by T. GormanPosted on Posted in SECActions

Yesterday’s article reviewed the remarks of SEC Chair Mary Jo White and Commissioner Kara M. Stein at SEC Speaks. The article today reviews the remarks at the conference of Commissioners Michael S. Piwowar and Daniel M. Gallagher. Collectively, the comments of the Commissioners provide insight into the future path of the agency.

Commissioner Michael S. Piwowar discussed the overall path of the SEC moving forward through the lens of its mission regarding the markets – to be fair, orderly and efficient. First, the Commissioner discussed “fair” in the context of rule making as well as litigation. Fairness in rule making demands that the SEC not act arbitrarily or capriciously. Accordingly, the agency “must ensure that the rules do not change day-to-day on the whims of the Commission and/or its staff. This means that under the Administrative Procedure Act the Commission must not adopt an new rule or rule amendments without proper notice and the opportunity for comment by the public. The corollary of this principle is that the Commission and its staff must not engage in rule making by enforcement or through examinations of regulated entities. For example, we must resist the temptation to include undertakings in enforcement settlements or principles in examination reports that serve as de facto rule requirements.”

Fairness also dictates that in rule making the Commission examine the length and complexity of its releases for new rules. Many of these run 500 or 1,000 pages and are extremely complex. Such releases suggest “that rather than merely explaining our rules, those documents now include extensive guidance akin to rule making, which can create entirely separate fairness concerns. For example, the most recent amendments to our money market funds include key guidance akin to rule making for all mutual funds, not just money market funds, which was buried in a footnote within an almost 900 page release,” the Commissioner noted.

“Our enforcement program could also benefit from a look through the lens of fairness,” Commissioner Piwowar stated. Recently, the staff indicated that they will recommend instituting more enforcement matters as administrative proceedings, including insider trading cases. “Announcement of this plan to increase the use of administrative proceedings in insider trading cases followed the Commission’s loss in two insider trading cases in federal district courts. Regardless of whether these circumstances are linked, this change has the appearance of the Commission looking to improve its chances of success by moving cases to its in-house administrative system,” according to the Commissioner. To avoid the perception that the Commission is taking its tougher cases to in-house judges “the Commission should set out and implement guidelines for deterring which cases are brought in administrative proceedings and which in federal courts.”

The imposition of corporate penalties and the issuance of waivers are two additional areas which would benefit from the consistent application of public guidelines. While the Commission offered guidance on corporate penalties in 2006, recent remarks by the SEC Chair raises doubts about those guidelines which are often ignored in staff recommendations. Likewise, Commissioners have been ignoring the established staff guidelines regarding waivers. While staff guidance need not be followed, where there are established practices they should be followed.

Orderly means that the Commission must at times prioritize its agenda in areas such as rule making, enforcement and inspections. To function efficiently the agency should prioritize its rule makings. In the area of enforcement it means that the “broken windows” approach does not work. By making regulatory compliance its most important objective the approach unnecessarily delimits important economic activity. Rather, enforcement efforts should be “closely aligned with the priorities developed by out policy-making division,” according to the Commissioner. In contrast OCIE has made significant strides in developing priorities.

Finally, it is critical that the Commission become more efficient. The increased utilization of technology is one way to help achieve this goal. Another is by “[e]ngaging with academics, attorneys, and others from the securities industry who work outside the SEC [and who] could greatly enhance our ability and effectiveness in identifying changes to improve our regulatory regime.”

Commissioner Daniel M. Gallagher centered his remarks on efforts to create a uniform fiduciary standard to which he is opposed. Recounting the history of these efforts, he noted that in 2010 the Department of Labor issued a proposal for such a standard. The proposal, which would have radically changed the law, according to Commissioner Gallagher, would have broadly defined the term “fiduciary” under ERISA to include any person who provided investment advise to plans for compensation. Following largely negative comments the proposal was withdrawn. In reformulating its proposal (which was recently issued) it did not consult with the SEC Commissioners.

In 2011 the SEC staff issued a study under Section 913 of Dodd-Frank calling for a uniform fiduciary standard for investment advisers and broker- dealers who provide investment advice regarding securities to retail customers. Two Commissioners opposed the proposals, noting that it did not adequately identify the issues to be addressed through additional regulation.

Recently a White House paper called for a similar standard. It was built on three basic principles. First, consumer and investor protections are inadequate. This point is not supported by any analysis, according to Commissioner Gallagher.

Second, the current regulatory environment “creates perverse incentives” that cost savers billions of dollars. At the same time, according to Commissioner Gallagher, there are SEC and SRO rules which address these issues. Finally, the White House memo states that academic research has established that advisors often act “opportunistically to the detriment of their clients” because of conflicts. Again, the point ignores current regulation. Accordingly, the White House position paper on this point is seriously flawed, the Commissioner concluded.

At the same time the extent of the SEC’s investment adviser examinations is “unacceptably narrow” which impacts SEC policy making in this area. Last year only 10% of the advisers were examined. This low rate of examinations can hinder the SEC’s work since the “purpose of an active and well-resourced examination program is an informed policymaking function, not a large, attention-grabbing number of enforcement referrals.” This limited focus also impacts the enforcement actions brought by the agency.

