REGULATORY REFORM AND THE MERGER OF THE SEC AND CFTC
Periodically, there have been calls to merge the SEC and the CFTC. As the market crisis unfolded, for example, former Treasury Secretary Henry Paulson proposed reforms which included merging the SEC and the CFTC. Many commentators thought the Madoff and other scandals the SEC found itself embroiled in might propel the agency into merger. Neither the Administration’s proposal for regulatory reform first advanced in its White Paper discussed here, the current House Bill (H.R. 4173), the proposal crafted by Senator Dodd and the Senate Banking Committee (S. 3217) or the more recent bill which emerged from the Senate Agriculture Committee chaired by Senator Blanche Lincoln, have renewed this call, however. Rather, each addresses various aspects of the market crisis with somewhat overlapping but different proposals. Each divides part of the regulatory landscape between the SEC and CFTC but not in the same way.
Nevertheless, SEC Commissioner Elisse B. Walter, in a recent speech, has revived the idea. In remarks entitled “Plans and Prospects for Financial Regulatory Reform,” April 23, 2010, before the UC San Diego Economics Round Table, available here, the Commissioner states that she favors merger.
Ms. Walter’s suggestion apparently stems from an effort to ensure uniformity of regulation for financial products. In her remarks, she highlights key differences in the regulatory approach for swaps put forward by the House, Dodd and Lincoln proposals. Under the Dodd bill, for example, securities-related swaps based on nine or fewer securities would be regulated by the SEC. In contrast, securities-related swaps based on ten or more securities would be regulated by the CFTC. Commissioner Walter rightly points out that this type of jurisdictional dividing line is “illogical and arbitrary,” inviting abuse. A more logical approach would be for all securities-related swaps to be regulated by the SEC while all commodity-based swaps should be overseen by the CFTC absent a merger, as the Commissioner noted.
Adoption of the Lincoln bill would create other problems, according to Ms. Walter. Under that bill, the definition of security based swaps is significantly narrower than the ones used in the House and Dodd bills. This will result in the bulk of securities-related swaps being regulated by a non-securities regulator. This again is an illogical approach, according to Commissioner Walter. This difficulty is compounded by the fact that the Lincoln bill would expand the definition of swap to include certain instruments that are currently regulated as securities, such as options and forward contracts, on broad based security indexes. Shifting regulatory responsibility for these products again is illogical.
Overall, Commissioner Walter notes, the approaches reflected in the House, Dodd and Lincoln bills might result in some instances in a kind of “regulatory arbitrage” where market participants shop for the must desirable – translate most lax – regulator. Other proposals would result in an illogical approach such as having securities-related products under the jurisdiction of a non-securities regulator. One resolution of this is to merge the SEC and CFTC. Another is to redraw the regulatory lines based on a logical division of products.
Commissioner Walter has a point. Merging the SEC and CFTC would avoid the potential difficulties embedded in the current version of the House, Dodd and Lincoln bills. It would also be consistent with the approach used in other countries. If Congress were writing on a clean slate, this would undoubtedly be preferable. It is not.
Congress is trying to legislate against a backdrop of years of regulation by the SEC and the CFTC. Each agency started from a very different prospective. The regulatory approach of each has evolved in a very different fashion as the command in the White Paper to attempt harmonization recognizes. Given the significant differences between each agency, merger may only further complicate the difficult task of regulatory reform.
This does not mean that Commissioner Walter does not have a point. The difficulties she highlights with each pending bill clearly need to be resolved if there is going to be true and effective regulatory reform. That may well mean going back to the beginning to create a logical, product and market driven solution to regulatory reform which is not reflected in the current proposals.