House Leader Circulates Draft of SEC Reform and Investor Protection Legislation
Draft legislation that would impose a uniform fiduciary standard on brokers and advisers, eliminate mandatory arbitration of brokerage disputes, and enhance the SEC’s authority to impose sanctions on and seek remedies from individuals who violated the securities laws but who are no longer associated with a regulated firm has been circulated by Rep. Paul Kanjorski, Chair of the House Subcommittee on Capital Markets. Broadly, the legislation would enhance investor protection, strengthen capital market competitiveness, make the SEC a more effective agency, and make the PCAOB and the SEC more accountable to the capital markets
The draft would also double the authorized funding for the SEC over five years and provide dozens of new enforcement powers and regulatory authorities. The SEC will be able to enhance its enforcement programs and gain the tools needed to better protect investors and police today’s markets. Further, because mandatory arbitration has limited the ability of defrauded investors to seek redress, the SEC will gain the power to bar these clauses in customer contracts.
In addition, every financial intermediary who provides advice will have a fiduciary duty toward their customers. Through a harmonized standard, broker-dealers and investment advisers will have to put customers’ interests first.
A whistleblower bounty program would create incentives to identify wrongdoing in the securities markets and reward individuals whose tips lead to successful enforcement actions. With a bounty program, said Chairman Kanjorski, Congress will have effectively out more cops on the beat in US securities markets.
The Madoff fraud revealed that the Public Company Accounting Oversight Board lacked the powers it needed to examine the auditors of broker-dealers. The draft would close this loophole and bring the auditors of broker-dealers under the Board’s inspection and registration regime.
The $65 billion Ponzi scheme also exposed faults in the Securities Investor Protection Act, the law that returns money to the customers of insolvent fraudulent broker-dealers. The Investor Protection Act closes these loopholes and fixes these shortcomings.
The draft amends the Securities Investor Protection Act, or SIPA, to allow investors to hold all equity-related positions in a single portfolio margin account. The SIPA amendment creates a clear pathway for regulators to follow in order to realize the state-of-the-art portfolio-based margining system for customers of broker-dealers. The SIPA amendments would also enhance the competitiveness of U.S. markets and eliminate inefficiencies in our current regulatory regime that put U.S. firms and customers at a competitive disadvantage internationally.
The draft would amend SIPA to extend Securities Investor Protection Corporation insurance to futures positions held in a portfolio margining account under a program approved by the Commission.
The draft would close a loophole regarding formerly associated persons of firms. Many provisions of the federal securities laws authorizing the sanctioning of a person who engages in misconduct while associated with a regulated or supervised entity explicitly provide that such authority exists even if the person is no longer associated with that entity. Several provisions, however, do not explicitly address this issue, although the intent of earlier Congresses appears to have been that the SEC had such authority, and no contrary statutory language or legislative history exists. In fact, Congress has earlier amended several statutory provisions to ratify and confirm the authority of the Commission to discipline a person formerly associated with a regulated entity for conduct while an associated person, but it did not express intent to provide such authority only for those provisions being amended.
To build on these previous efforts, the draft would amend additional provisions of the securities laws that do not expressly address this issue. These changes confirm that the SEC may sanction or discipline persons who engage in misconduct while associated with a regulated or supervised entity, even if they are no longer associated with that entity. The amendments would not alter or expand the Commission's current authority. They would only ratify and confirm it.
As a general rule, it is the intent of the Congress that the securities laws, including but not limited to those provisions amended by this section, apply to and provide meaningful remedies for sanctioning persons who engage in misconduct while associated with a regulated or supervised entity, even if the person is no longer associated with that entity.
The draft would enhance the SEC’s aiding and abetting enforcement authority under the Securities Act and Investment Company Act. Specifically, in an SEC action, any person that knowingly or recklessly provided substantial assistance to another person in violation of a provision of the 1933 or 1940 Act, or any regulation issued them, will be deemed to be in violation of such provision to the same extent as the person to whom the assistance is provided. A similar amendment to the Investment Advisers Act provides that any person that knowingly or recklessly has aided, abetted, counseled, commanded, induced, or procured a violation of any provision of the Act, or of any regulation or order under it will be deemed to be in violation of such provision, regulation, or order to the same extent as the person that committed such violation.
