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Remarks before the U.S. Chamber Center for Capital Markets Competitiveness

Commissioner Daniel M. Gallagher

U.S. Securities and Exchange Commission

Washington, D.C.

Jan. 16, 2013

Thank you, David [Hirschmann], for that kind introduction. I’m very pleased to be here this afternoon addressing such strong supporters of American global leadership in capital formation, one of the foremost goals of the Commission. Before I continue, I must tell you that my comments today are my own, and do not necessarily represent the positions of the Commission or my fellow Commissioners.

As I’m sure you’re all aware, next Monday the nation will observe both the Inauguration and Martin Luther King Jr.’s birthday. What you may not be aware of is that Monday also marks the two-and-a-half-year anniversary of the enactment of the Dodd-Frank Act. To commemorate the occasion, I’d like to take a few moments today to talk about the Act — specifically, the misallocation of resources and opportunity costs that have arisen from the many false assumptions underlying the Act and how they continue to impact the Commission's everyday efforts to carry out its mission to protect investors, maintain fair, orderly, and efficient markets, and to facilitate and capital formation.

You can say this about the Dodd-Frank Act: it’s a perfect example of not letting a crisis go to waste. Indeed, the Act is a model of the new paradigm of legislation — a core concept, in this case regulatory reform, overwhelmed by a grab bag of wish-list items. What continues to amaze me about the Act is not only what it covers in its 2319 pages, but also the crucial regulatory issues it does not address. The juxtaposition of the two is jarring. The Act tasks the SEC with a mandate to create unprecedented new disclosure rules relating to conflict minerals from the Congo — but not to reform money market mutual funds, which, we were later told, are ticking time bombs of systemic risk. Dodd-Frank addresses extractive resource payments made by U.S. listed oil, gas and mining companies — but leaves the reform of Freddie Mac and Fannie Mae for another day. The Act fundamentally restructures the nation’s financial regulatory infrastructure by establishing the Financial Stability Oversight Council, not to mention the Consumer Financial Protection Bureau — but failed to eliminate the redundancy of having the SEC and the CFTC share jurisdiction over substantially similar and interrelated markets and products. Dodd-Frank creates a system of regulation for so-called SIFIs but does not address the shortcomings of the short-term funding model of banks that continue to be too big to fail. The Dodd-Frank Act's attempts to “solve” the financial crisis illustrate the peril of false narratives — it justifies its mandates as answers, but only after asking the wrong questions.

I suppose that this shouldn’t be a surprise given that the statute was not the product of bipartisan compromise and was enacted shortly after the onset of the crisis — and many months before the bodies charged with examining the causes of the crisis issued their reports. This was a markedly different approach than the deliberative process undertaken after the 1929 stock market crash.1

In total, the Dodd-Frank Act contains approximately 400 specific mandates to be implemented by agency rulemaking, with approximately a hundred applying directly to the SEC. The SEC has adopted final rules implementing nearly a third of those statutory mandates and continues to devote tremendous amounts of resources to drafting additional proposals, completing required studies, and implementing the new rules. The result has been a dramatic increase in both the volume and pace of SEC rulemaking. As I’ve said in the past, it’s no exaggeration to say that the Commission is handling ten times its normal rulemaking volume, with “normal” being the post Sarbanes-Oxley normal, itself a marked increase from the pace before that law’s enactment.

As a result, the SEC, like other regulators, is now dealing with the problem of rushed, inadequate rule proposals that were pushed out in a bid to meet arbitrary congressional deadlines. As you might expect, it is not easy to promulgate high quality final rules from faulty proposals. The Volcker Rule serves as a case in point.

This increased pace raises two sets of concerns. The first stems from the difference between getting rules done and getting them done right. Smart regulation requires taking the time to understand the problem that needs to be addressed, including not only the proximate cause of the problem but also the often complex and hidden factors underlying that problem. It is at this stage where the peril of false narratives is at its greatest, for incorrectly identifying the causes of a problem — whether outright or by oversimplifying complicated issues— makes finding the right solution far more difficult, if not impossible. And, it should go without saying that we need to ensure that we are performing a rigorous cost-benefit analysis of all rules, whether proposed or final.

