With Norm Champ, Former Director of the Division of Investment Management at the SEC, Author of Going Public: My Adventures Inside the SEC and How to Prevent the Next Devastating Crisis
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Norm Champ
Ever wondered what goes on at the Securities and Exchange Commission (SEC), the agency tasked with making sure financial service providers operate within the law to ensure the overall economic health of the country? To get an inside look, Steve speaks with Norm Champ, former Director of the Division of Investment Management at the SEC, about his new book, Going Public: My Adventures Inside the SEC and How to Prevent the Next Devastating Crisis. Norm is also a lecturer on investment management at Harvard Law School.
Steve dives into the conversation by asking Norm why he joined the SEC in January 2010 when there were a lot of questions about the SEC and how the 2008 crisis happened under its watch, calls for immediate reform, and multiple scandals such as the Bernie Madoff case.
Norm Champ says his main motivation was that, as a securities lawyer working on IPOs and M&A deals, he had worked with people at the SEC throughout his career and had tremendous respect for them. Then, when he saw the agency in crisis—from being looked at as experts to being derided—he wanted to step in and help them fulfill their mission.
The SEC Needed Reform
Shortly after Norm joined the SEC, he realized they were not as market savvy as he’d expected and that many of its employees were essentially there for the agency’s tremendous benefits and lifetime employment. So, the agency had gotten a little stagnant in its thinking about the markets and its role as a watchdog. It had become bureaucratic, ossified, and set in its ways.
For example, SEC staffers who were examining Bernie Madoff and the like had no manual or framework on how to conduct such inquiries and, instead, relied on investment advisors and broker dealers following their manuals on standard operating procedures. That surprised Norm shortly after he joined the SEC and also surprised Steve when he heard that the SEC did not follow its own rules while imposing a ton of compliance requirements on the investment world.
While Norm was there, his lasting accomplishments were to institute policies and procedures so the SEC could effectively protect investors and get back on its feet.
No Carrots, No Sticks
As Norm explains in his book, Going Public: My Adventures Inside the SEC and How to Prevent the Next Devastating Crisis, the crux of the cultural problems in government, in general, not just the SEC, is that there are neither carrots nor sticks. For example, the SEC and the Public Employee Union would never agree to the type of pay-for-performance system that exists in the private sector. So, there is no way to reward high performers and to pay them more, which makes the government environment very difficult. Fortunately for Norm, the union too was under pressure because the SEC was being pilloried by the media and so worked with Norm to make a lot of changes.
Quiet Patriots Who Triumph Despite the System
Next, Steve picks a quote, “Quiet patriots who triumph despite the system” from Norm’s book and asks him about it. Norm says the SEC still has people who join the agency for public service, to do the right thing, to protect investors, and make things better. And it’s those quiet patriots that his book, Going Public: My Adventures Inside the SEC and How to Prevent the Next Devastating Crisis, is dedicated to.
Money Market Mutual Fund Reform
While at the SEC, Norm was instrumental in passing the Money Market Mutual Fund Reform. Money Market mutual funds are funds that almost everyone with an investment account uses but is not aware of. Brokerage firms, such as Fidelity and Vanguard, put investors’ spare cash into a Money Market Mutual Fund so it earns a small return while it’s not invested.
The SEC’s reform was to essentially remind investors that a Money Market Mutual Fund was an investment product like any other and a dollar in did not guarantee a dollar out.
Finally, Norm talks about the SEC’s involvement in the Volcker rule and the Dodd-Frank Wall Street Reform and Consumer Protection Act and why the government should not promote the worst investment in human history—the lottery which Norm views as a monopoly exempt from truth in advertising and a regressive tax on lower-income Americans.
Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital. Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances. The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.
Steve Pomeranz: Ever wonder what goes on at the SEC, the Securities and Exchange Commission? That’s the agency whose primary purpose is to make sure that the financial service providers in this country operate within the law to ensure the overall economic health of the country. Let’s take a look inside this SEC to find out, and to do that, I’ve invited Norm Champ. Norm is the former Director of the Division of Investment Management at the SEC, and he has a new book. It’s entitled, Going Public: My Adventures Inside the SEC and How to Prevent the Next Devastating Crisis. Also, Mr. Champ is a lecturer on investment management at Harvard Law School. Welcome to the show, Norm.
Norm Champ: Thanks so much for having me, Steve, I really appreciate it.
Steve Pomeranz: So, I didn’t know you could have adventures inside the SEC, but we’ll just pass that for a second. Look, in 2008 Americans were reeling from the devastating financial crisis that caused the Great Recession. We all know about this; we’ve all felt it. There were a lot of questions about how the crisis was allowed to happen, and then, of course, calls for immediate reform. Then the multiple scandals, like the Madoff scandal, sent real fear throughout the investment community, and it put a lot of pressure on the SEC. So right about that time in 2010, you joined the SEC. Why did you join at that time?
