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SEC chief under fire as Fed seeks bigger Wall Street role
The Wall Street Journal
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Published: 6/24/2008 12:05 AM

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One Friday in March, with investment bank Bear Stearns Cos. teetering toward collapse, the chieftains of U.S. financial regulation dialed into a 5 a.m. conference call to craft a bailout plan. When they were done, the Treasury secretary informed the president. The head of the Federal Reserve Bank of New York called Bear Stearns.

Christopher Cox, chairman of the Securities and Exchange Commission, didn't call anyone. Though the SEC was Bear Stearns's regulator, he didn't take part in the meeting.

In an interview, Mr. Cox said the time of the call changed overnight and no one told him. SEC staff members were on the early call and Mr. Cox says he was involved in calls later that day and throughout the weekend with his peers.

Big crises put Washington's regulators to the test. At pivotal times during the current financial turmoil, Mr. Cox has appeared peripheral. The next night, as Fed and Treasury bosses negotiated a bailout, Mr. Cox was at a birthday party. He was missing from a Sunday conference call announcing the sale of Bear Stearns and the Fed's plan to lend funds to investment banks. The following weekend, he left town for a family vacation.

Critics say America's top securities regulator didn't act boldly enough to restore confidence when the financial world shuddered. His profile was low just when the SEC may have most needed an outspoken champion: The Bear Stearns meltdown has fueled calls to reorganize U.S. financial regulation, just as a proposal was published to eliminate the SEC and shift responsibility for Wall Street to the Fed.

On Thursday, Treasury Secretary Henry Paulson called for broadening the Fed's oversight role over a range of institutions, likely including investment banks. The SEC and the central bank are in the final stages of negotiating an agreement that would start that process. Congress is planning hearings on the matter beginning next month.

Mr. Cox's defenders say he acted within his powers as an SEC chief and didn't step beyond them. Some advocates say that as the Bear Stearns crisis swirled, he worked closely with the Fed and damped potential panic with his optimistic take on investments banks' financial health. "Your activities in regard to the recent credit crisis events were proper responses in an extremely difficult emergency situation," former SEC chief David S. Ruder wrote to Mr. Cox on Friday in an email that was also addressed to The Wall Street Journal. Mr. Cox says his area of expertise is corporate law and that he put his best markets team in place to deal with the crisis.

Still, many of Mr. Cox's predecessors were more visible in times of turmoil. In 1990, amid debate over a possible bailout of investment bank Drexel Burnham Lambert Inc., then-SEC Chairman Richard C. Breeden worked alongside Federal Reserve of New York President Gerald Corrigan and Treasury Secretary Nicholas Brady. On Sept. 12, 2001, as officials scrambled to reopen markets after the 9/11 terrorist attacks, then-Chairman Harvey Pitt boarded an Amtrak train for New York to meet with the heads of the brokerage firms and major exchanges.

Some of these predecessors are getting vocal. Ex-Chairman Arthur Levitt has been peppering Mr. Cox with emails urging him to move more aggressively to preserve the SEC's authority. At a recent public round-table meeting at the SEC, Mr. Cox asked a panel of former chairmen for advice. In talking about plans to change future financial regulation, Mr. Pitt responded the SEC should "lead the discussion, instead of being led in the discussion."

Mr. Breeden said in an interview that during the Drexel crisis, the SEC took the lead in interagency discussions. "We were the primary regulator charged by Congress with overseeing all aspects of the securities markets," Mr. Breeden said. "Drexel was our responsibility, and we had no hesitation about exercising our powers to protect investors and the integrity of our regulatory system."

If anything, the Bear Stearns demise was more serious, Mr. Breeden said. Drexel unraveled after illegal conduct there, limiting the risk that trouble would spread, he said. "The context at Bear Stearns was far worse due to market conditions, liquidity constraints and confidence issues affecting many firms around the world," Mr. Breeden said.

