More On Legal & Compliancefrom The Advisor's Professional Library
- Trading Practices and Errors When SEC-registered investment advisors conduct annual audits of firm policies and procedures, they should pay close attention to trading practices. Though usually not required to, state-registered advisors should look at their trading practices and revise policies that do not fully protect clients.
- The Few and the Proud: Chief Compliance Officers CCOs make significant contributions to success of an RIA, designing and implementing compliance programs that prevent, detect and correct securities law violations. When major compliance problems occur at firms, CCOs will likely receive regulatory consequences.
Treasury Secretary Henry Paulson's Blueprint for a massive overhaul of the financial services regulatory structure, which he unveiled March 31, is already sparking much debate among finance officials and lawmakers (Congress is planning to hold hearings on the Blueprint). The depth of the reaction to Paulson's proposals, and the battle lines already being drawn, suggest that these are issues that will dominate discussion within and without the Beltway for a significant period of time. To help shape that discussion and influence the final form of the reform, advisors and their partners and their industry associations will need to not only understand Secretary Paulson's proposals, but will need to have their voices heard during what is sure to be a drawn out process.
It's likely to be a long process not only because of the scope of the proposed Blueprint but also considering Treasury's past reform efforts, the most recent being the Gramm-Leach-Bliley Act of 1999--which brought down the Glass-Steagall Act and allowed banks to affiliate with securities firms. Treasury first recommended the Gramm-Leach-Bliley changes in the early to mid 1980s by a special commission in the Reagan Administration, recalls Duane Thompson, managing director of the Financial Planning Association's (FPA) Washington office. So Treasury suggestions "like this [blueprint] tend to take 10 to 15 years, if at all," to come about, warns Thompson. This reality, combined with the fact that there are only eight months left in the Bush Administration's term, leaves little time to implement any significant changes.
Indeed, Paulson even acknowledged when releasing the Blueprint that the most urgent issues at hand are "working through this capital market turmoil and housing downturn," and those will be the administration's top priorities until they are resolved. "With few exceptions, the recommendations in this Blueprint should not and will not be implemented until after the present market difficulties are past," Paulson said.
How long it will take for the capital markets and housing market to rebound is anyone's guess. Federal Reserve Board Chairman Ben Bernanke told the Senate Banking Committee on April 3 that "financial markets remain under considerable stress," and he has even uttered the word "recession" when talking about the current situation. Bernanke conceded in his testimony, however, that "monetary and fiscal policies are in train that should support a return to growth [in the U.S. economy] in the second half of this year and next year." Bernanke defended the decision to rescue Bear Stearns from bankruptcy through a takeover by JPMorgan Chase and a $30 billion taxpayer loan during the April 3 hearing, arguing that a Bear Stearns meltdown would have had unpredictable and potentially disastrous consequences on the U.S. economy.
Members of Congress asked at the hearing whether a Fed rescue of this sort would set a precedent, and become standard practice if other investment banks were to teeter on the edge of financial ruin. Bernanke assured them that would not be the case, stating that the Bear Stearns situation was extraordinary and unique. Nevertheleless, Rep. Barney Frank (D-Massachusetts) is calling for legislation that would create a federal regulator for investment banks.
Treasury began the process leading to release of the Blueprint in March 2007, after holding a conference for industry leaders and policymakers on capital markets competitiveness. In his Blueprint, Paulson recommends short-, intermediate-, and long-term goals for regulatory reform, stating that the U.S. "should and can have a structure that is designed for the world we live in, one that is more flexible, one that can better adapt to change, one that will allow us to more effectively deal with inevitable market disruptions, and one that will better protect investors and consumers."
In the short term, the Blueprint suggests creating a new federal commission for mortgage origination to better protect consumers, modernizing the President's Working Group on Financial Markets, and clarifying the Federal Reserve's liquidity provisioning. Intermediate goals include consolidating the Securities and Exchange Commission (SEC) and the U.S. Commodities Futures Trading Commission (CFTC), creating an SRO for investment advisors, eliminating the thrift charter, and creating an optional federal charter for insurance.
