When financial market regulatory reform comes, one of its key features should be a way for pension funds and other institutional investors to serve as an “early-warning” system to regulators on market developments that raise systemic risk and overall market stability concerns.
Such a direct link with regulators is in a set of principles for regulatory reform crafted by the $167.3 billion California Public Employees' Retirement System and eight other pension systems and unveiled earlier in March.
Pension funds and other institutional in-vestors are in the market trenches real time, all the time, in a wide array of asset classes, publicly traded and private, U.S. and internationally. They not only employ investment strategies and trading techniques but also receive — and hear about from peers in the business — a constant stream of pitches for new investment ideas.
Institutional investors take the proposals seriously. They are keenly interested in seeking new ideas to improve their investment performance, mitigate risk and lower their funding cost, while sifting out the weak, improbable or potentially fraudulent ones, which could cost them dearly. They have years of experience in studying academic research. They have developed tough due diligence disciplines and apply precise benchmarks to analyze performance. Just as importantly, they are dedicated to protecting confidence in and integrity of the markets. They know they cannot have a sustainable program for reaching their financial goals without having a viable market. And they are well-positioned to assist in policing the market.
Investors have been willing to help communicate troubles, but the Securities and Exchange Commission, among regulators, isn't always receptive. Starting in 2000, Harry Markopolos, a financial analyst, repeatedly warned the SEC of suspicions about Bernard L. Madoff Investment Securities LLC. In 2005, he sent the SEC a memorandum titled “The World's Largest Hedge Fund is a Fraud.” His warnings were to no avail.
Christopher Cox, former SEC chairman, said in a statement last December that the agency “learned that credible and specific allegations regarding Mr. Madoff's financial wrongdoing, going back to at least 1999, were repeatedly brought to the attention of SEC staff, but were never recommended to the commission for action.” Mr. Cox authorized “a full and immediate review,” including recommendations for improvements to its oversight.
A direct link between institutional investors and the SEC would be a big step to reform oversight by helping to detect not only investment frauds but market destabilizing forces that create the too-big to fail impacts that puts all investors at risk.