Norm Champ: Yep. So I took the oath in January of 2010, and that was really just right after the crisis. I think the main motivation for me was that I had worked with the SEC my whole career, as a young lawyer working on offerings, working on M&A deals and speaking with SEC people and working with them. And they had this reputation as this expert agency that was fulfilling the mission of markets in the United States and capital formation. Here they were, I think of any agency in the crisis, they took the biggest tumble from being that expert to being basically derided all around the street. It was hard to watch, and I thought that I had this expertise around expert asset management and that it would make sense to come in and try to offer some of that expertise to help them fulfill their mission.
Steve Pomeranz: Well, you were still on the outside, and what did you actually think you would find once you got there?
Norm Champ: So, I thought that it would more expert than it was. I thought it would be more market savvy than it is. It’s a place where people end up staying a long time because it has tremendous talk about it, it has tremendous benefits, and sort of lifetime employment, you can never be fired. So, it had gotten a little stagnant in its thinking about markets and what it was doing, and things had really gotten ossified. It was much more bureaucratic and ossified and sort of doing things the way did them because they always did them that way. There was much of that than I expected.
Steve Pomeranz: Yeah, so there was this idea of what you thought you would find when you got in there, and then what you actually did find. Would you characterize that as being much worse?
Norm Champ: Yes. So, some of it, I often say to people, it’s something that you just couldn’t make up. The idea that the examiners who were examining Madoff, examining Stanford, the idea that they had no manual, no framework of how to conduct exams and what to do when they went to conduct exams, and what to look for, was just stunning. Because SEC rules require investment advisors and broker dealers to have manuals, to set out how they’re going to do their job, how you’re going to prevent fraud, how you’re going to protect the client, all those things. And yet my second or third week, the examiners asked me, “Well how do you want this exam done?,” and I said, “Well, don’t we have some guidance, some sort of framework?” “Well, we sort of, we kind of know how to do these things,” and that easily was the biggest surprise.
Steve Pomeranz: Well, I mean the irony is, I’ve been in the investment world for 35 years, and you’re right, the amount of material and requirements and manuals and checklists … I mean it goes on and on and on. What we are required to have on premises and in our compliance departments and the like, is incredible, and basically, I’m hearing from you they don’t follow their own rules.
Norm Champ: So, there was very little infrastructure, very little setting down of how you’re going to do things. And one of the lasting accomplishments of what we did while we were there was to get a manual in place in the Exam Division and also get a manual in place in the Division of Asset Management. Those are things that will be there for, I think, a long time and people will follow them and I think that will help protect investors and help the SEC get back on its feet.
Steve Pomeranz: In the private sector, you have the ability as a manager to install monetary rewards, monetary carrots. In the public sector, are monetary rewards appropriate?
Norm Champ: They are, and I would like to see more of them. The real crux of the cultural problems in government now—and this is not just the SEC, this is across all kinds of governments—the real crux of the problem is there are neither carrots nor sticks. So, the SEC and the Public Employee Union that represents employees there could never agree on a pay-for-performance system. So, there was no way to reward the high performers and pay them more. So when we did surveys of employees, that was the number one sticking point because people come in there, they are devoted to the mission, they kill themselves, they work really hard. The guy two doors down is doing nothing. That inability to reward the hard worker makes the government environment very difficult.
Steve Pomeranz: So was the union, the Public Employee’s Union, is that very, very strong in the SEC or across government?
Norm Champ: They are very strong at the SEC and very strong across many arms of the Federal Government, similar to the state level. It is something that … they help make the culture very difficult because they are constantly trying to get more benefits for their employees. They don’t have to do day-to-day work for the SEC if they are the union rep. So their goal is to be re-elected as the union rep which means you’ve got to get more benefits for employees. Now, to me, that’s actually pretty logical. In other words, a lot of my colleagues railed at that. I was like, “Look, this guy wants to get re-elected. He’s going to try to get more benefits for employees, that’s what he’s doing.”
Steve Pomeranz: That’s the job of the union is to get more benefits.
Norm Champ: Exactly. So to expect them not to is not that realistic. Now, of course, I would love to see some changes so that they weren’t able to do that, but we had the system we had. One of the things—I really sort of made a strategic decision right away—was that, if I wanted to work with them because they’re going to be there long before—they were there long before I was, they could be there long after. If I fight them and try to punch them in the nose, it’s just not going to happen. And they had some motivation to make some changes as well because their examiners were being pilloried in the paper, and there was a lot of heat. So I spoke to the union every Tuesday morning for five years, and we worked to make a lot of changes together. I really put my effort on that as opposed to trying to fire people. Some people come in and they’re like, “I’m going to fire this guy, fire that guy.” Effectively, you cannot fire anyone because of Civil Service Rules and the union rules, and so you spend a lot of brain damage on trying to fire somebody and you don’t get anywhere.
