House Financial Services Committee Chairman Aims To Restructure SEC

On August 2, chairman of the House Financial Services Committee, Rep. Spencer Bachus, announced his intention to “modernize” the Securities and Exchange Commission. He plans to introduce the SEC Modernization Act, which will consolidate certain SEC offices and institute managerial and ethics reform.

Bachus is responding to his view that the SEC is structurally flawed, which results in operational inefficiencies. According to Bachus’ announcement, the forthcoming Act purportedly will address those issues making the agency “more efficient, consolidate duplicative offices, enable the agency to use better technology, and strengthen ethical safeguards to avoid conflicts of interest.” Despite clamoring from the SEC for additional funds, Bachus contends that additional funds will not make the agency improve performance unless these key flaws are fixed.

The draft proposal expressly amends four provisions of the Dodd-Frank Act (Sections 342, 915, 965, and 991). Such amendments would combine the Office of Compliance, Inspections and Examinations; the Division of Trading and Markets; and the Division of Investment Management. As well as consolidate the Divisions of Corporate Finance, Enforcement, Investment Management, and Trading and Markets.

According to a press release from the Financial Services Committee, the draft also makes managerial and ethics reforms, including combining the functions the Executive Director and the Chief Operating Officer, requiring the Office of Ethics Counsel to develop a system for tracking employee recusals, and restore an independent ombudsman.

John Nester, a spokesman for the SEC, responded that such changes should come internally and not imposed legislatively because internal reforms can be more readily adapted to evolving market dynamics. He also stated that the SEC is “actively reviewing a number of similar recommendations from the Boston Consulting Group study to evaluate improvements in the structure, operations, and processes of the agency.”

More detailed information regarding this draft proposal can be obtained from the House Financial Services Committee website.

Senate and House Strike Deal on Fiduciary Duty Issue

On June 24, 2010, lawmakers from the House and Senate working to merge two versions of the financial-regulation overhaul into a single bill agreed to let the SEC impose a fiduciary duty on brokers once the regulator completes a six-month review. House lawmakers had earlier proposed implementing stiffer rules without a study period, prompting opposition from senators led by Tim Johnson, a South Dakota Democrat.

Johnson proposed language that could have, among other things, maintained the study requirement. However, Johnson's proposal made it even more difficult for the SEC to act on its findings by allowing the SEC to set new rules regarding the fiduciary duty standard only if the agency concluded after its study that regulatory gaps between certain brokers and investment advisors could not be addressed through other approaches.

A fiduciary duty would obligate brokers to act in the best interest of their clients and to disclose all conflicts of interest. Brokers now only have to ensure a product is suitable before marketing it to a customer. As discussed in an earlier blog post, the expansion of the fiduciary duty has met resistance from the broker-dealer and insurance industries whose sales practices would be subject to the new fiduciary duty standard. Whereas consumer advocates have said the fiduciary obligation is needed because investors can be misled into buying products they don’t understand and are often confused by the titles used by financial advisers.

However, the debate is not over just yet, even if federal lawmakers pass the legislation. Once the job of conducting the study and making the rules goes to the SEC, the debate over the details of just how the new rules will apply will likely continue.

A copy of the Businessweek article discussing this development can be found here, and an article from Financial Advisor Magazine can be found here.

FINRA CLOSES COMMENTS ON REGULATORY NOTICE 09-70: PROPOSED CHANGES TO REGISTRATION AND QUALIFICATION REQUIREMENTS

In December 2009, the Financial Industry Regulatory Authority (“FINRA”) proposed changes to the consolidated FINRA rulebook, which incorporated the National Association of Securities Dealers (“NASD”) rules on registration and qualifications. These changes were proposed pursuant to FINRA Regulatory Notice 09-70: “FINRA Requests Comment on Proposed Consolidated Registration and Qualification Requirements” (“Proposal”).

Essentially, the purpose of the Proposal is to streamline NASD Rules 1021 and 1031. Under the NASD, these rules governed registration requirements of representatives and principals. Under current FINRA rules, investment bankers and broker-dealers of FINRA member firms must register. Additionally, FINRA member firms may register any individuals that engage in legal, compliance, internal audit, or back-office operations. The primary effect of the proposal would significantly broaden the current “permissive” registration categories to allow member firms to register certain persons employed by member firms or their financial services affiliates. Because of this expansion, FINRA also would introduce new stand-alone registration categories:

(1) active registration, for individuals engaged in investment banking or securities activities

(2) inactive registration, for individuals engaged in the “bona fide” business purpose of the member

(3) retained associate registration, for individuals functioning as financial services affiliates.

The actual text of the Proposal can be accessed here.

The comment period was slated to end February 1, 2010, but was extended to March 1, 2010. Twenty-one organizations submitted comments, voicing opinions ranging from full support to complete abandonment. The organizations included investment firms such as Edward Jones and T.Rowe Price and industry associations like the North American Securities Administrators Association, Inc. (“NASAA”) and the Securities Investment and Financial Markets Association (“SIFMA”). Most of the comments voiced general overall support, but suggested small changes to help effectuate a more efficient transition. See SIFMA Comment and Edward Jones Comment. The NASAA was one of the few who voiced complete abandonment of the acquisition of NASD rules into the consolidated FINRA rulebook. The primary objection to the Proposal is FINRA’s lack of guidance on the appropriate substance of a registered inactive person’s education and continuing education requirements. However, NASAA suggests this issue could be solved by continued use of FINRA’s current qualification examination waiver process, which would be superseded by the new rules. Further, the NASAA believes these three new registration categories constitute radical changes that are structured for the convenience of member firms not investor protection.

FINRA has not yet filed its rule proposal with the Securities and Exchange Commission, which may suggest the organization will make changes before its submission.