A NEW DECADE WILL BRING NEW AUTHORTY FOR THE SEC
This is the first of a series of articles examining future trends for in securities enforcement.
A new decade and a new year begin with the prospect for significant changes in securities enforcement. Legislative initiatives being considered by Congress have the potential to dramatically alter the regulatory landscape. The Supreme Court, which is working through a docket of potentially blockbuster cases, could impact that regulatory picture. At the same time, the SEC is in the process of redefining enforcement in an effort to regain its position as Wall Street’s top cop. DOJ, however, is not only vying for that role, but has grabbed the lead in some areas with aggressive enforcement.
When Congress returns from its holiday recess, both the House of Representatives and the Senate will consider draft legislation which seems destine to rewrite financial regulation. That regulation should add to the authority of the SEC, an agency which just last year many considered to be on the brink of extinction. New Chairman Mary Schapiro and her team have worked hard to revive the embattled agency and now have it poised to receive significant new authority and funding.
While the precise contours of any final legislation are difficult to determine at this point, the various proposals under consideration have a number of common elements which seem destined to be written into law in some form. The various proposals which the House and the Senate will take up include provisions regarding OTC derivatives, hedge funds and a new consumer agency. Additional authority for the SEC regarding aiding and abetting, the harmonization of fiduciary standards, executive compensation and rating agencies also threads through the various proposals.
Rising out of the market crisis, the clamor for the regulation of OTC derivatives, such as credit default swaps and other exotic instruments, as well has hedge funds, is likely to command a great deal of lawmakers’ attention in coming months. For derivatives, Treasury is backing a plan which began with its White Paper last June, discussed here, carried through in proposed legislation, discussed here, and is now reflected to various degrees in a number of proposals such as the current version of the house bill, H.R. 4173 discussed here, and the Senate Finance Committee bill unveiled in November, discussed here. Essentially, those proposals call for standardized derivatives to be traded on exchanges. All derivatives would be subject to disclosure, margin and record keeping requirements, with a focus on transparency. The SEC and CFTC would share authority over this huge market.
SEC Chairman Schapiro and CFTC Chairman Gary Gensler have supported these proposals. Both have advocated robust regulation for derivatives. Mr. Gensler in particular, has strongly urged lawmakers to write comprehensive legislation which would force most derivatives onto exchanges and narrow any exceptions as discussed here. Former CFTC Chairperson Brooksley Born (1996-1999), who warned against deregulating these markets, as Congress did earlier in the Commodity Futures Modernization Act of 2000, would go even further. Ms. Born has urged Congress to require that all derivatives either be traded on an exchange or, for customized transactions that cannot be exchange traded, require that one party be a hedger.
As with derivatives, both the House and the Senate will consider the regulation of hedge funds. Both will likely pass legislation which includes new regulation over funds of a certain size. Here again, the proposals stem from the Treasury White paper, versions of which are included the pending House bill and the one crafted by the Senate Banking committee. The Treasury proposals mandate registration for fund advisers and impose record keeping requirements. H.R. 4173 along with various proposals being considered in the Senate, includes registration and record keeping requirements.
Any financial regulatory bill will likely contain provisions which will enhance the authority of the SEC in other areas as well. Those are likely to include additional authority in the area of aiding and abetting and rule writing authority to harmonize the duties of those who give investment advice. Versions these provisions, included in the pending House bill and the Senate finance committee bill, trace to the Treasury White Paper. There will also likely be provisions on executive compensation and “say-on-pay” and perhaps rating agencies.
H.R. 2873 would also enhance the authority of the SEC. That bill, which passed the House last year, would give the SEC nationwide service of process in district court enforcement actions – the same kind of authority currently available to DOJ in criminal cases. More controversial will be the provisions of S. 2886 which would effectively overrule the Supreme Court’s decisions in Central Bank and Stoneridge, discussed here, on aiding and abetting and scheme liability. If passed, the bill would give private litigants the ability to bring fraud damage actions based on secondary liability theories.
Perhaps the most far reaching bill pending on Capital Hill is S. 2886, introduced by Senators Cantwell and McCain. This bill would significantly redraw the financial landscape by essentially restoring the Glass-Steagall Act, the depression era law which separated commercial and investment banking. That statute was repealed in 1999 by the Gram-Leach-Bliley Act after being slowly undermined over the years through regulatory exceptions.
While proposals like McCain-Cantwell, as well as others, are sure to spark a heated debate on Capital Hill, a recent report by accounting firm Grant Thornton issued a recent report as part of its Capital Markets series will help fan the flames. That report suggests the emphasis on trading in recent years had undermined the IPO market in the United States. This trend, according to the report, has had a deleterious effect on the health of the U.S. capital markets in a number of areas including new exchange listings and job creation.
Whatever the final configuration of financial services legislation, it seems all but certain to include provisions which will enhance the authority of the SEC and its enforcement program. That legislation is likely to include new regulation for OTC derivatives and hedge funds. The SEC will almost surely receive enhanced authority in those areas as well as others identified by Treasury in its proposals, strengthening their overall presence in the market place and their enforcement programs. While this new authority will empower the agency, it will also create additional pressure to restore SEC Enforcement to its prior position as the top cop of Wall Street.
Next: Reorganizing the SEC enforcement program