Mr. Cox says the Bear Stearns and Drexel matters weren't comparable. In a two-hour interview in his office overlooking the Capitol building, the 55-year-old Mr. Cox said he was deeply involved the week of the Bear Stearns meltdown. He has since asked Congress to mandate the SEC's oversight of investment banks and says SEC staff immediately began working with the Fed to strengthen investment banks' risk-assessment models. He said he supported moves by the Treasury and Fed to find a buyer for Bear Stearns but then stepped back, saying his agency should oversee the industry, not orchestrate its deals.

"We are the regulator," he said. "It would have been difficult to regulate one's own transaction."

When Congress created the SEC in 1934, it gave the agency authority to oversee stock markets and investment advisers, and to enforce laws against market manipulation and insider trading. The independent agency has four commissioners and a chairman, each nominated by the president and confirmed by the Senate.

The SEC's oversight powers haven't kept pace as markets have expanded: The agency regulates U.S. broker-dealers but has no mandate to oversee many of investment banks' other lines of business, including overseas-based brokerage arms or insurance entities that can underwrite structured products. (The nation's five largest investment banks - including Bear Stearns - volunteered since 2004 to let the SEC oversee their entire operations.) Unlike the Fed, the SEC can't lend money.

Mr. Cox took over the SEC in August 2005 from William Donaldson, a controversial chairman who was more confrontational with investment banks than most previous SEC chiefs. Mr. Cox, by contrast, had a reputation as a peacemaker. A former Reagan White House counsel and a U.S. Representative from California's Orange County for nearly two decades, he was seen as favoring free-market solutions and striking bipartisan deals. At the SEC's helm, he continued to seek consensus.

But he also maintained a distance from Wall Street. More than a half-dozen top investment-banking executives say they have barely spoken with Mr. Cox over the past year, in contrast to the frequent chats they say they had with past chiefs. Many say they have regular contact with Federal Reserve of New York President Timothy Geithner.

Mr. Cox said he shied away from frequent conversations to avoid the impression of political interference, and says the role belongs with his staff. But in recent months, he said, he has had "deeper and more regular" contact with Wall Street bosses.

Signs of trouble at Bear Stearns emerged late last July, with the collapse of two internal hedge funds that made bad bets on securities tied to subprime mortgages. The SEC stepped up official contact from weekly to daily. In August, Bear Stearns's then-chief financial officer said credit markets were the worst he'd seen in 22 years. By December, the firm had taken more than $1 billion in write-downs.

As rivals Merrill Lynch & Co. and Lehman Brothers Holdings Inc. sought outside funding, Bear Stearns was less aggressive in raising capital. SEC staff privately urged Bear Stearns to raise cash, say Bear Stearns and SEC officials. Some industry watchers say the SEC should have exerted more pressure on Bear Stearns or its board.

"The SEC could have told them to go out and raise capital," says Lynn Turner, a former chief accountant at the SEC and a frequent critic of the agency. "If Bear Stearns had had enough capital there never would have been a run on the bank - because there would have been confidence in the system."

At a Feb. 14 congressional hearing, Federal Reserve Chairman Ben Bernanke and Treasury Secretary Paulson urged all banks to raise money. That same month, Mr. Cox said his agency was satisfied with liquidity at the five largest U.S. investment banks.

"Their positions are strong," he told reporters after receiving a leadership award from the European-American Business Council. He repeated that sentiment on March 11, when markets were awash with rumors that Bear Stearns could be running out of cash.

Mr. Cox said he stands by those comments, because Bear Stearns's problem wasn't a lack of capital. Instead, it was a lack of confidence, something he said the SEC and the other regulators didn't foresee.

Within two days, Bear Stearns's clients were cashing out accounts. Banks were pulling their business. On the night of Thursday, March 13, officials from the SEC and Bear Stearns called the New York Fed, saying it was likely the firm would have to file for bankruptcy-court protection. Later that night, the Fed and Treasury decided to find a buyer.

Mr. Cox said he signed off on the Fed/Treasury plan. Once the Bear Stearns matter became a "commercial transaction," he added, the SEC's responsibility became only to ensure that customer accounts were protected, which they were, and to sign off on regulatory aspects of the deal.

Staff from the New York Fed worked into the early hours of Friday morning to map out how a Bear Stearns failure could work through the financial system. Bear Stearns had trading positions with 5,000 other firms.

