Rewriting The Financial Regulatory Landscape: For The SEC, A Premier Role

“Financial Regulatory Reform — A New Foundation: Rebuilding Financial Supervision and Regulation” is the title of the regulatory reform “white paper” issued by the Department of the Treasury on Wednesday. To create what may be the most sweeping reform of financial regulation since the great depression, Treasury builds on existing institutions, seeking to enhance and update their authority while adding a new coordinating council and a new agency. Many elements of the proposal were presaged in earlier congressional testimony and speeches by the Treasury Secretary.

Treasury’s proposal would give the SEC a key role, beginning with its membership in the Financial Services Oversight Council (FSOC). That group, which includes the Chairman of the key financial regulators, is designed to assure proper coordination among regulators. It is a key part of the plan to avoid the “to big too fail” problem which, in recent months, caused the government to pump billions of dollars into banks, auto companies and AIG.

The SEC’s regulatory authority would be enhanced under Treasury’s White Paper. The Commission would be granted authority over hedge fund advisors and derivatives. Hedge fund advisors would be required to register with the SEC while commodity pools registered with the CFTC would remain under the jurisdiction of that agency. The purpose of the new authority is to assess whether any of the funds poses a threat to the stability of the financial markets. To facilitate this goal, the registered advisors would be required to report information on the funds they manage.

The SEC and the CFTC would be given authority over OTC derivatives within their respective jurisdictions. Again regulation is focused on reducing risk to the financial markets by promoting efficiency and transparency, preventing fraud and abuse and ensuring that OTC derivatives are not marketed inappropriately to unsophisticated parties. The plan would promote the standardization. Those derivates would be traded on exchanges.

Under the plan there would be, for derivatives, a “robust regulation regime . . . [of] conservative capital requirements . . . business conduct standards, reporting requirements, and conservative requirements relating to initial margins on counterparty credit exposures. Counterparty risks associated with customized bilateral OTC derivatives transactions that should not be accepted by a CCP would be addressed by this robust regime covering derivative dealers.” The Commission would also be given authority to require reporting by issuers of asset backed securities.

The White Paper also calls for the SEC to be given expanded authority to promote transparency in investor disclosures and new tools to increase fairness for investors by “establishing a fiduciary duty for broker-dealers offering investment advice and harmonizing the regulation of investment advisers and broker-dealers” — issues the Commission has already started to address. The SEC’s recently established Investor Advisory Committee would also be given a permanent role in the to be created Financial Consumer Coordinating Council which will act under the supervision of the FSOC and be composed of members from federal and state consumer protection agencies.

In other areas, the SEC is directed in the White Paper to continue with initiatives it presently has under way. These include plans to strengthen the regulatory framework for money market funds, add transparency and standardization to the securitization markets and increasing regulations of credit rating agencies. Likewise, the SEC and FINRA should expand the Trade Reporting and Compliance Engine to include asset-backed securities.

Finally, the SEC and the CFTC are to work together to harmonize regulation under their respective statutes. To facilitate this goal, the two agencies are to prepare a report to Congress by September 30, 2009 that “identifies all existing conflicts in statutes and regulations with respect to similar types of financial instruments . . .” The report is to include appropriate recommendations. If the SEC and CFTC cannot agree on appropriate recommendations, the differences will be referred to the new FSOC which will address them and make appropriate recommendations to Congress.

Overall, the White Paper enhances and strengthens the SEC’s role as a financial regulator. It offers the embattled agency a new lease on life, a way out of the scandals in which it has been mired and an opportunity to once again be a premier financial regulator.

Two High Profile Cases Move To Toward Conclusion

The SEC announced two settlements yesterday as it moved forward to resolve two of the highest profile cases it has brought in recent years — Madoff and Guttenberg. Action in the former was taken in anticipation of the completion of the criminal case next week, while in the latter it follows the resolution of the criminal action.

In In the Matter of Bernard L. Madoff, Adm. Proc. File No. 3-13520 (June 16, 2009), the Commission filed a settled administrative proceeding against reputed Ponzi scheme king Bernard Madoff. In the action, Mr. Madoff, a former chairman of the board of directors of the NASDAQ stock market and the founder of Bernard L. Madoff Investment Securities LLC, consented to the entry of an order under Section 15(b)(6) of the Exchange Act and Section 203(f) of the Advisers Act, barring him from association with any broker, dealer, or investment adviser. The Commission’s civil injunctive action against Mr. Madoff is still pending. SEC v. Madoff, Civil Action No. 08-10791 (S.D.N.Y.). There, Mr. Madoff has consented to the entry of a permanent injunction. The question of relief has not been resolved.

The administrative proceeding against Mr. Madoff anticipates his court appearance next Monday, June 22, 2009 in the criminal proceeding against him, discussed here. Mr. Madoff, who has admitted to running what may well be the largest Ponzi scheme in history, is due to be sentenced on Monday. It is widely expected that Mr. Madoff, 70, will effectively be sentenced to life in prison. Presumably, the SEC will resolve its civil action against Mr. Madoff following the sentencing. Key questions to be resolved focus on the amount of disgorgement and penalties to be paid.

The SEC concluded its insider trading action as to Mr. Guttenberg, SEC v. Guttenberg, Civil Action No. 07 CV 1774 (S.D.N.Y.). Mr. Guttenberg consented to the entry of a permanent injunction prohibiting future violations of the antifraud provisions of the Securities Act and the Exchange Act. He also agreed to the entry of an order requiring him to pay disgorgement of $15,810,000. See Lit. Release No. 21086 (June 16, 2009). In a related administrative proceeding, Mr. Gutenberg agreed to the entry of an order barring him from the securities business.

The Guttenberg case has been called one of the most significant insider trading cases brought by the SEC since the Wall Street scandals of the 1980s. The case was brought against fourteen individuals, most of whom were Wall Street professionals. Mr. Guttenberg, an employee of UBS, was at the center of one insider trading ring which furnished inside information to others regarding up coming recommendations of his employer.

Parallel criminal cases were brought against eleven individuals including Mr. Guttenberg. In those cases, all of the defendants have pled guilt. Mr. Guttenberg was sentenced to 78 months in prison. U.S. v. Guttenberg, Case No. 1:07-CR-141 (S.D.N.Y.).