Steve Pomeranz: You mentioned in the book that, and I’m going to quote here, “Quiet patriots who triumph despite the system.” It sounds great, can you give us an example of that?
Norm Champ: Sure. So, you have all this cash, you have a lot of things going on, and you have people who aren’t doing their jobs. And yet you have people who come there, they’re there for public service, they want to do the right thing, they want to protect investors, they want to make things better. So, it’s those people that the book is dedicated to because they screen out all this noise and they’re out there protecting investors every day. And they’re doing it in ways that mostly the public will never know about. So, one example that I talked about in the book that I think is most telling, is there was a broker dealer that was in a lot of trouble in 2011, almost failed, and that failure would have been the largest failure of a US broker dealer by far, by number of accounts and by amounts of people impacted. And, literally, a team of people worked behind the scenes tirelessly, traveling away from their homes for weeks, months at a time, doing everything they could to … essentially, we found a buyer ultimately for it. In the end, we got someone to buy most of the assets; the rest of the assets declared bankruptcy and investors were not harmed. No one had to go through a SIPC proceeding to sort out a bankrupt broker dealer. That’s one of those where you see people just sacrificing everything to help the investors.
Steve Pomeranz: Is that the function of someone in SEC to find a buyer for a troubled company?
Norm Champ: Not usually. But in the immediate post-crisis and melt-down atmosphere, I think we all felt like we had to get more involved.
Steve Pomeranz: You had to do something.
Norm Champ: You just couldn’t have another failure because there was so much attention and so much going on. So, you’re right, I would say ordinarily, probably not, but in those kinds of crisis times, people went above and beyond. And I feel like those are the kinds of people that … And every improvement I tried to make at the SEC was to help those people to be able to do their job better, to be able to improve it so that they could do better.
Steve Pomeranz: My guest is Norm Champ, the former Director of the Division of Investment Management at the SEC, and his new book is Going Public: My Adventures Inside the SEC and How to Prevent the Next Devastating Crisis. So, you left when?
Norm Champ: So, I left in January of 2015.
Steve Pomeranz: Okay. And you went to go back to the private sector? What are you doing now? Or you went to write the book.
Norm Champ: Yeah, right, yep. First thing I did was I went to write a book. So, I took a whole year off, rented one of these shared work spaces on the Upper West Side of Manhattan and then one of these group office spaces, and worked on the book for a year. And I spoke to a variety of different people about opportunities and ultimately ended up back in private practice at a law firm and have been helping investment funds comply with the law since then. So, that’s mostly what I do.
Steve Pomeranz: One of the policies that you were instrumental in passing or areas of reform was the Money Market Mutual Fund Reform. What is that? What was the problem and how was it reformed?
Norm Champ: So, in the fall of 2008 while everything else was falling apart, one main feature of the US Financial System was falling apart and it didn’t get as much publicity as the rest of it. Money Market Mutual Funds are something that almost all of us are invested in, but most of us don’t even know we’re invested in. So, if you have a securities account somewhere, Fidelity, Vanguard, whatever, you mostly have your spare cash in a Money Market Mutual Fund that’s earning a little extra return as you wait to put it into a new investment or what have you. You probably filled out a form when you opened that account 20 years ago, and you don’t even know that your money is going into that Money Market Mutual Fund. That’s all fine, those funds, essentially, if you put a dollar in, you get a dollar out like a bank account, and nobody really paid any attention to any of this until the fall of 2008 when after Lehman went bankrupt on September 15th, 2008, a Money Market Mutual Fund called Reserve Primary woke up to find out that it owned 680 million dollars-worth of Lehman Brothers debt. And all of a sudden putting a dollar in was not going to get a dollar out.
Steve Pomeranz: This was a relatively small Money Market too, wasn’t it?
Norm Champ: No, they were the biggest, they were one of the biggest.
Steve Pomeranz: Oh, they were the biggest. They rivaled the ones you just mentioned like Fidelity and …
Norm Champ: They did because they were offering better returns primarily for institutional investors, so they had detracted a lot of capital. So, when they woke up owning a lot of what then became, at least for the moment, worthless papers from Lehman Brothers, people started withdrawing like crazy from the Money Market Mutual Fund now-
Steve Pomeranz: Like a bank run, a run on the bank.
Norm Champ: It’s a run on the bank for mutual funds. Treasury and the Fed stepped in and guaranteed all Money Market Mutual Funds in the United States. Ironically, they did so with a 34 million, M as in million dollar fund. My market funds were around three trillion.
Steve Pomeranz: Yeah, I was just going to say, what is that going to do?