The second set of concerns centers around the concept of opportunity cost and the misallocation of limited resources. I have no doubt that the businesses represented by the Chamber understand the concept of limited resources and the need to set clear and sensible priorities far better than does the federal government. Every hour spent by the SEC staff on drafting rules or carrying out studies to implement Dodd-Frank mandates represents one less staff hour spent focusing on the Commission’s core regulatory responsibilities.

I’m not here to enumerate the flaws of the legislation as a whole, but I'd like to spend a few moments using the Volcker Rule to illustrate both of these sets of concerns. As I’m sure you all know, the Dodd-Frank Act requires the three Federal banking agencies, the SEC, and the CFTC to adopt rules to implement two significant prohibitions on banking entities and their affiliates: a prohibition on engaging in proprietary trading, and a prohibition on sponsoring or investing in “covered funds” such as hedge funds or private equity funds. The Rule identifies certain specified “permitted activities,” including underwriting, market making, and trading in certain government obligations, that are excepted from these prohibitions but also establishes limitations on those excepted activities. The legislative text of the Volcker Rule defines — in expansive terms — key concepts such as “proprietary trading” and “trading account” and grants the Federal Reserve Board, the FDIC, the OCC, the SEC, and the CFTC the rulemaking authority to further add to those definitions.

The banking agencies and the SEC issued a proposal in October 2011, with the CFTC following in February of last year. Fifteen months later, the rulemaking remains at the proposal stage, with ongoing talks between the agencies aiming to address the myriad concerns raised in over 18,000 comment letters regarding the dire, albeit presumably unintended, consequences they argue would result from the proposed implementing regulations.

And yet, “If you look at the crisis, most of the losses that were material for the weak institutions — and the strong, relative to capital — did not come from those [proprietary trading] activities.  They came overwhelmingly from what I think you can describe as classic extensions of credit.” Those aren’t my words — Treasury Secretary Geithner spoke them in September 2009. In case Secretary Geithner merely misspoke, I’ll provide another quote from a different speaker, this time from March 2010: “[P]roprietary trading in commercial banks was there but not central” to the financial crisis. That speaker? Paul Volcker. 

Don’t get me wrong — as illustrated by notable hedging failures last year, bank trading and hedging practices can indeed be a whale of a problem. It’s just not a problem the Volcker Rule, or the Dodd-Frank Act as a whole, purport to address. Like much of the Act, the Volcker Rule is a solution in search of a problem.

The Act, however, is still the law of the land, and banks have long since accepted the Rule and its implications for their business activities. In fact, I’ve been told by several firms that although the implementing rules have yet to be finalized, they’ve taken significant steps to shut down their U.S. prop trading activities and, in some cases, have already done so completely. Even as firms have looked to the statutory text and spirit of the Rule and proactively taken action to bring their hedging and trading practices into compliance, however, high-level staff from five regulatory agencies continue to work behind closed doors to refine a rulemaking proposal that, according to a letter sent to the agencies by a bipartisan group of six Senators, "as drafted, could adversely affect Main Street businesses by reducing market liquidity and increasing the cost of capital."2

In another comment letter, Senators Merkley and Levin, both strong supporters of the Volcker Rule, wrote, "The Volcker Rule demands Wall Street change its culture. Implemented in a smart, vigorous way, the Volcker Rule can both protect the U.S. economy and taxpayers from some of the gravest risks created by the nation's largest financial institutions, while providing plenty of space for these financial institutions to provide the plain vanilla, low-risk, client-oriented financial services that help the real economy grow."3 These are certainly laudable goals. Almost uniformly, however, critics of the Volcker Rule argue that it is those very "plain vanilla," Main Street customer-facing products that will be harmed, not necessarily by the text of the Volcker Rule as set forth in the Dodd-Frank Act, but by the draconian interpretation of the Rule that the October 2011 proposed rules would impose upon the financial industry — and its customers. Notably, our foreign regulatory counterparts in Europe, Canada, and Japan have been some of the fiercest critics of the proposed implementing rules.