At 5 a.m., New York Fed's Mr. Geithner initiated a conference call. On it, Messrs. Bernanke, Paulson and Geithner agreed to extend a loan to Bear Stearns through J.P. Morgan Chase & Co. Mr. Cox arrived at the SEC's office around 7 a.m. He was on a second conference call around 8:30 a.m.

By Saturday evening, J.P. Morgan was weighing an outright purchase of Bear Stearns. Erik Sirri, head of the SEC division that oversees investment banks, tried to reach Mr. Cox at his home in Alexandria, Va., to brief him on the tentative deal.

Mr. Cox said he had been speaking with Mr. Paulson throughout the weekend.

On Sunday, March 16, Mr. Sirri reached Mr. Cox to discuss certain regulatory approvals needed to speed the deal. Mr. Cox said he spoke frequently with SEC staff who were working to sign off on a completed sale before markets opened in Asia.

That night, senior officials from the Treasury, Fed and big Wall Street firms joined a conference call to hear details of the Bear Stearns sale to J.P. Morgan. They also discussed a Fed plan to lend funds to investment banks, a radical shift that took the central bank into the SEC's turf. Mr. Sirri was the senior SEC representative on the call.

Mr. Cox says his participation wasn't required. "Because 1/8the Bear Stearns loan 3/8 was the Fed's money, they were chiefly responsible for the terms," said Mr. Cox.

The SEC, which typically has five commissioners in all, had two vacant seats. Paul Atkins, one of Mr. Cox's two remaining fellow commissioners, was traveling overseas and wasn't informed about developments. He was furious, a person familiar with the matter says.

Mr. Cox says commission approval wasn't warranted. He instead worked with his staff on "very intense and rapid" decisions.

The weekend after the Bear Stearns bailout, Mr. Cox headed to the Caribbean for a scheduled family vacation. He worked throughout, he said, staying in touch with SEC staff when needed.

The next week, as Mr. Cox returned from his trip, the Treasury Department unveiled a proposal to overhaul financial-services regulation. It called for dissolving the SEC and handing its Wall Street brief to another federal body.

Mr. Cox wrote to his staff that the report will "stimulate a productive debate about the best approach to financial regulation." He told them it was a "think piece" and to make up their own minds about whether it would lead to the SEC's elimination.

Mr. Cox forwarded the memo to Mr. Levitt, the former SEC chairman, who had urged Mr. Cox to be more visible. Mr. Levitt was taken aback. He felt the threat to the SEC's authority deserved a stronger response.

"Chris, sometimes the middle ground is not where you want to be," he wrote in an email that has been viewed by others, according to one person familiar with the note. Mr. Levitt declined to comment on the correspondence.

Mr. Cox said he's not engaging in a public-relations battle on the future of U.S. financial regulation because the decision lies with lawmakers. "Deep interaction with the Congress is what's called for here, not picketing in the streets in St. Louis," he said. "It's not something the SEC gets to decide."

Instead, Mr. Cox says he has been focused on working on "real time" solutions, including a formal cooperation arrangement with the Fed to share information and data from investment and commercial banks, which could be announced as early as this week.

Inside the SEC, one commissioner and staff urged Mr. Cox to be more assertive, according to a person familiar with the matter. During a May speech before the Security Traders Association, a Wall Street group, he appeared to accommodate those calls, saying Congress needs to broaden the SEC's mandate to regulate investment banks.

"Very soon, the SEC -- or if not the SEC then another regulator -- should be given the express authority" to regulate investment banks in their entirety. Immediately, calls from the Fed flooded the SEC: Was Mr. Cox saying the agency didn't want the job?

He had been misunderstood, the SEC staffers replied.

In the interview, Mr. Cox said he meant only that the Fed will inevitably play a greater role overseeing investment banks as long as it, not the SEC, is lending money. Last Thursday, he stepped up his public profile with an appearance on CNBC and an opinion piece in The Wall Street Journal. In the Journal piece, he said that "maintaining the diverse perspectives of the Fed and the SEC" would be "useful."