SEC Chair Endorses Administration Legislative Proposals

SEC Chair Mary Schapiro has strongly endorsed Obama Administration legislative proposals to reform the regulation of the US financial markets, including SEC regulation of securities-related OTC derivatives, SEC registration of hedge fund advisers, and bestowing additional enforcement powers on the Commission, such as the imposition of collateral bars.. In testimony before the House Financial Services Committee, she also said that the SEC and CFTC are working on the harmonization of regulation as directed by the Administration.

Regarding OTC derivatives, the SEC recommends a straightforward and principled approach to help the Administration achieve its policy objectives. Under this approach, primary responsibility for all securities-related OTC derivatives would be retained by the SEC, which is already responsible for the oversight of markets affected by this subset of OTC derivatives. Primary responsibility for all other OTC derivatives, including derivatives related to interest rates, foreign exchange, commodities, energy, and metals, would rest with the CFTC.

Under what the SEC Chair called a functional and sensible approach to regulation, OTC derivatives markets interconnected with the regulated securities markets would be incorporated within a unified securities regulatory regime. The direct link between securities-related OTC derivatives and securities is such that SEC regulation of the former is essential to the effectiveness of the SEC’s statutory mission with respect to the securities markets.

Over the years, she noted, Congress has fashioned a broad and flexible regulatory regime for securities accommodating a wide range of products and trading venues, including equities, debt, options, exchange-traded funds and many other types of derivative contracts on securities. In addition, securities products trade in many different ways in a wide variety of venues, including 11 national securities exchanges with self-regulatory responsibilities, more than 70 alternative trading systems that execute OTC transactions, and hundreds of broker-dealers that execute OTC transactions.

In the SEC Chair’s view, the current securities laws are broad and flexible enough to regulate all of these varied securities products and trading venues. Thus, under the SEC’s proposal, securities-related OTC derivatives would be brought under the same umbrella of oversight as the related, underlying securities markets in a relatively straightforward manner with little need to “reinvent the wheel.” Specifically, Congress could make a limited number of discrete amendments to the statutory definition of a security and certain other provisions to cover securities-related OTC derivatives. With these changes, securities-related OTC derivatives could be incorporated within an existing regulatory framework that is appropriate for these products.

The SEC also would have authority to establish business conduct standards and recordkeeping and reporting requirements, including an audit trail, for all securities-related OTC derivatives dealers and other firms with large counterparty exposures in securities-related OTC derivatives, so called major OTC participants. This umbrella authority would help ensure that the SEC has the tools it needs to oversee the entire market for securities-related OTC derivatives. Major OTC participants also would be required to meet appropriate standards for the segregation of customer funds and securities. In addition, under the approach being set forth by the Commission, clearinghouses for securities-related OTC derivatives would be subject to oversight as clearing agencies by the SEC and trading markets would be subject to oversight by the SEC.

As noted in the Administration’s white paper, securities regulation and futures regulation share many of the same public policy objectives. In this regard, said the Chair, the SEC appreciates the benefits that could be achieved through greater coordination and harmonization between the SEC and the CFTC for regulation and oversight of economically equivalent instruments. According to Ms. Schapiro, more efficient oversight consistent with the protection of investors could be achieved by filling regulatory gaps and fostering harmonization between the SEC and the CFTC with respect to similar financial instruments.

To advance this initiative, the SEC staff has undertaken a coordinated effort to identify and explain significant differences in oversight and regulation of similar types of financial instruments such as options and futures in light of the underlying public policy objectives. The SEC staff is also working with the CFTC staff in developing a coordinated approach to this task.

With regard to hedge fund regulation, the SEC strongly endorses the Administration’s Private Fund Investment Advisers Registration Act of 2009, which Ms. Schapiro believes will close a significant regulatory gap by requiring advisers to hedge funds and other private pools of capital to register with the SEC under the Investment Advisers Act. She look forward to working with Congress on issues regarding the level of additional resources that would be necessary if private fund managers were required to register with the SEC, as well as ensuring that any law passed would provide the Commission with sufficient time to establish and make effective any necessary recordkeeping requirements.

Separately, the SEC Chair believes that all financial service providers, brokers and advisers alike, providing personalized investment advice about securities should owe a fiduciary duty to their customers and be subject to equivalent regulation. As such, she supports the standard contained in the Administration’s proposed Investor Protection Act of 2009, which would enable the Commission to promulgate rules to provide that all broker-dealers and investment advisers providing investment advice to retail customers act solely in the interest of their customers without regard to the financial or other interests of the financial service professional. The Chair emphasized that the establishment of this investor-focused approach as a consistent standard for all broker-dealers and investment advisers providing investment advice would represent a significant step forward in the protection of retail investors.

Finally, the SEC official supports the expanded arsenal of sanctions that the proposed legislation would give the Commission. Currently, a securities professional barred from being an investment adviser for serious misconduct could still participate in the industry as a broker-dealer. The Chair believes that the SEC should be permitted to impose collateral bars against such regulated persons. The Administration’s proposal would authorize the SEC to bar a regulated person who violates the securities laws in one part of the industry, for example a broker-dealer who misappropriates customer funds, from access to customer funds in another part of the securities industry, such as an investment adviser. By expressly empowering the SEC to impose broad prophylactic relief in one action in the first instance, reasoned Ms. Schapiro, the proposal would enable the SEC to more effectively protect investors and the markets while more efficiently using SEC resources.

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