In the end fiduciary is supposed to mean that the adviser acts in the best interest of its client. It does not mean “that all models where financial professionals are not fiduciaries are flawed,” the Commissioner noted.

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by T. GormanPosted on Posted in SECActions

The SEC Speaks conference has traditionally been a forum in which the agency reviewed significant recent undertakings and indicated its future direction. This year was no different. Four of the five Commissioners addressed conference participants, discussing recent significant undertakings and sketching the future direction of the SEC. This article reviews the comments of Chair Mary Jo White and Commissioner Stein. An article tomorrow will review the remarks of Commissioners Piwowar and Gallagher.

Chair Mary Jo White: Ms. White reviewed recent significant rule making initiatives by the agency before turning to a discussion of the enforcement efforts last year and future undertakings. Last year the Commission focused on three key rule making initiatives tied to the risks exposed by the financial crisis. First, the SEC reformed money market funds. New rules were promulgated regarding institutional prime money markets funds. Those funds will be required to maintain a floating net asset value, for the first time. At the same time non-government money market funds will have new tools to address runs on the fund while all money market funds will be subject to enhanced diversification, disclosure, reporting and stress testing requirements.

Second, the agency moved forward with its mandate under Title VII of Dodd-Frank regarding the swaps market. The SEC has now proposed all of the required rules. Last June it adopted the threshold rules that create the foundation for the regulatory regime for these products. Early this year the SEC adopted two sets of rules which will add transparency to these markets.

Finally, last year the Commission adopted what Chair White called a “strong, comprehensive package of reforms for the regulation and oversight of credit rating agencies, implementing over a dozen rulemaking requirements under the Dodd-Frank Act. The SEC also proposed additional rules to enhance oversight of clearing agencies and requiring companies to disclose their hedging policies.

Enforcement set records last year, bringing 755 actions and obtaining over $4.1 billion in monetary relief, accord to Ms. White. She then reviewed a series of “first of a kind” cases, summarizing the SEC’s earlier press release on enforcement. OCIE complemented these efforts by conducting over 1,850 examinations, an increase of 15% compared to the prior year.

For 2015 Ms. White highlighted three core initiatives. First, the “staff is developing recommendations to enhance the transparency of alternative trading system operations, expand investor understanding of broker routing decisions, address the regulatory status of active proprietary traders, and mitigate market stability concerns through a targeted anti-disruptive trading rule.” Those efforts will be aided by the formation of the new Market Structure Advisory Committee.

Second, the staff is developing three sets of initial recommendations to address the increasing complexity of portfolio composition and the operations of the asset management industry. Those initiatives center on improving data reporting, requiring funds to have controls in place to more effectively identify and manage risks and on planning for market stress events.

Finally, in 2015 the Commission will focus on capital formation for smaller issuers. The final two major mandates of the JOBS Act will be a key focus as well as the pilot program to widen tick sizes for the stocks of smaller companies.

Commissioner Kara Stein delivered remarks which centered on three key topics. First, the Commissioner noted that the agency should “be reimagining disclosure and [the use of] data to keep pace with the digitized and data-centric market.” Now is the time to consider a “fundamental shift in disclosure.” Commissioner Stein mentioned two potential initiatives. One would involve updating EDGAR. A second would focus on making data “available more quickly and in a format that is more usable . . .” In this regard data could be made available so that investors could “click” their way through to “deeper and more extensive information.”

Ms. Stein then turned to the question of over complexity in financial products. Once of the lessons of the great crash of 1929 was the pyramiding of leverage and complexity that ultimately played a role in the crash of the market. That lesson was reiterated in the last financial crisis when innovation created very complex financial instruments that ultimately imploded. It is imperative that everyone learn the lesson that innovation in financial products can lead to a level of over-complexity.

Finally, turning to enforcement, Commissioner Stein focused on what she called “bad actor bars,” a topic which is becoming of increasing concern. Here Ms. Stein began by stating “Let me be clear, bad actor bars, including partial bars or conditional waivers, are not intended to be used as ‘punishment.’” The critical question is whether these tools are being properly and effectively applied.

The building blocks for the application of these provisions are recidivism and deterrence. This begins with tone at the top of the organization: “The degree to which those at the top knew or should have known about a violation or a failed culture of compliance is an important factor in analyzing whether an automatic bad actor bar should occur. I have been urging the Commission to adopt and use this factor in the context of evaluating these bars. And if a firm is so sprawling and large that the top simply cannot manage it at all isn’t that a problem in and of itself . . .” Commissioner Stein noted.

The critical question in applying these provisions is not whether the reason for the automatic disqualification is “unrelated” to the waiver. Rather, “If you manipulate LIBOR, enable offshore tax evasion, or launder drug money, should we wait for you to defraud a pension fund before barring you from raising money outside of strict Commission oversight?” the Commissioner asked. The point here should be to continue developing a consistent and transparent process for the application of bad actor bars.

Tomorrow: Commissioners Piwowar and Gallagher

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