Commentary

Cox in the Crucible

By Craig Pirrong
This article appeared in the Orange County Register on June 3, 2005.

For Rep. Christopher Cox, the proverb “May you live in interesting times” will hopefully be a blessing and not a curse. The Newport Beach Republican, who was named yesterday to be the next chairman of the Securities and Exchange Commission, will (if confirmed) take over the agency in the midst of very interesting times for American financial markets. The hangover from the financial scandals of the very recent past, the growth of new investment vehicles (most notably hedge funds) and the rapid pace of technological and organizational change in securities markets all make this a fascinating period in the history of our financial markets, and present Cox with stern challenges - and opportunities.

The SEC chairmanship was not kind to its last two occupants, outgoing chairman William Donaldson and his predecessor, Harvey Pitt. Their tenures were embroiled in controversy and criticism, and both left the commission after relatively short tenures. Cox will need all of the political acumen he developed in his 18-year congressional career to avoid a similar fate.

The primary challenge facing the new chairman will be overseeing the implementation of 2002’s Sarbanes-Oxley Act. A response to the Enron, WorldCom and other accounting scandals of recent years, the act has greatly increased the accounting burden on companies and their managers. As originally constituted, the act is a blunt instrument; Cox and his fellow commissioners will likely spend a great deal of time trying to convert it from a cudgel to a rapier.

Hedge funds - relatively unregulated investment vehicles that have exploded in prominence in recent years - pose another challenge. The funds arguably make financial markets more efficient, rather than less. Unfortunately, hedge funds have become one of the usual suspects to be blamed for any episode of financial volatility and instability. Donaldson’s SEC required hedge funds to register with the commission, much to the chagrin of fund managers. Cox will need to ensure that the commission avoids the temptation to play Capt. Renault and round them up at the next sign of trouble. Moreover, hedge fund-related issues affect banking regulators and the Federal Reserve. The SEC should cooperate with those authorities before adopting further regulations.

Another controversy facing the new chairman concerns the structure of American stock markets. Chairman Donaldson led the effort to pass Regulation NMS (for National Market System), which links electronic American stock markets in such a way as to create a quasi-unified market. RegNMS has had a dramatic impact on the competitive landscape. The recent merger between the New York Stock Exchange and the online exchange Archipelago, and the NYSE’s decision to become a for-profit, publicly traded company, are directly attributable to the new regulation. The consolidation of equity trading will raise concerns about the intensity of competition in stock markets, and those concerns will occupy the SEC’s attention (and antitrust authorities) in the coming years. Controversies about securities market structure have not abated over the last 30 years, and will probably intensify during Cox’s tenure.

Cox also faces a decision over the expensing of stock options - a key concern in Silicon Valley and other high-tech areas. Donaldson leaves this for his successor to tackle.

To top it off, Cox must preside over a commission that has split along party lines on key votes and that has been subjected to some stern congressional criticism.

Interesting times indeed, and important ones too. America’s dynamic, innovative and sometimes messy financial markets are unique in the world, and have contributed to our economy’s remarkable performance over the last two decades. The SEC can help make those markets operate more smoothly - or can throw sand in the gears.

Cox’s congressional record suggests he understands the adverse consequences of heavy-handed regulation and litigation in securities markets (note his sponsorship of the Private Securities Litigation Reform Act). Here’s hoping that he can resist the political winds that buffeted his predecessors and steer a course toward more efficient and competitive securities markets.

Craig Pirrong is professor of finance at the University of Houston. He is author of “The Thirty Year War,” an article on RegNMS that is forthcoming in the Cato Institute’s Regulation magazine.