The Consolidated Supervised Entity (CSE)

The SEC’s mandate

“The mission of the U.S. Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.” (U.S. Securities and Exchange Commission: What We Do, 2016). When we consider the Enron and Madoff scandals and the stunning collapse of several large U.S. investment banks in 2008, one has to conclude that the SEC failed in fulfilling its basic mission. From one perspective, the effects of the Enron and Madoff scandals pale in comparison to the global magnitude of the 2008 financial crisis. In hindsight the SEC’s actions leading up to that crisis are striking.

The Consolidated Supervised Entity (“CSE”) Program: Unintended consequences:

At the beginning of

By the late fall of 2008, all of these investment banks, none of which were owned by larger commercial banks, had either failed or changed their status to bank holding companies under pressure from the Federal Reserve. Bear Stearns and Merrill Lynch, both almost insolvent, were forced by federal regulators to merge with larger commercial banks. Lehman Brothers filed for bankruptcy. All these firms had survived previous market turmoil and some could trace their histories back over 150 years. However, despite their long histories and ability to withstand past market failures, each of them either failed or were close to failing within the same short period in early 2008. There is one commonality that unites each of them in their demise, all of these banks had voluntarily enrolled in the SEC’s Consolidated Supervised Entity (“CSE”) Program. In fact, these were the only investment banks permitted to enter the CSE program. The CSE Program, established by the SEC in 2004, permitted these banks to bypass the SEC’s net capital rule, which dictated certain limits on their debt to equity ratios, instead allowing a more relaxed “alternative net capital rule” that contained no similar limitation. All of this was granted in exchange for greater SEC oversight of

For example, the Federal Reserve typically assigns staff members to every office within a regulated bank holding company, however the SEC assigned only three regulators to each CSE firm. The SEC’s Office of Prudential Supervision and Risk Analysis, which oversaw and conducted the CSE monitoring effort, was comprised of only thirteen individuals. “From the start, it was a mismatch: three SEC staffers to oversee an investment bank the size of Merrill Lynch, which could easily afford to hire scores of highly quantitative economists and financial analysts, implied that the SEC was simply outgunned.” (Coffee & Sale, 2009) The SEC’s Inspector General’s Report supports this critique, specifically with details regarding staffing levels of the CSE program: “The CSE program consists of a small number of staff, several of whom have worked in the CSE program since its inception in 2004. The Office of CSE Inspections currently has only two staff in Washington, DC and five staff in the New York regional office. It also does not currently have an Assistant Director (i.e., an office head). In March 2007, Chairman Cox decided to transfer inspection responsibility from OCIE to Trading and Markets