Criticism of the Securities & Exchange Commission and its chairman, Christopher Cox, rose sharply on Sept. 18 as Republican Presidential candidate John McCain suggested he should be fired. "Mismanagement and greed became the operating standard while regulators were asleep at the switch," McCain said at a campaign appearance in Cedar Rapids, Iowa. "The chairman of the SEC serves at the appointment of the President and has betrayed the public's trust. If I were President today, I would fire him."

While the comments sharply escalate public criticism of the SEC's role in the unfolding financial crisis, they echo complaints that have been building since Bear Stearns' collapse last spring, when Cox took heat for his apparent absence as other regulators and corporate chiefs drafted a rescue plan. Cox, formerly a representative from California, has been more visible in recent weeks, joining key weekend meetings with Federal Reserve officials and Treasury Secretary Henry Paulson—who has been careful to mention the involvement of Cox and the SEC—and issuing two statements saying the agency had "worked closely with regulators around the world…in the interest of orderly markets."

In a statement on the evening of Sept. 18, Cox defended his agency's actions during the financial crisis, saying it had taken multiple steps to curb short-selling, crack down on market manipulation, and share information with other regulators. "History will judge the quality of our response to this economic crisis, but now is not the time for those of us in the trenches to be distracted by the ebb and flow of the current election campaign," he said. "And it is precisely the wrong moment for a change in leadership that inevitably would disrupt the work of the SEC at just the wrong time."

Too Little, Too Late?

But critics argue that the agency has leaned toward a hands-off regulatory approach in recent years that has left it unprepared or unwilling to use the powers it has and slow to step in as trouble brewed. Too often, they say, it cracks down only after misdeeds have become blatant. "The SEC hasn't been leading the charge as much as they've been following it," says Howard Schiffman, a former SEC enforcement division attorney and partner at Schulte Roth & Zabel in Washington, D.C. "The house burns down and then they do a really good job to say, 'Whose fault is that?'" The philosophy in recent years, says Tamar Frankel, a Boston University law professor specializing in financial regulation, has been "to do as little as possible—the market will take care of it."

Supporters counter that the SEC's role is necessarily limited: It can't lend to struggling companies, and a balkanized regulatory structure spreads oversight of commercial banks, investment banks, mortgage lenders, and insurers across multiple state and federal agencies. Though the SEC is the primary regulator for broker-dealers—the operating units of the giant investment banks—it has less authority over their parent companies. So while it could demand that the broker-dealers stay adequately capitalized, it has little control over parent companies that have loaded up on risky investments.

"The one thing that's clear is that the SEC didn't cause these problems," says former SEC Chairman Harvey Pitt. Rather, Congress, by failing to modernize financial regulation when it deregulated the financial-services industry in the 1990s, left the SEC and other regulators without the tools to regulate new markets and securities as they arose. "In essence what we have is a 21st century financial system and a 19th century regulatory system," Pitt said. That's a view shared by Richard Breeden, the SEC chairman under President George H.W. Bush. He argues that while "we will have to reexamine how permissive [the agency] had been" about the supercharged levels of leverage the investment banks have taken on, much of the current mess can't be laid at the SEC's feet.

An agency spokesman declined to respond to criticism of the agency's actions but pointed to congressional testimony from Cox last spring and over the summer. Cox has argued that the agency's narrow authority over broker-dealers meant it wasn't in a position to rein in the holding companies that owned them or limit the risks their investment strategies posed to the broader market. "These are considerations of systemic risk that extend far beyond the commission's mandate to protect investors," Cox testified to a congressional committee in April.

Criticized as Passive

Douglas Holtz-Eakin, the former head of the Congressional Budget Office who is now McCain's top economics adviser, says such arguments let the SEC off far too easily. He says the agency has failed in its most fundamental oversight and surveillance functions. "There is the basic issue of identifying institutions that are at risk," he says. "And the surveillance would appear to be severely impaired because we're having entities show up every day that are in desperate shape without any warning." As to Cox's argument that he didn't have enough authority to adequately regulate the firms as they grew far bigger, and more leveraged, in recent years, Holtz-Eakin is blunt: "Did he ever ask for it?" he says. "The flow-of-funds [numbers] suggest that we have become an incredibly leveraged nation in the eight years of the Bush Administration. Is there anything that suggests an adequate recognition of the increased leverage or rules to support it?"

Some former SEC staff and commissioners agree the agency could have done more, particularly in the months and years leading up to the current crisis. They point out that, while the SEC's direct regulatory authority over investment banks centers on the broker-dealer subsidiaries, the agency has expanded its influence over the holding companies in recent years. Since 2004, under an arrangement designed to make it easier for U.S. securities firms to operate in Europe, the SEC collects detailed financial data about a broker-dealer's holding company and its subsidiaries to assess the company's financial stability as a whole. "The aim," then-SEC Commissioner Annette Nazareth told a securities industry gathering in March 2007, "is to effectively monitor the holding company, and unregulated entities within the group, for financial and operational weaknesses that might place regulated entities or the broader financial system at risk.

"The commission has authority under [these] rules to take action in the event of a weakness or potential weakness." Nazareth, who left the SEC early this year, could not be reached for comment. With the information it collects about investment bank finances, the agency should have taken into account the growing risks as complex financial instruments proliferated, Schiffman argues. "Why haven't they been reevaluating that as the market became more and more and more leveraged?" he asks. John Coffee, a Columbia University securities law professor, notes that Lehman Brothers' (LEH) bankruptcy, along with deals to acquire Bear and Merrill Lynch (MER) as they struggled, mean just two major investment banks remain independent. "If 60% of the investment banks of any size have disappeared, I can't say the SEC is as good at prudential financial regulation as they are at disclosure and consumer regulation," Coffee says.

Questions also remain about whether the agency has taken advantage of all the tools at its disposal, particularly its ability to demand that publicly traded companies improve their financial disclosure if it is judged inadequate. Exhibit A: To this day, many investors still don't have a clear idea of just how leveraged financial-services companies have become, or how intertwined are their various market risks. While accounting rule makers determine what types of financial information companies must reveal, the SEC can require more. "That's the basic role of the SEC—disclosure," says Barbara Black, director of the University of Cincinnati's Corporate Law Center and editor of the Securities Law Prof Blog. "If [SEC officials] think there was not adequate disclosure of the risks, they could have compelled greater disclosure."