Securities and Exchange Commission overview

SEC

The mandate of the Securities Exchange Commission (SEC) is, according to the SEC's website, "to protect investors, maintain fair, orderly and efficient markets and facilitate capital formation" (SEC.gov, 2009). It accomplishes this in several ways. The SEC required holds public companies accountable for adhering to the laws that govern public securities in the U.S. By compelling companies to produce a standard set of information at regular intervals, investors can readily compare the performance of different companies. The SEC also oversees the participants in the securities world, "including securities exchanges, securities brokers and dealers, investment advisors and mutual funds" (SEC.gov, 2009).

The agency has been granted enforcement authority to achieve these objectives. It has the capacity to bring civil enforcement actions against those who violate securities law. The SEC also works in close concert with many other agencies that are involved in the preservation of the economic system.

The economic crisis was precipitated by an excess of subprime lending and the subsequent collapse of the housing market. The full impact of the crisis became evident when a credit crunch and some major bank failures brought about a steep decline in the stock market. The role within the mandate of the SEC was to attempt to manage the decline in the stock market. According to the SEC, it did take steps to curtail short-selling during the market's decline, to crack down on market manipulation and to work with other financial industry regulators (Francis, 2008).

Critics, however, contend that the agency did not do enough. The SEC had a fundamental policy of keeping its hands-off financial regulation and did little to curtail the sorts of activities that led to the economic crisis. For the SEC's part, they feel that Congress let them down by failing to provide the necessary tools to regulate the new markets created by financial industry deregulation (Francis, 2008).

Considering the mandate of the SEC, the agency's argument is reasonable. It must work within the framework provided to it by Congress. While some may feel that it did not take a strong enough lead on financial industry regulation, the SEC's mandate is with respect to the integrity of financial statements and announcements, rather than controlling risk in financial institutions. The market may have suffered greatly as a result of the economic crisis, but the market's collapse was merely a symptom of the crisis, rather than its cause.

In the wake of the crisis, the SEC has been involved in its regulatory duties. For example, the agency is conducting an investigation into whether or not the boards of the financial institutions that took on too much risk were negligent in their oversight and governance duties. Of particular concern to the SEC is whether or not the boards of the institutions in question had sufficient financial knowledge to understand the complexities of the derivative instruments in which those institutions were invested. The outcome of the investigation is expected to be improved power for shareholders to demand higher financial qualifications in the board members of financial institutions (Goldfarb, 2009). This investigation fits within the scope of the SEC's mandate and can lead to the prevention of future crises.

Another element of SEC response to the crisis was in instituting new accounting guidelines for writedowns of bad assets at banks. This move served to weaken rules with respect to the fair market value principle, which dictates that companies must report assets at their fair value. This includes assets that the company intends to hold until maturity. The impact of this change is that companies no longer were required to write down worthless assets as such, but could choose to record them at higher values theoretically reflective of their hold-until-maturity value (Sibun, 2008). This maneuver allowed financial institutions to maintain stronger balance sheets during the worst of the crisis, but it also served to obfuscate the true value of these bad assets. The market, after all, is assumed to trend towards equilibrium and therefore reflects fair value. The move essentially confirmed that the market's valuation is not rational. Moreover, it allowed financial institutions to escape some degree of punishment by investors by recording values for bad assets that are unrealistic. This could be viewed as contributing to stronger short-term stock prices, but also to longer-term problems as companies continue to record higher asset levels than they actually possess.

Overall, the SEC has accomplished little thus far in terms of the financial crisis. The outcome of the agency's work on improving governance and board member standards for financial institutions will be the final determinant of the agency's performance with regards to the crisis. During the leadup to the crisis and its initial impacts, there was little that the SEC could have done within its mandate and with the tools supplied to it by Congress to prevent the crisis or to curtail its impacts. By defending against short-selling and market manipulation, the SEC performed well and controlled some of the irrational market behavior. This reduced some of the damage that could have occurred, as stock prices fell more slowly than they otherwise would have during the fall of 2008.

There are changes that the SEC can make, however, to position itself better to deal with future crises. The agency took significant criticism, including a famous rebuke by then-Presidential candidate John McCain. This left the SEC in the position of having to defend itself for not taking action that, in fact, it has little power to take. Thus the first change recommended to the SEC is that the agency petition Congress for more powers to deal with boards that allow institutions, especially financial institutions, to carry too much risk. The SEC may have power to deal with the issue after the fact, but it needs to gain the power to address the issue beforehand.

The second recommendation for the SEC is that the agency takes a proactive approach to explaining its mandate. The agency comes under such fire because the public knows little about the scope of its mandate. That the SEC has a specific, limited mandate and limited powers to enforce that mandate is not well-known among the general public.