I had the opportunity last week to meet with regulators and industry participants in the UK and Ireland, where I encountered a distinct lack of enthusiasm for either the Volcker Rule or its “ring-fencing” counterpart proposals set forth by the UK Independent Commission on Banking and the European Union’s Liikanen Group. Indeed, Sir John Vickers, chairman of the Independent Commission, has already criticized the UK coalition government for backing away from his original proposal,4 while the European Commission’s recent report summarizing the responses received to the Liikanen Report acknowledges the widespread opposition to the proposal in a charmingly understated fashion, stating, “In general, banks welcomed the Group's analysis, but argued that a compelling case for mandatory separation of trading activities has not been made. They felt that the proposal was not backed by the required evidence, and that there was a need for a thorough impact assessment.”5 With all due respect to my friends in the European financial regulatory community, when a regulatory proposal is viewed within the European Union as being too harsh on the financial industry and harmful to markets, I think that’s a clear sign that it’s time to take a step back and reevaluate.

Regardless of what happens with respect to the Vickers or Liikanen proposals, even if all of the most vitriolic allegations Wall Street's harshest critics set forth are true — even if our financial giants act solely and ruthlessly out of craven self-interest — those financial institutions know that the Volcker Rule isn't going away. As such, they have already begun the process of determining which of their activities would be prohibited under the Rule as set forth in the text of the Dodd-Frank Act and proactively moving to shut down their truly proprietary trading desks as appropriate. Accordingly, as my friend and colleague Troy Paredes and I have often stated, the final regulations implementing the Volcker Rule should, for the most part, simply be a codification of what most banks have already done in response to the requirements set forth in the legislative text. The critics of the proposing release are no longer, if they ever did, realistically contemplating repeal of the Volcker Rule. They simply want us to get its implementing regulations right.

The October 2011 proposal fails to accomplish this goal by focusing only on the latter part of Senators Merkeley and Levin's call for the implementation of the Act in "a smart, vigorous way." Operating on the narrative that banks' proprietary trading practices were a central cause of the crisis, the proposal eschews a focus on smart regulation in favor of pursuing the most vigorous possible interpretation of the Rule's mandates. The proposal throws the baby out with the bathwater — along with the rubber ducky, the bathtub and all of the plumbing as well for good measure. Rather than carefully examining banks' trading practices to determine which of those practices constitute proprietary trading and which are instead customer-facing activities providing liquidity and reducing the cost of capital, it stretches its definitions of covered activity on an almost punitive basis, as if based on an assumption that any trading that could result in profits for the trading entity must fall within the ambit of the Volcker Rule's prohibitions.

This failure to separate market-critical, customer-facing activities from true proprietary trading illustrates the second set of concerns — opportunity costs and the misallocation of resources. The entire rulemaking exercise so far has been carried out in a manner that has wasted the resources of all of the agencies involved. By every account, the bank regulators have taken the lead role throughout the rulemaking process. Presumably, this stems from the fact that the Rule applies to the vast financial firms regulated at the bank holding company level by the bank regulators, coupled with the Byzantine nature of interagency rulemaking and the Washington power game. The Volcker Rule, however, isn't about the financial entities involved — or the relative political standing of the different regulatory agencies — but instead the activities in which those entities engage. Those activities — the trading and hedging practices of those entities — unquestionably fall within the core competencies of the SEC. For example, the SEC has built an extensive library of rulemaking and interpretive releases concerning exceptions for bona fide hedging or market making in the context of short sales. These exceptions, which date back to the early 1980s, built upon the bona fide hedging exceptions to the Commission’s proprietary trading rules for members of national securities exchanges set forth in a 1979 rulemaking. The Rule expressly envisions that quintessential market-making activity continue to be carried out by the firms affected by the Volcker Rule, yet the agency that has regulated securities market-making in order to facilitate liquidity and promote the efficient allocation of capital for decades has played a secondary role in drafting regulations to implement the Rule.

