As a Securities and Exchange commissioner for the past five years, Roel Campos helped oversee the most dramatic reforms in the investment markets in a generation—the implementation of the Sarbanes-Oxley Act. Campos, one of two Democrats on the five-member panel, will be leaving the SEC to join a law firm next month. But he took time off from an August vacation to tell U.S. News that until about three months ago, he thought subprime mortgages were "high risk, but we didn't think there was any contagion problem." Now, however, he's concerned that market panic may be aggravated by the lack of information about the quality and extent of newfangled investment products such as collateralized debt obligations.
One of the reasons given for the turmoil in the credit and investment markets these days is that investors "don't know" which companies or funds might have subprime mortgage or other troubled loans on their books. Does that mean there needs to be new regulations, say, requiring funds and companies to report more about these kinds of investments?
If you're asking if there is a need for transparency in terms of positions in subprime mortgages or other types of risky loans, the question becomes how do you get the information in a way that is not obtrusive, that is not viewed as meddlesome, and doesn't interfere with normal practices in the industry? This is where it starts getting difficult. Then, what do you do with that information? If we're talking about reporting portfolio positions in debt instruments by hedge fund managers, the SEC has no authority to require them to report information unless the fund manager has voluntarily registered as an investment adviser—and then it would require our agency imposing new information requirements. Then the question becomes if you have a requirement to report a position, it might be out of date the day they've filed because they might have moved on and turned over their portfolio. Also, how do you deal with a situation in which they are using a proprietary algorithm [that they would want to keep secret]? There are no good answers.
Well, if hedge funds, which aren't regulated, don't have to tell investors, how about companies that are regulated?
Under the "Management's Discussion and Analysis" [which public companies must include in their annual reports to the SEC], risks are supposed to be disclosed. Executives can make the wrong call and convince themselves that something like a subprime loan isn't a risk. But public companies are supposed to disclose risks.
The SEC has very stringent rules requiring lots of disclosure by companies that issue stock or bonds. But these new financial instruments that have been invented in the last several years, such as collateralized debt obligations and credit swaps, can be issued without much information because the laws and regulations haven't been updated to catch up with the financial engineers.
A lot of these new products can be covered by the current acts, but might require new interpretations...If it is a commodity or a future, then the regulator should be the Commodity Futures Trading Commission. We think that since they have an equity component, it is fair for the SEC to be involved. The fault lines that have to be worked out are over who has authority over any these instruments. We're trying to work all this out, and when you're trying to reach agreement, things go slowly...We're also trying to work with the President's Working Group on Financial Markets so that all the agencies have a consolidated approach. But there is a danger of homogenization. Our mission is to protect retail investors. Our enforcement is designed to be a deterrent. The Federal Reserve is concerned with runs on banks. And the Treasury Department is part of the executive branch. That potentially injects viewpoints having to do with politics.
You've been in the minority on the commission for a long time. What if you could do anything you wanted? What would you do in response to the current situation?
The environment has been antinew regulation for several years. It was impossible to even bring up the subject of more regulation without being called some kind of financial markets traitor. I'm no fan of regulation. But you have to keep a level playing field, and our job is to keep confidence in the markets... I would want a very, very serious study, with a short time frame, by serious people, and academic research, on the transparency and complexity of these instruments. What is the right balance? How do we do it? What do we do with the information? Do we speak privately and ask everybody to have tea with us like the British do? No one has the answer. It is time we went out and sought it out... The enemy of the efficient functioning of the markets is emotion. When you have fear and panic, markets don't work. A regulator does have a duty to not let panic or emotion hurt the market.