Norm Champ: Yeah, what 34 million was going to do, but it shows the power of psychology in financial markets-
Steve Pomeranz: Ah, I gotcha, I gotcha.
Norm Champ: … And it stopped the run on the funds. But it was incumbent on the SEC which had created this product and allowed the fixed dollar price. It was incumbent on the SEC to get organized and figure out how to reform these funds so this wouldn’t happen again.
Steve Pomeranz: So, I remember, I don’t know, maybe a year ago we got a notice … Our custodian is Fidelity, we got a notice saying that the law had changed and that now the mutual fund could break the buck, as they say, the dollar price per share could go below, it will start to fluctuate. And I think we were told if we wanted to prevent that then put your money in a government backed money market which we automatically did. So, is that the rule that you’re referring to?
Norm Champ: Yes. And so, after a long saga, we got that rule passed in the summer of 2014, and that’s why you got that notice in 16 because it was about a two-year implementation period. And, effectively, what it said was, “Look, this product is an investment product, it’s not a dollar-in-dollar-out bank account.” So, we want people to understand that it can fluctuate in value and that’s what the new rule says. Now you are correct, your memory’s great, it does allow the Government funds to stay at a dollar. I was not necessarily a huge fan of that part of it or retail funds staying at a dollar, but, nonetheless, we got a substantial part of that market turning into a floating price.
Steve Pomeranz: I can see the issue because not that everybody’s going to be moving to the Government, it doesn’t really take the responsibility or the liability away from the Government, it just kind of loads it more directly on them as opposed to indirectly on them.
Norm Champ: Exactly. And it’s had another impact which we knew, which was a lot of people relied on that short-term funding coming into those Money Market Mutual Funds.
Steve Pomeranz: Yeah.
Norm Champ: So now you’re moving that to the Government. So that funding has had to come from elsewhere over the last couple years. Many more credit funds and those kinds of people providing finance.
Steve Pomeranz: Be careful how you fix something right? It always has some consequence somewhere else.
Norm Champ: Agreed. But I was pleased that we were able to get a significant chunk of the industry to a floating net-asset value. I would have preferred all of it, but politics is the art of compromise. So we got much of it to floating.
Steve Pomeranz: All right. So also, there is the Volcker rule and the Dodd-Frank Wall Street Reform. We don’t really have that much time, a couple minutes. What involvement did you have there and what did you take away from that?
Norm Champ: So, the SEC was one of the five agencies that had to write the Volcker rule. The Volcker rule is just … it’s nothing but Glass-Steagall turned into a big bureaucratic rule.
Steve Pomeranz: Were you going to say mess, or?
Norm Champ: Yes. I mean, we could have had Glass-Steagall where you just separate things and investment banks; instead, they kept them together and they wrote the Volcker rule to try to separate the two impacts. It’s a complicated rule, it gives a lot of powerful regulators, I don’t really think it helps safety and soundness very much, but it doesn’t look to me like there’s going to be much appetite to change it in the new administration. So, it seems like it’s here to stay.
Steve Pomeranz: One last thing, you addressed this … You’re in favor of increased financial literacy and education, of course, and who isn’t? But you mentioned one thing here, force the lottery to do truthful advertising. What is that all about?
Norm Champ: So, after making a bunch of policy recommendations in Chapter 10, I do think that the number one way that Americans can prepare for the next crisis is to improve their own balance sheets, increase their own savings, use tax-free savings accounts which are one of the rare breaks offered by the IRS system. One of the things that’s so frustrating is that Government, instead of encouraging savings, encouraging individuals to create their own balance sheets and strengthen their own balance sheets, instead, advertises relentlessly the worst investment in human history, which is the lottery. The lottery is a monopoly, they pay about half of what they take in out the people who win, and then they tax even that over a certain level. Your odds of winning are about the same as being hit by lightning. The saddest part, low-income New Yorkers spend, and I talked about this in the book … Low-income New Yorkers spend about 10% of their income on lottery tickets.
Steve Pomeranz: Oh, wow.
Norm Champ: I could take that income, you could, we could invest that in a tax-free account. Those people would have a net worth. So, I’d like to … The lottery is exempt from truth in advertising laws, it’s a monopoly. I would like to see big changes there to stop this tax which is a regressive tax on the lower-income Americans.
Steve Pomeranz: Wow, that’s a very good point. Norm Champ is my guest, the former Director of the Division of Investment Management at the SEC. His new book is, Going Public: My Adventures Inside the SEC and How to Prevent the Next Devastating Crisis. And, obviously, it’s a book about what has happened, what is currently happening, and also Norm’s thoughts about other things that need to be fixed. To find out more about Norm and to hear this interview again, don’t forget to join us, and join the conversation at stevepomeranz.com. Thank you so much for joining me Norm, it was great.
Norm Champ: Thanks for having me, I really appreciate it.
