New SEC head faces fights on several fronts, legal straitjacket

Mary Schapiro's successor as head of the U.S. Securities and Exchange Commission is going to have to hit the ground running.

With an ongoing battle over regulating the $2.5 trillion money market fund industry, some 63 unfinished rule makings required by the 2010 Dodd-Frank Wall Street reform law and continuing fears about market stability and high frequency trading, the new top securities regulator will have a lengthy list of critical issues to address on day one.

And it will all have to be done under prickly circumstances. All new rule-making faces potential legal challenges from opponents strengthened by a U.S. Court of Appeals ruling last year which will force the agency to do deeper "cost benefit" analysis. Such requirements can drag out rule proposals for months, or even years.

"It's an ongoing, enormous challenge," said Amy Borrus, deputy director of the Council of Institutional Investors, a group representing many of the largest public and private pension funds.

The first challenge, though, may be figuring out just how long current Democratic commissioner Elisse Walter will run the agency. On Monday, President Barack Obama designated Walter as chairman not as "acting" or "interim" chairman. In theory, she could run the agency until December, 2013, when she would have to be re-nominated and re-approved by the U.S. Senate.

A White House official said the president plans to nominate a full-term replacement for Schapiro in the near future. If Walter remains in charge, the move likely would be more of the same at the SEC, as she and Schapiro were considered close allies on the commission.

With Schapiro gone next month, Walter's biggest initial challenge may be working with a divided four-person commission that is likely to be bottle necked with two-two votes on important issues like money fund reform or stricter corporate governance rules, according to Edward Fleischman, a former SEC commissioner.

"Nothing happens under a 2-2 vote," said Fleischman, who worked with Walter when she was deputy director of the SEC's division of corporation finance in the early 1990s.

Walter and Schapiro generally voted in tandem on most issues and were often opposed by Republicans Daniel Gallagher and Troy Paredes, while Democratic appointee Luis Aguilar has been a swing vote.

MONEY FUND WAR

Among the top policy issues facing the commission, the most heated debate is over reforming money market mutual funds, a critical savings vehicle for ordinary investors and an important source of corporate lending.

The commission tightened rules on the quality of fund holdings in 2010. But Schapiro and other regulators contend more is needed to avoid another run of withdrawals from the funds that could freeze lending across the entire economy. That is what happened in 2008 after Lehman Brothers went bankrupt causing the asset value of one major fund to "break the buck", or to drop below the industry's target of $1 per share.

Schapiro planned to pursue two options: forcing funds to abandon the fixed $1 per share policy or set aside capital to cover potential losses. But in August, amid bitter opposition from the fund industry, she withdrew the proposals. Of the commissioners, only Walter backed Schapiro's ideas.

The issue then moved to the Financial Stability Oversight Council overseen by Treasury Secretary Timothy Geithner - which issued for public comment a recommendation that the SEC consider proposals similar to those Schapiro had pursued. The council could vote on a plan that would then go to the SEC to consider.

Walter "may be more willing to compromise and the fund industry may be more willing to compromise with her," said Peter Crane, a longtime money fund analyst and president of Crane Data LLC.

In a speech in March, Walter offered conciliatory words, saying she wanted "a process of constructive engagement instead of one of unconstructive disengagement."

UNFINISHED RULES

The agency also has a long way to go to complete the 95 rule makings required under Dodd-Frank. Only 32 have been completed and the agency has missed the deadlines for another 50, according to an analysis by law firm Davis Polk & Wardwell.

Among the missing are tighter rules governing some derivatives trading as well as requiring companies to reclaim bonuses and other incentive pay after accounting scandals.

Schapiro's battle to hold securities firms to higher ethical standards will likely take a back seat to other unfinished business, said former SEC Chairman Harvey Pitt. Dodd-Frank empowered, but did not require, the agency to develop such standards.

"You can't put everything first," said Pitt. "Some things have to go second or later."

And some rules are not optional. In addition to Dodd-Frank, the JOBS Act that was signed into law in April requires the SEC to develop rules that would lift advertising restrictions for companies raising funds through certain private offerings. The SEC proposed those in August, but has yet to finalize them.

Many investors also remain concerned about the stability of the markets in the face of high frequency trading and other computerized strategies that have taken some of the blame for the 2010 "flash crash" when the Dow Jones Industrial Average plunged 700 points in just a matter of minutes before rebounding. Following the flash crash, the SEC tightened some rules related to stock trading and added a new set of circuit breakers for individual stocks.

But worries persist and earlier this year, after a trading glitch almost bankrupted trading firm Knight Capital Group, Schapiro asked SEC staff to speed up efforts to propose a rule that would set industry-wide standards "to ensure the capacity and integrity" of market systems.

Finally, big investors plan to push the agency for rule changes to give them greater say in corporate governance matters. Walter should "make the financial regulatory system more transparent, accountable and responsive to investors," Ann Yerger, executive director of the Council of Institutional Investors, said in a statement.

The SEC also needs to fix the system used to count proxy votes cast by shareholders. The system has been under review for years amid fears that corporate elections could go haywire. "Making sure that investors' proxy votes are cast and counted as intended is imperative," council deputy director Borrus said.

(Reporting by Aaron Pressman and Ross Kerber in Boston and Jed Horowitz, Suzanne Barlyn and John McCrank in New York. Editing by Jennifer Merritt, Martin Howell and Tim Dobbyn)