Financial regulation, at least in the United States, is famously resistant to technological change.
Bernie Madoff’s infamous sixteen-year fraud lasted as long as it did because multiple offices at the Securities and Exchange Commission were unaware of one another’s parallel inquiries into Madoff firms.
The Madoff failure was a data failure.
Different parts of the SEC use different electronic codes to identify the companies and firms they are supposed to track. Even within the agency, a particular entity cannot be matched to its subsidiaries and affiliates. Without a standard data field, there is no way to aggregate data on a complex company or firm - at least, not without lots of manual research.
In 2013, the SEC’s investor advisory committee pointed out that crucial disclosure forms are expressed as documents, instead of data. Executive compensation tables, mutual fund voting records, and many other types of information would be much more useful to investors if they were “tagged” using a standard data format. But because these disclosures are documents, there is no electronic, let alone automated, way for the markets to quickly absorb the information that they contain.
Three years later, the agency has not acted on the committee’s recommendations. This, too, is a data failure.
The SEC is not the only financial agency whose reporting regime has been stuck in the twentieth century. In 2014, a commissioner of the Commodity Futures Trading Commission criticized his own agency for failing to set a standard format for swaps data reporting under the Dodd-Frank law. Financial transactions were reported inconsistently, so the CFTC’s massive swaps database was not searchable as a whole.
Because the financial agencies have not adopted standard data fields and formats, financial information in the United States is opaque to investors - that is, unless they invest in tedious manual review and expensive translation platforms.
Moreover, compliance is more expensive than it should be for companies and firms. One study suggested that over three-fourths of the information that large companies report to the Bureau of Economic Analysis is also reported to the SEC. If the two agencies aligned the data fields, software could handle both requirements at once - as has already happened in the UK and other countries. Since they haven’t, millions of dollars are wasted compiling, editing, and submitting redundant reports.
Finally, the lack of open, searchable data hurts the agencies’ missions. It makes data analytics cumbersome and expensive. It allows frauds like Madoff’s to go undetected.
But fortunately, change is coming.
First, the SEC has started to pay more attention to the need for open data. Seven recent rule proposals have specified a standard data format for the new disclosures they require. But the SEC needs to overhaul its existing disclosure rules. The Financial Transparency Act (H.R. 2477), proposed in Congress last year, would require the SEC to do that.
Second, last December, the CFTC finally proposed a standard data format for its swaps reports, five years after Dodd-Frank first mandated those reports.
Finally, the Treasury Department has called for all financial agencies to adopt a single, standard data field, known as the Legal Entity Identifier (LEI), to identify all the companies and firms that report to them.
The LEI will allow information from a particular entity to be aggregated across all the different agencies regulating that entity. The LEI will turbocharge transparency, reduce compliance costs, and reveal frauds like Madoff’s - but only if all the agencies start using it.
Next week, on March 29, our two organizations will host the second annual Financial Data Summit in Washington. The Financial Data Summit will connect the agency officials who are trying to bring open data to financial regulation and the Congressional leaders who are embracing the same goal.
Open data also means a surge of opportunity for the financial technology industry that we represent.
In 2008, a group of coders and former CFOs founded Workiva, whose software uses a standard data format to help automate financial reporting. Within seven years, Workiva was earning more than $100 million annually.
The more financial agencies adopt standard data fields and formats, the more entrepreneurs can build companies like Workiva. Our industry has already developed tools that can automate and analyze. The government needs to catch up.
We can discover the next Madoff before his victims lose their assets - but only if financial agencies get smart and replace all their old-school disclosure documents with searchable, open data.
LeDuc is the policy director of the Software and Information Industry Association. Hollister is the executive director of the Data Coalition.