All of this comes with a cost. Both the Commission staff playing second fiddle and the banking regulators struggling to convert the widely lambasted proposing release into workable regulation could be focusing on other matters rather than spinning their wheels with no end in sight. Simply put, we could be spending our time in a far more productive manner, focusing on mandates that are critically important such as those in the JOBS Act, as well as addressing the SEC’s basic “blocking and tackling.” Indeed, one personal frustration of mine has been the Commission's inability to fully implement what I believe is the most useful and important provision of the Dodd-Frank Act, the Section 939A mandate to remove all references to Commission-registered credit rating agencies, formally referred to as nationally recognized statistical rating organizations, from all agency regulations. This clear and direct mandate is actually responsive to one of the core problems underlying the financial crisis — overreliance on inaccurate credit ratings by both investors and regulators — yet the most important rules continue to include such references.

Meanwhile, FSOC, charged with averting the next financial crisis, is apparently spending more time hectoring the Commission — a purportedly “independent “ agency — on the reform of money market funds — an issue that falls directly, and solely, within the Commission's regulatory sphere of responsibility but that was somehow not important enough to be addressed by the Dodd-Frank Act — than they are focusing on the bubbles that have the potential to cause another crisis. On the issue of money market funds, I am happy to report that Craig Lewis and his fine staff in our economic analysis division have completed the rigorous study and economic analysis that a bipartisan majority of Commissioners had long asked for in advance of considering new rulemaking. We are currently working with the economic analysis staff and the Division of Investment Management to shape a reform proposal based on that rigorous economic analysis.

Separately, I'm encouraged by Chairman Walter’s commitment, even as we continue to implement the Dodd-Frank mandates, to focusing as well on the everyday, core blocking-and-tackling issues that affect investors most. In the coming months, I look forward to working together to address the Commission's priorities — both short-term priorities such as the long-overdue amendments to the Commission's net capital and customer protection rules commonly referred to as the Onnig amendments and longer-term ones such as engaging in a formal, thorough evaluation of equity market structure issues, last done in a comprehensive manner in the Commission's Market 2000 Report all the way back in 1994.

For all the recent talk of gridlock in a divided Commission, I believe that notwithstanding our party and policy differences, this Commission is fully united in its desire to carry out the Commission’s mandate to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. With a clear, data and analysis-based understanding of the problems we face and the complexity of their underlying causes coupled with a deliberate, measured allocation of our resources, I believe that the Commission can accomplish great things, and can avoid the mistakes of the past, over the course of the coming year. I thank you all for your attention as well as for your commitment to advancing our nation's global leadership in capital formation by supporting capital markets that are the most fair, efficient, and innovative in the world, and I wish you a productive and successful conference.

1 See, e.g., Financial Crisis Inquiry Commission, The Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States (2011) at 443 (Dissenting Statement of Peter J. Wallison) (“Without waiting for the [Financial Crisis Inquiry] Commission’s insights into the causes of the financial crisis, Congress passed and the President signed the Dodd-Frank Act[,] far reaching and highly consequential regulatory legislation. Congress and the President acted without seeking to understand the true causes of the wrenching events of 2008[.]”).

2 Letter from Senators Thomas R. Carper, Pat Toomey, Mark Warner, Mike Crapo, Christopher Coons, and Scott Brown, United States Senate, dated February 16, 2012.

3 Letter from Senators Jeff Merkley and Carl Levin, United States Senate, dated February 13, 2012.

4 See, e.g., Jill Treanor, John Vickers says George Osborne's banking reforms don't go far enough, The Guardian, June 14, 2002, available at

5 European Commission Directorate General Internal Market and Services, Summary of the Replies to the Consultation of the Internal Market and Services Directorate General on the Recommendations of the High-Level Expert Group on Reforming the Structure of the EU Banking Sector, December 2012, available at

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