FINANCIAL REFORM: WHAT IS NEEDED OR THE USUAL GRIST?
In the opening scenes of the film The American President, Michael Douglas as President Andrew Shepard, rebuffs his chief of staff over a piece of draft legislation. The staff member wants to propose a much more aggressive piece of legislation than what the President is backing. President Shepard cautions that governing is about the art of the possible, or essentially taking what you can get, even if it is not that meaningful. By the end of the film, the President once again finds the basic principles which got him elected, scraps the watered down draft bill and begins a campaign for legislation that is meaningful and which the country needs, vowing to fight the battle door-to-door.
Currently, Congress is considering legislation on financial reform. In the wake of what is, without a doubt, the worst market crisis since the great depression, it is clear that reform is needed. Many proposals have been made. Many bills have been proposed. Nothing is final. Assuming legislation is passed – and that is not free from doubt – will it be like the draft bill that President Shepard initially proposed or the one he vowed to enact at the end of the film? Stated differently, will the final product reflect what is possible given the Capital Hill grist mill or what is required to avert another financial crisis?
The various proposals for financial reform have clearly evolved over time. Last June for example, the Administration offered its White Paper, discussed here, which was followed by proposed legislation. Crafted to address the kinds of market turmoil that created the chaos of the market crisis, it contained key elements regulating derivatives, hedge funds, standards for those who give investment advice and called for the creation of a consumer protection agency. Since then, the House has passed a bill which adopts some of the administration’s provisions, while the Senate has yet to get a bill out of committee.
What, if anything, will emerge from this process? The fight over one key provision in the various proposals may give some indication. The administration and the SEC have strongly backed a provision which would require the harmonization of standards governing those who give investment advice. The new standard would replace the current outmoded one under which registered investment advisers have a fiduciary duty to act in the best interests of their clients while brokers and others are only required to make suitable recommendation to their clients. The difference is significant. Being required to act in the best interests of your clients means that the client comes first. That is not the obligation of a broker, subject to a suitability standard which focuses only on the investment objectives of the client. Many industry groups, such as The Securities Industry and Financial Markets Association, agree that a uniform standard should be adopted, although there is disagreement as to how to achieve that result.
The current House bill contains one version of this provision. While the initial version of the Senate committee bill had such a provision, it reportedly is being scrapped in favor of having the SEC conduct a study on the question. Translation – this is not even the beginning of The American President. As the Washington Post reported Sunday in an article on the Dodd bill (page G-1) (available here, registration required), a study commissioned by the SEC in 2008 reviewed this question and found investors were confused. There should not be any confusion. Whether the investor is a first time market participant or a more experienced person, those giving the advice should put the interests of the investor first, end of story.
More importantly however, what does dropping this important provision from the Senate bill mean for other critical issues which must be addressed? What of the proposals regarding derivatives and hedge funds? There is little disagreement, for example, that the lack of disclosure regarding derivatives coupled with rampant abuses underlies the market crisis. CFTC Chairman Gary Gensler has lead the charge on this issue, supported by former CFTC Chairman Brooksley Born, who correctly warned at the end of the Clinton Administration against deregulating those markets as discussed here, and others.
If there is going to be meaningful reform, it is critical that the legislation address the key issues and not reflect the usual Capital Hill sausage mill. Unfortunately, it appears that what is about to emerge from the Senate is the early version of the bill from the film The American President. Perhaps at some point before the legislative process ends, principle will prevail, we will fact forward to the end of the film, and meaningful legislation which fully addresses the crisis will be passed.