The draft would also establish an investor advisory committee to advise the SEC on regulatory priorities, new products, trading strategies, fee structures and the effectiveness of disclosure. The advisory committee would also be available to consult on SEC initiatives to protect investor interest and enhance the integrity of the markets. The SEC Chair would appoint the advisory committee members, who must represent both retail and institutional investors. By statute, the advisory committee must meet at least twice a year. The draft expressly states that the SEC is not required to agree with the advisory committee’s findings or accept its recommendations.
The legislation also amends the securities laws to clarify the SEC’s authority to engage in consumer testing. The SEC is specifically authorized to gather information, communicate with investors or other members of the public, and engage in temporary or experimental programs that the Commission in its discretion determines is in the public interest or for the protection of investors.
The draft clarifies the SEC’s authority to require investor disclosures before the purchase of shares in an investment company. Changes to Section 24 of the Investment Company Act would authorize the SEC to adopt rules designating documents or information that must precede a sale to a purchaser of securities issued by a registered investment company. The draft would also amend the 1940 Act to invoke SEC authority to protect redeeming investors in mutual funds. Specifically, the measure provides that the SEC may adopt regulations limiting the extent to which an investment company may own or hold or invest in illiquid securities.
Implementing a proposal of the Obama Administration, the legislation would direct the SEC to consider prohibiting or limiting mandatory dispute resolution clauses if the Commission finds that such a prohibition or limitation is in the public interest.
The draft would also set up a whistleblower regime under the Exchange Act authorizing the SEC to pay a whistleblower award to persons who voluntarily provided original information that led to a successful enforcement action resulting in monetary sanctions exceeding $1 million. The award is capped at no more than 30 percent of the monetary sanctions imposed in the action, with the amount awarded in the SEC’’s sole discretion. The draft provides that all SEC award decisions are final and not subject to judicial review. In deciding the amount of the award, the SEC may consider the significance of the whistleblower’s information to the success of the enforcement action, the degree of assistance provided, the Commission’s interest in deterring violations of the securities laws, and other factors the SEC may establish.
Whistleblowers making a claim may be represented by counsel, but whistleblowers submitting information anonymously must be represented by counsel. And, before the payment of any award, the whistleblower must disclose his or her identity and provide any other information the SEC may require.
The draft mandates a deadline for completing enforcement actions, inspections, and examinations. The Commission must complete any examination, investigations, or enforcement action initiated by the Commission not later than 180 days after the date on which such examination, inspection, or enforcement action is commenced.
The draft contains an exception for complex actions. If the head of any division or office within the Commission determines that a particular examination, investigation, or enforcement action is so complex that it cannot be completed within the 180-day deadline, the head may, after providing notice to the SEC Chair, extend the deadline by an additional 180 days.
The draft would also require annual congressional testimony by the Chairs of the SEC, PCAOB and FASB. The annual testimony mandated for the Chairs of the SEC, the PCAOB and FASB is a key part of the broader regulatory reform effort because it will help Congress in its drive to reduce the complexity and costs of financial reporting and to increase transparency for investors. In the legislation, Congress specifically finds that the complexity of accounting and auditing standards in the United States has added to the costs and effort involved in financial reporting. In this regard, the bill mandates the SEC, FASB and the PCAOB to annually provide oral testimony to Congress on their efforts to reduce the complexity of financial reporting in order to provide more accurate and clear financial information to investors.The testimony must also discuss the reassessment of complex and outdated accounting standards. The agency chairs must additionally discuss how to improve the understandability, consistency, and overall usability of the existing accounting and auditing literature. Congress also wants information on how the development of principles-based accounting standards is progressing. In addition, there must be a discussion of how to encourage the use and acceptance of interactive data, as well as efforts to promote disclosures in plain English.
In another provision affecting the PCAOB, the draft would provide that all information received by the Board as part of an inspection or investigation relating to a public accounting firm within the inspection authority or enforcement jurisdiction of a foreign auditor oversight authority may be made available to the foreign auditor oversight authority upon the providing of assurances of confidentiality as the Board determines appropriate. The legislation would define a foreign auditor oversight authority as an entity empowered by a foreign government to conduct inspections of public accounting firms or otherwise to administer or enforce laws related to the regulation of public accounting firms.
.