A Substantial Rewrite of the Laws Governing US Financial Markets Looms in 2009

This blog is the first in a series of blogs that will examine the current economic crisis and the role technology might play in future regulations.

Warren Buffet has a saying about business that goes "In the business world the rear view mirror is always clearer than the windshield." So in today's business environment, that quote just begs the question, "Just how dirty was the business world's windshield leading up to this current economic crisis?" With uncertainty around every corner and bad news being topped by even worse news on an almost daily basis, it would seem 2009 could very well be the year of regulation as President Elect Obama and the Democratic majorities that control both houses of Congress appear to have a clear cut mandate from the US population to take a hard look in the rear view mirror.

If there was ever any doubt that Congress will delve deeper into how this crisis transpired and take steps to prevent it from occurring again, a recent statement that DCIG obtained from Representative Congressman Paul E. Kanjorski (D-PA), Chairman of the Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises should remove it. Congressman Kanjorski shared with DCIG that beginning on January 5th, 2009, he will convene hearings into the Madoff case and stated, "The hearing will help guide the work of the Financial Services Committee in the 111th Congress as it begins to undertake the most substantial rewrite of the laws governing the U.S. financial markets since the Great Depression."

The motivation behind these new regulations is to start to restore the confidence of investors who have seen the Dow Jones Average fall from its all time record high of 14,164.53, on October 9th, 2007 to its recent close of 8668.39 on December 30th, 2008. Furthermore, illegal and questionable activities such as the recent $50 billion dollar Ponzi scam carried out by Bernard Madoff and out of control hedge funds has everybody up in arms calling for further government oversight in this industry. In fact, it has gotten so bad that even hedge fund managers acknowledge that stricter oversightof their industry is warranted. But what becomes more interesting as we start to look in the rear view is the timeline of events that have led up to the situation we find ourselves in now.

To understand where this all begins, we actually need to go all the way back to the 1920's. At that time, short selling raids played a significant role in the 1929 stock market crash which resulted in the creation of a rule in the 1930's called the "up-tick rule". This simply required a buyer to be willing to purchase a stock for more than the amount of the last sale before a stock could be shorted. This was done to prevent the short selling bear raids on stocks which contributed greatly to the rampant selling in 1929.

But what the SEC failed to take into account at the time it did the test was the fact that the Dow Jones was in the middle of a bull market so it did not fully understand what the impact of the law would be in a bear market. So essentially what happened in 2008 was the same thing that occurred in the 1920's -bear raids on financial stocks. When bear raids occurred on large financial companies stocks, financial companies such as Bear Stearns, Lehman Brothers and others bore the brunt of this panicked selling. As a result the credit markets froze that helped to contribute to a deep and protracted worldwide recession.

The SEC has been taking enforcement action and numerous examples of this enforcement are available on their web site. A recent example is the announced emergency court order stopping "investment clubs" that have defrauded Haitian-Americans of over $23 million dollars. But, Rep. Kanjorski plans on bringing the SEC into the spotlight in the upcoming hearings regarding the Bernie Madoff case. As part of Rep. Kanjorski's statement to DCIG, he also communicated, "These proceedings will help us to discern whether or not the Securities and Exchange Commission had the resources needed to get the job done; how such a sizeable scheme (Madoff's Ponzi scheme) could have evaded detection for so long; and, what new safeguards we need to put in place to protect investors."

As these proceedings convene it appears that the SEC and hedge funds will be front and center in determining how best to regulate and protect the markets and investors. If past history is any indicator, technology will play a large role to help enforce in these sweeping new changes. Protecting communications, ensuring data is archived and retrievable, and being able to provide that information in a timely manner will most assuredly be part of this equation and software such as Estorian LookingGlass will clearly be needed to meet the demands of these forthcoming regulations. In my next blog entry I will expand upon the hedge fund timeline and dive deeper into this issue.