It was the latest shift in the regulatory landscape stemming from the financial crisis that has gripped the markets and thrown Washington into fevered negotiations over a $700 billion bailout plan.
SEC Chairman Christopher Cox announced the agency's decision to end the program under which SEC examiners inspected the five biggest Wall Street banks: Goldman Sachs (GS, Fortune 500), Lehman Brothers (LEH, Fortune 500), Merrill Lynch, Morgan Stanley (MS, Fortune 500) and Bear Stearns Cos.
The financial upheaval of the last six months has "made it absolutely clear that voluntary regulation does not work" for the bank supervision program, Cox said in a statement. The program "was fundamentally flawed from the beginning, because investment banks could opt in or out of supervision voluntarily," he said.
The SEC inspector general, meanwhile, found that the agency's oversight of Bear Stearns - which nearly collapsed into bankruptcy in March and was purchased by rival JPMorgan Chase (JPM, Fortune 500) with a $29 billion federal backstop - and the other four banks was lacking.
The SEC's oversight of the firms "should be improved" and the guidelines covering their capital and liquidity requirements should be reevaluated, according to the report by Inspector General H. David Kotz made public Friday.
Cox said the report "validates and echoes" the concerns he has expressed to Congress. The weakness of the supervision program stems from the lack of specific legal authority for the SEC or other agencies to act as regulator of big investment-bank holding companies, he said.
In recent days, Lehman Brothers buckled under bad mortgage debt and filed the biggest bankruptcy in U.S. history, and Merrill Lynch agreed to sell itself to Bank of America Corp (BAC, Fortune 500).
That left only two independent investment banks standing on Wall Street - Goldman Sachs and Morgan Stanley - and they won approval from the Federal Reserve last week to change their status to bank holding companies in order to stay in business.
The seismic regulatory shift allows the two firms to create commercial banks that can take deposits, thereby bolstering their resources. It also puts them squarely under the regulatory jurisdiction of the Fed.
Earlier in the year, Cox told Congress he wanted the SEC to supervise big investment banks at the level of their parent holding companies. Fed officials said the prevailing system, in which the central bank is the primary overseer of those firms, generally works well.
The Bush administration has proposed giving new powers to the Fed to oversee financial institutions and supplanting the SEC as primary supervisor of Wall Street investment firms. That change could only come through legislation - something that will have to wait until after the presidential election and the installation of a new Congress next year.
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