Revolving Wall Street Door Tested in Schapiro's Money Market Reform

Updated from 11:28 a.m ET with Schapiro statement and to clarify GE use of Federal Reserve financing

NEW YORK ( TheStreet) -- Former Securities and Exchange Commission head Mary Schapiro will test theories on a revolving door between Washington and Wall Street, now that she's taken roles at General Electric ( GE) and financial sector consultant Promontory Financial, just as the SEC takes up a watered down version reforms she proposed for the opaque $2.7 trillion money market industry.

During her three years as chair of the SEC, Schapiro drove a series of financial industry regulations and helped restore some belief the regulator would police illegal activity on Wall Street, even if few top executives have faced prosecution. But Schapiro's unfulfilled proposal to reform the money market industry stood out as one of the big disappointments of her tenure.

Schapiro has already indicated she would like to see the SEC adopt the more expansive reform to the industry. Meanwhile, as the SEC conducts a 90-day comment period on its new money market industry regulations, Schapiro's potential comments on behalf of GE, Promontory or herself would stand out as influential in a policy debate.

Financial sector interests were able to use comment periods on industry reforms such as the 2010 Dodd Frank Act to propose amendments and stall subsequent rulemaking processes.

Only about a third of Dodd Frank Act rules were finalized at the end of 2012, according to a January report by law firm Davis, Polk & Wardwell.

On Wednesday, the SEC made two alternative proposals for money market reform, and invited public comment for a period of 90 days. The first proposal is that prime institutional money market funds move from reporting a fixed net asset value (NAV) of $1 a share to investors and towards a floating NAV that would more accurately reflect the profits and losses a fund might have on its holdings.

The alternative proposal "would allow the use of liquidity fees and redemption gates in times of stress," in order to help money fund managers maintain stable $1 NAVs, according to the SEC's press releases.

While such rules are crucial to restructuring the money market industry to take into account shortcomings that were exposed during the financial crisis of 2008, prime institutional funds represent only about 35% of money market funds and not many of the products ordinary Americans use.

Citigroup characterized the SEC's proposals as a "good cop scenario" for money market industry players focusing on retail customers such as Federated Investors ( FII). Analyst William Katz also indicated the phase in period of the SEC's reforms could last several years, following the comment period.

Money market funds buy short-term debt such as commercial paper from highly rated companies like General Electric, in an effort to return a yield slightly above bank savings account rates. The market, however, seized up with the failure of investment bank Lehman Brothers in September of 2008.

After Lehman collapsed, a major money market fund, the Primary Reserve Fund, wrote down the value of its Lehman holdings to zero, causing its assets fall to less than $1.00 a share in value, meaning it had "broken the buck." Because the fund had reported only a fixed asset value, the sub $1 a share value surprised investors, eroded confidence and precipitating unprecedented withdrawal from money funds.

The investor flight put major players in short-term debt markets, including banks and asset managers such as Fidelity, Vanguard and Charles Schwab ( SCHW), in retreat. Issuers relying on money market funds to buy their short-term paper, such as GE, CIT Group ( CIT) and even corporations as ordinary as McDonald's ( MCD) fell into a severe cash crunch.

To stem the seizure of the market, Henry Paulson -- Treasury Secretary at the time -- guaranteed the entire $3 trillion money market system, risking taxpayer funds to reverse the historic flight of capital.

In response to the market freeze, GE got a life-saving $3 billion investment from Warren Buffett of Berkshire Hathaway ( BRK.A), and its financing arm GE Capital received far more support by way of a government backstop to debt it sold to the public during the credit crunch. GE Capital also was a significant user of the Federal Reserve's Temporary Liquidity Guarantee Program.

As SEC chair from 2009 through December 2012, Schapiro was the most prominent supporter of reforms to the U.S. money market industry.

Given the Treasury guarantee, the FDIC's involvement and even the Federal Reserve's intervention in the market, Schapiro lobbied to strengthen investor confidence in money markets and make them better prepared for a cash crunch.

Specifically, Schapiro proposed money market funds float their net-asset-values and use mark-to-market valuations so as to give investors a clearer picture of their financial health.

A floating NAV and mark-to-market accounting might also better prepare investors for potential rough patches, given the surprise that the Primary Reserve Fund's collapse had on markets.

Schapiro also proposed money market funds hold a small 1% capital reserve to cushion against potential losses on their short-term debt holdings.

Near the end of Schapiro's tenure at the SEC, her reform proposals were not taken up by a vote of commissioners. When resigning from the regulatory agency in December, money market reform stood out as one of Schapiro's biggest unfulfilled policies.

" There is no 'back-up plan' in place if we experience another run on money market funds, because money market funds effectively are operating without a net," Schapiro said in an August 2012 statement when her ideas failed to gain support.

With Wednesday's proposals from the SEC, some of Schapiro's reform agenda may become a reality.

A floating NAV for institutional funds may bolster confidence in money market assets and help to prevent a cash crunch that hit the likes of GE and Corporate America generally.

The SEC's alternative proposal to is to implement "redemption gates" or penalty fees for ordinary investors who pull cash from money market funds during financial panics.

But floating NAVs for all money market funds, along with capital buffers, appear to be off the table, for now.

Schapiro appears to continue to press her concept of reform.

"After efforts ranging over four years to complete unfinished business from the financial crisis, the SEC took a step Wednesday in acknowledging the need to address the structural weakness of money market funds and offered some proposals to mitigate the risks of a run for a subset of MMFs," Schapiro said in an e-mailed statement.

"While I applaud the efforts of Chairman White in getting a proposal out for public comment, I hope the Commission will remain open to meaningful reform of the entire sector and not just institutional prime funds, which only account for 40% of money market fund assets," Schapiro added.

In February, twelve Federal Reserve bank governors told the U.S. Financial Stability Oversight Council that redemption gates the SEC is seeking could have negative unintended consequences. Those gates could encourage runs on funds and erode investor confidence, the governors said.

A GE spokesperson, Seth Martin, declined to comment on the firm's opinion of the SEC's proposals or Schapiro's role in the prospective policy reform as a board director. A Promontory Financial spokesperson said Schapiro has recused herself from any work at the consultancy firm in the arena of money market regulation.

Schapiro was roundly criticized in the media after she told the Wall Street Journal her exit from the SEC and work at Promontory wouldn't constitute a so-called "revolving door." She committed not to return to government or appear in front of a regulatory agency on behalf of a client of Promontory Financial.

Still, Schapiro's role outside the SEC may give her continued influence in newfound attempts to remake the money market industry.

Money market reform may test whether Schapiro is considered part of a revolving door between Wall Street and Washington, or whether former regulators and advocates of financial reform can have a positive influence in private sector careers.

Schapiro is a managing director leading Promontory's governance and markets practice. She was elected by shareholders to GE's board at an April 24 annual investor meeting.

-- Written by Antoine Gara in New York

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