Sunday, August 01, 2010

Key Senator Concerned About SEC-FOIA Provision in Dodd-Frank, SEC Chair Says Commission Will Provide Staff Guidance to Carry Out Intent of Congress

Senator Ted Kaufman is concerned that Section 929I of the Dodd-Frank Wall Street Reform and Consumer Protection Act appears to exempt the SEC from any Freedom of Information Act (FOIA) requests for information received by the Commission from registered entities. As written, said the senator, the exemption throws a cloak over all information received by the Commission from regulated entities. Sen. Kaufman said that the statute is too broad and does not serve the public interest. Moreover, Sec. 919I is not consistent with the general goal of greater transparency that President Obama has emphasized both with respect to FOIA and financial regulatory issues. He called for Congress and the SEC to reevaluate Sec. 919I.

While Sen. Kaufman understands the provision might allay the concerns of institutions reluctant to release sensitive proprietary information to the SEC that might later be subject to FOIA requests, he noted that FOIA already has exemptions in it to deal with such concerns. If those exemptions need to be broadened, he added, Congress should have done so with a scalpel. Since only transparency can best restore the damaged credibility of the markets, he reasoned, any exemptions to transparency should be narrowly crafted. In this sense, Section 929I needs a do-over, he said. In the coming weeks, Sen. Kaufman hopes to work with the SEC and other Senators to craft a more reasonable approach that satisfies the legitimate concerns of the SEC without sacrificing the goals of transparency and public accountability.

Meanwhile, in a letter to Senator Chris Dodd and Rep. Barney Frank, SEC Chair Mary Schapiro said that Section 929I is critical to the Commission’s ability to develop a robust examination program that better protects investors by allowing the SEC to gain timely access to information that it otherwise may not receive, thereby further enhancing its ability to identify fraud. Sec. 919I does not provide a blanket SEC exemption from FOIA, she noted, and the statute is not designed to protect the SEC as an agency from public oversight and accountability.

Rather, Section 929I is designed to ensure that the Commission can gather the information it needs to perform its required examination, enforcement and oversight duties, including proprietary and customer information. In addition, specific statutory carve-outs clarify that the SEC may not use the provision to withhold information from Congress, other federal agencies or from a court in response to an order in an action brought by the Commission or the United States. In order to address any uncertainty about how the SEC will use Section 929I, the Chair will ask the Commission to issue and publish on the SEC website guidance to staff that ensures the provision is used only as it was intended.

The SEC Chair also noted that Dodd-Frank mandates a number of new responsibilities for the SEC to protect investors, including new authority over hedge funds, private equity funds and venture capital funds. Fulfilling these responsibilities will require the SEC to expand and improve its examination and surveillance capabilities in order to provide the type of risk-focused regulatory oversight investors deserve. In order for these efforts to be successful, said the Chair, it is important that registered entities be able to provide the SEC with access to confidential information without concern that the information will later be made public.

In Ms. Schapiro’s view, Sec. 929I addresses a significant and longstanding impediment to the Commission’s ability to quickly obtain important information from registered entities when performing examinations. SEC examination and surveillance efforts often seek to gather highly sensitive proprietary information and records from regulated firms including customer information, trading algorithms, internal audit reports, trading strategy information, portfolio manager trading records and exchanges' electronic trading and surveillance specifications and parameters. Such information is critical to effective oversight and the detection of misconduct. Prior to the Dodd-Frank Act, continued the Chair, regulated entities not infrequently refused to provide Commission examiners with sensitive information due to their fears of ultimate public disclosure.

Existing FOIA exemptions were insufficient to allay concerns due in part to limitations in FOIA, including that certain existing exemptions may not apply to all registrants and the fact that FOIA exemptions are not applicable when the SEC must respond to a subpoena as either a party or non-party. The Commission's resulting inability to obtain this information hindered its enforcement capacity, she said.

Given the amount of automated trading, she observed, it is critical for anti-manipulation purposes that the SEC be able to obtain, review and potentially deconstruct these highly proprietary algorithmic formulas. High-frequency trading firms, however, have been reluctant to provide these formulas to the SEC out of a concern that if they were deconstructed or the data within them were merged into central databases, the SEC might be forced to disclose them under FOIA.

Similarly, to assess if insider trading has occurred at certain regulated entities, SEC staff needs to review personal trading records of investment management personnel. Advisers routinely refuse to turn over such materials for fear of public disclosure, noted the Chair, instead requiring staff to review hard copies of the records on the adviser's premises. This limitation materially impacts the ability to detect insider trading activity. Section 9291 addresses these and other related issues head-on, emphasized the SEC Chair, and provides certainty to registrants by clarifying that the information the Commission receives in its examination or surveillance efforts cannot be compelled by third parties, and also enables the SEC to protect the confidentiality of the data and information it receives that is extrapolated and consolidated into surveillance or risk assessment databases. Protecting the confidentiality of this information makes sense, she reasoned, as the non-public or proprietary nature of those documents should not be lost simply because registrants provide the documents to the Commission in connection with its oversight duties.

Neither the need for Section 929I nor the statute’s general language is new, she explained, adding that in 2006 then SEC Chair Chris Cox sought language similar to what is contained in Section 9291. On September 11, 2008, the House of Representatives passed H.R. 6513, the Securities Act of 2008, by voice vote with bipartisan support. Section 15 of H.R. 6513 contained language similar to Section 9291. In July 2009, the SEC provided legislative proposals that staff believed would allow the Commission to better protect investors. Contained in those proposals was language similar to Section 929I regarding the protection of certain information provided to the Commission. After receiving these proposals, they were placed on the House Capital Markets Subcommittee website.

The Wall Street Reform and Consumer Protection Act that passed the House on December 11,2009 contained Section 7409, Protecting Confidentiality of Materials Submitted to the Commission, with language that again was very similar to the language in Section 929I. The Conference Committee's base text contained Section 929I.

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