Is it time to start using body cams in regulating financial markets?

There is a growing sense among investors, the public and even within government itself that the regulations protecting the markets are rigged in favor of the investment and finance industry. The revolving door of staff members taking jobs back and forth between the regulated firms and the regulator has all the trappings of a corrupted system.

A series of academic studies have theorized on the extent and effects of this dynamic known as “regulatory capture.” Lingering concerns swirl around the lack of industry leaders being held accountable for the great financial crisis, suggesting industry does rule the roost.

There is no bigger destroyer of trust in the financial services industry than a regulatory system where civil and criminal enforcement is captured by personal connections and industry influence, especially when it comes to investments and the reliance of institutional investors on honest markets. Having a better record of industry/regulator interaction would help. Perhaps the time has come for market cops to don body cameras.

In a September report, the CFA Institute revealed findings on whether market regulation is captured by industry. The report is based on a survey involving detailed, in-person interviews from late 2015 through early 2016 with global leaders in regulatory enforcement, former regulatory staff, chief compliance officers and legal experts who represented firms in their interactions with regulators. It examined an important question: How well does the investment regulatory system stand up to influence and the revolving door?

To our relief, not one of the more than 70 respondents said they had witnessed regulators backing away or going lightly on enforcement because of a personal connection or political pressure/influence by firms. Attempts to influence regulators no doubt occur with great frequency, but systematic “caving-in” to aggressive industry players by turning a blind eye to bad behavior or meting out weak enforcement is not at all prevalent, say these informed interviewees.

Clearly, influential firms will always try to use that influence. We suspect that over time, connections have affected outcomes in many markets including the U.S., but it is by no means a rigged system. Yet, even the perception that influential connections translate into favored regulatory treatment is highly damaging to investor and public trust.

It is important to note that collaboration between firms and regulators often gets confused with influence. The expectation is the relationship must be guarded, even contentious between the parties lest it be considered too cozy. The survey disputed this and confirmed the value of collaborative interaction between regulators and regulated industry players who have deep knowledge and expertise. While some see it as the fox guarding the henhouse, many of those professionals interviewed stressed that regulators cannot operate as effective market cops with an amateur understanding of industry or how markets work. Experts at these regulated businesses play a significant role in properly educating regulators.

The potential effects of regulatory capture can be mitigated by these important steps. First, collaborations must exist and regulators must understand the finer details of how the regulated businesses operate. What is critical in this regard is staying up-to-date on trends and practices. As we learned from the 2008 financial crisis, market regulation and enforcement must evolve as quickly as the securities and investment business itself. That means a very high and evolving level of market expertise among regulatory staff is necessary. Because of the need for continuing collaboration with industry, ensuring regulatory staff is specifically prepared for the inevitable influence game is fundamental. New tools and technology can help.

What we have learned recently from law enforcement in other contexts is the value of documented interactions — what really took place and what was the nature of the interaction. Many police departments mandate the wearing of body cameras to document their policing function. Market cops should consider using the equivalent in the context of engaging the industry on regulatory enforcement matters. A video or audio record would be beneficial in documenting the complete narrative of such interactions, it could be used to verify enforcement outcomes and potentially train staff.

These steps will improve effectiveness and transparency and serve to bolster public confidence in the regulatory system and market players. In a low-return environment, we need that confidence more than ever. n

Kurt N. Schacht is New York-based managing director, standards and advocacy, CFA Institute, and chairman of the Investor Advisory Committee of the Securities and Exchange Commission.