Long-term goals would create a Market Stability Regulator--which the Blueprint says would give the Federal Reserve the "ability to monitor risks across the financial system." A Prudential Regulator would focus on safety and soundness of firms with federal guarantees, and a Business Conduct Regulator would focus on consumer protection. Business conduct regulation would include key aspects of consumer protection "such as disclosures, business practices, chartering and licensing of certain types of financial institutions, and rigorous enforcement programs," Paulson said in releasing the Blueprint. "Having one agency responsible for these critically important issues for all financial products should bring greater consistency to regulation where overlapping requirements currently exist."
Reaction Is Swift
Renewing an old threat, Treasury suggests in its Blueprint that the Financial Industry Regulatory Authority (FINRA) become the SRO for advisors. Mark Johannessen, president of the Financial Planning Association, says that the word in Washington is that the SEC is willing once again to go along with FINRA (formerly NASD) becoming the SRO for advisors, but would limit its oversight to dually registered firms (to read more on the FPA's position, see our exclusive Soapbox from Johannessen on page 136.) Mary Schapiro, FINRA's CEO, said through a spokesman that she is "not ready to talk about the specifics" of the Treasury plan.
Schapiro has been vocal about the fair treatment of individual investors and especially older investors, and noted, "Today's increasingly complex financial services landscape and fragmented regulatory environment has made it nearly impossible for the average investor to navigate the marketplace and fully understand the risks they may be exposed to and the protections they are entitled to. Investors shouldn't be left exposed and confused. Retail investors should get the same basic regulatory safeguards and protections no matter which investment product they choose."
Treasury's Blueprint argues that investment advisors should be overseen by an SRO because of the "continued convergence of the services provided by broker/dealers and investment advisers," but David Tittsworth, executive director of the Investment Advisor Association (IAA), says this does not justify establishing an SRO for advisors. He said in a prepared statement that direct regulation of advisors by the SEC is "appropriate and effective," adding that "the reasons that persuaded Congress to authorize the creation of an SRO for broker/dealers--the high level of interconnectivity between broker/dealers and the technical issues related to settlement, execution, and reconciliation involving broker/dealer transactions--simply do not exist in the investment advisory profession."
But Lou Stanasolovich, president of Legend Financial Advisors in Pittsburgh, argues that it's been "decades" since the SEC has done an adequate job of effectively regulating advisors. He's okay with an SRO for advisors as long as "we all report to the same body," and as long as that body is not FINRA. "Who's making the rules at FINRA? It's a joke," he says. There should have "been more painful fines, suspension, revocations, and even jail terms in terms of some of the stuff that's been going on the past few years with the broker/dealers and mutual funds."
Financial services officials may not agree with all of Paulson's recommendations, but most concur that the current regulatory structure is outdated and does not reflect today's market reality.
Financial Services Institute (FSI) President and CEO Dale Brown spoke cautiously about the Blueprint, but believes that it is at least "a step in the right direction, and it's a debate that must be engaged. Our members work in an environment where they are delivering financial advice, products, and services to their clients under laws and rules that were written 70-plus years ago, so it's time for modernization. It's time for the regulatory structure to be adapted to the realities of how business is done in the 21st century."
Brian Murphy, FSI's chairman, and also chairman of Woodbury Financial Services, in Woodbury, Minnesota, a broker/dealer owned by The Hartford, says that "The present system, while very well intended, is archaic, and duplicative, costly, and in some ways conflicting, and I especially agree with the point [that] it's fraught with potential for 'regulatory arbitrage,' so I think that the principles that have been laid out in this [blueprint] really are very worthy and something that we support." Murphy adds that he'd like to see "consumers" included: "That's why regulation exists, to ensure that consumers are getting a fair deal, and that they're getting information, education; they're getting access, they're getting advice, and they're getting it in plain language. Those are the most worthy of principles, and what we've done with regulation over the years, is [that] we've added layers and in some instances they're competitive so that [they've] watered down the ultimate benefit to the consumer."
Tim Ryan, president & CEO of the Securities Industry and Financial Markets Association (SIFMA), complimented Treasury in a statement for delivering a "thoughtful and sweeping plan which should provoke intense discussion, debate and potential legislative changes." Echoing the statements of other participants, Ryan noted that the current regulatory framework was "born of Depression-era events and is not well suited for today's environment where billions of dollars race across the globe with the click of a mouse. That fact, teamed with the current market conditions, result in an universal agreement that it is time to modernize and revitalize the current system."
Washington Bureau Chief Melanie Waddell regularly covers legislation and regulation. She can be reached by e-mail at firstname.lastname@example.org.