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SEC Commissioner Walter: "Plans and Prospects for Financial Regulatory Reform"

SEC Commissioner, Elisse B. Walter, addressed the UC San Diego Economics Roundtable last week, and took the opportunity to highlight issues in the various financial regulatory reform bills working their way through Congress that relate to the SEC's mission to protect investors, maintain fair, orderly and efficient markets, and facilitate capital formation.  Walter organized her remarks into five main principles she feels provide a framework to understand the ongoing legislative efforts.

Principle 1: The objectives of managing systemic risk and protecting investors should both be maintained and pursued in a balanced manner.

I fully support efforts to remove the silos that exist today and address systemic risk in a manner that looks across the markets. But, I also strongly believe that such efforts should not be allowed to override or erode the central role that the SEC plays in protecting investors or to confine the SEC's role to a retail sales perspective. More generally, we should ensure that new systemic risk rules add to, rather than undercut, needed consumer and investor protections. In other words, while new rules relating to systemic risk should be able to supersede existing regulatory requirements that conflict and are less stringent, important investor and consumer protections should remain fully in place.

. . .

The best approach to the application of new systemic risk powers, I believe, is to ensure that any new systemic risk framework breaks down silos, is appropriately tailored to system risk, is additive to existing and future rules and protections, and is implemented through an open and transparent process to avoid unintended consequences. This can be accomplished under the legislation now before Congress; however, depending on how that legislation is implemented, there is a risk that it could erode the strength of the investor protection voice that is critical to strong financial services regulation.

Principle 2: The current regulatory framework should be restructured to eliminate gaps and weaknesses, and to increase market transparency, so that important products and market actors are not beyond the oversight of regulators.

I generally support these efforts to shine a spotlight on private fund activity. There are two ways, however, in which I think the bills could be improved.9 First, the Dodd bill would provide exemptions from registration for venture capital and private equity fund advisers, while the House bill would do the same for venture capital funds. Since most rules under the Advisers Act apply only to advisers that are registered, this could result in new regulatory gaps. I am not convinced that the different goals and strategies employed by venture capital and private equity fund advisers are so different from the goals and strategies of hedge fund managers to justify "partial regulation," although I recognize that there are important benefits these funds provide, notably seed capital for start-up businesses.

Second, the House bill and the Dodd bill would increase the assets-under-management dollar threshold for investment advisers to register with the Commission. Advisers below the threshold would be prohibited from registering with the Commission, and would instead be regulated by state authorities. Even though, as a result of other changes under the bills, new private fund advisers would have to register with us, the net effect of increasing the threshold would actually mean that more advisers would leave our oversight than come under it. And, this would all happen at a time when we need more oversight of these private fund advisers, not less. . . .
I—and others—have expressed the view that Congress should seek to merge the regulatory oversight responsibilities of the SEC and CFTC to provide more comprehensive oversight of the increasingly interrelated futures and securities markets.11 I formed this opinion from experience working at both agencies. But neither the House bill nor the Dodd bill would merge the two agencies. Indeed, the bills add unnecessary complications to the regulation of the swap markets by dividing jurisdictional responsibility for swaps in a way that can only be described as "jurisdictional gerrymandering." Consider that, under both bills, as well as the Lincoln bill just reported out of the Senate Agriculture Committee, jurisdiction over securities-related swaps would be divided between the SEC and CFTC.

Principle 3: Consumers should receive the same level of protection when they purchase comparable products and services, regardless of the financial professional involved.

The House bill would make important progress in this direction by requiring the SEC to adopt rules requiring that the standard of conduct for a financial professional giving personalized investment advice about securities to retail customers would be to act in the best interest of the customer without regard to the interests of the professional. It would also prescribe that the standard shall be no less stringent than the standard applicable to investment advisers under the antifraud provisions of the Advisers Act, from which the fiduciary duty for investment advisers arise. The Dodd bill, in contrast, would require that the SEC conduct a study regarding the effectiveness of existing legal and regulatory standards of care for brokers, dealers, and investment advisers.

 . . .

I believe that just mandating the SEC to conduct a study would be a mistake.

 . . .

We do not need another study to tell us that investors are confused. Instead, it is time to move forward with substance. Of course, as I have said many times, what I would prefer to see is a legislative approach harmonizing the regimes governing investment advisers and broker-dealers comprehensively, taking into account the strengths and weaknesses of both regimes. Unfortunately, both bills fall short of proposing this comprehensive solution.

Principle 4: Important gatekeepers should be regulated to minimize conflicts of interests, increase transparency, and foster competition.

. . . both the House bill and Dodd bill would provide important improvements to the SEC's regulatory oversight of credit rating agencies. Both bills would provide investors with the ability to sue credit rating agencies for gross negligence, establish a new Office of Credit Rating Agencies at the SEC to strengthen regulation (with the House bill also calling for the establishment of an Advisory Board to advise the Commission and to ensure that it fully executes its oversight responsibilities over the rating agencies), and require rating agencies to have an independent board of directors. Both bills also would improve internal controls, require greater transparency of rating procedures and methodologies and management of conflicts of interest, provide the SEC with greater enforcement tools, and reduce reliance on credit ratings. The Dodd bill would establish and enhance penalties for poor performance to address shortcomings identified during the financial crisis—including broadening penalties that the SEC could impose to include fines and expanding the misconduct to which such penalties apply to include failure to reasonably supervise an individual who violates the securities laws. Significantly, the Dodd bill would also provide the SEC with the authority to suspend or deregister an NRSRO for providing bad ratings over time.

Principle 5: No matter what new shape is constructed for financial regulation, it must incorporate strong enforcement powers for regulators to pursue wrongdoing and deter future misconduct, but those powers must be in addition to—not in lieu of—regulatory authority.

I am pleased to see the House bill and the Dodd bill have included several legislative measures advocated by the SEC to improve its ability to protect investors and deter wrongdoing. In the interest of time, I will just mention one. New whistleblower legislation would provide substantial rewards for tips from persons with unique, high-quality information about securities law violations. This legislation, along with our own cooperation initiatives, would increase incentives for persons to share information quickly while expanding protections against retaliatory behavior. We expect this program to generate significant information that we would not otherwise receive.

The full text of Commissioner Walters' April 23, 2010 address is available at: