchange Act of 1934 to make a report to the SEC if a client’s illegal act has a material effect on the financial statements and if the firm is prevented from investigating the impact of the illegal act on the financial statements or informing the client’s audit committee. It may be also be necessary for the auditor to resign if the company’s board of directors does not take appropriate action.)

Stein: I did not know there was a GAO report.

MarketWatch: And I did not know the PCAOB was looking at the standards regarding an auditor’s obligation to report illegal client acts to the SEC. Many people who should know better do not know that provision exists or when it comes into play. What prompted you to ask Duhnke about it?

Stein: I asked a version of that question two years ago. I wanted to know about rules around the issue. And again it was a non-response. Duhnke said they are not done, not ready to talk about it yet.

(Senator Elizabeth Warren’s KPMG and the PCAOB about when KPMG had learned about audit client Wells Fargo’s illegal account opening activities and whether the firm had an obligation under audit standards to report the illegal activities to the SEC or to investors.)

MarketWatch: It’s not just a PCAOB issue. It’s also an SEC issue because it’s reporting to the SEC. The SEC told the GAO it was going to start tracking those reports better and it doesn’t seem to have done that yet.

Stein: This goes back to how you have an effective enforcement program. I’ve been also very pleased with the whistleblower program. We have an office within enforcement with 12-15 people focused on this full-time which we did not have before Dodd-Frank. This program has been much more effective than the Sarbanes-Oxley whistleblower provisions as a result. We are getting far more whistleblower reports now because of the Dodd-Frank anti-retaliation provisions but even more so because whistleblowers can get a percentage of the fine. I think that’s been a bit of a game-changer. It encourages people to file a tip.

MarketWatch: The SEC itself has said that the whistleblower program is more successful than ever before. In its most recent annual report for the program the program’s chief writes, “In FY 2018 alone, the SEC awarded more than $ 168 million in whistleblower awards to 13 individuals whose information and cooperation assisted the Commission in bringing successful enforcement actions. This amount exceeds the total amount awarded in all prior years combined and reflects the significance of the information that whistleblowers are reporting to the Commission.”

See also: SEC proposes to limit whistleblower awards

Stein: In public policy I think about how can I create incentives, and avoid disincentives, for people to engage in certain behavior. It is very difficult to discover, investigate and bring enforcement actions in the accounting area, for example in complex accounting fraud.

MarketWatch: So final question… What are you going to do next?

Stein: Ha! What should I do? I don’t know yet but I am drawn to the academic space. I’ve been in government 21 years. The happiest I know have a portfolio of things to do – consulting, teaching, writing. I want to be able to keep doing the right thing.

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