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These are busy times at the Securities and Exchange Commission and other financial regulatory agencies. Officials are scrambling to write rules for carrying out their broadened missions under last year’s Dodd-Frank legislation, formally known as the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Financial crises often bring expansions of regulatory authority in their wake, along with uncertainty over what these will mean in practice. Regulators typically have considerable discretion as to how to implement their powers, which thus are shaped not just by the written law but also by the politics and personalities involved.
The Panic of 1907, involving bank runs and stock price plunges, brought new interest in regulating finance. President Theodore Roosevelt broached the issue of federal oversight of the stock market in 1908, but Congress showed little interest and his administration was drawing to a close anyway. In 1912, Roosevelt made such regulation a plank of the platform for his unsuccessful “Bull Moose” presidential run.
In 1911, Kansas, prompted by bank commissioner Joseph Norman Dolley, became the first state to enact a “blue sky” law requiring registration of securities and brokers. Such laws — so named since they aimed to combat investment offers based on “blue sky” or “hot air” — were adopted by most states over the next few decades. An effort to harmonize this patchwork of laws in the late 1920s achieved little, however.
The 1913 Federal Reserve Act, creating a central bank and lender of last resort, marked a major step-up in federal involvement in the financial sector (expanding the previous role initiated by Civil War legislation that had allowed nationally chartered banks and set up the Office of the Comptroller of Currency). But Washington’s focus still was on stabilizing banks and the dollar, not on overseeing stocks and bonds.
The securities business thus remained lightly regulated overall through the Roaring Twenties. Industry touted its ability to self-regulate, as it had done since the 1790s by fixing brokers’ commissions. In 1922, the New York Stock Exchange imposed capital requirements on its member firms. Amid prosperity and rising stock prices, there was little public or political pressure for a tighter regulatory regime. Soon there would be.
The 1929 Crash and the Great Depression’s onset opened the way for a sweeping transformation of the regulatory landscape. The Senate’s Pecora hearings (in which banking committee lawyer Ferdinand Pecora grilled top financiers) fueled a growing push for new regulation. Financial reform became a priority in the New Deal agenda of President Franklin D. Roosevelt and Democratic majorities in the House and Senate.
This would take various forms including mandatory bank deposit insurance, regulation of bank account interest rates and the Glass-Steagall separation of investment banks and deposit-taking institutions. Moreover, the New Deal brought the federal government into oversight of securities markets for the first time.
The Securities Act of 1933 set up registration and disclosure requirements for companies that issued publicly traded securities and did not meet certain exemption requirements (such as making offerings only to residents of their own states). The Federal Trade Commission was briefly the agency in charge of such securities registration.
The following year, the Securities and Exchange Act set up the SEC and expanded the federal oversight role beyond securities issuance and into the day-to-day secondary market. The new agency would have the power to regulate stock exchanges and prohibit manipulative trading practices, such as when “pools” coordinated transactions to bid up the price of an investment briefly before dumping it on unsuspecting investors.
To be the SEC’s first chairman, Roosevelt appointed Joseph P. Kennedy (father of future president John F. Kennedy), a businessman with experience in the shady practices the agency was supposed to combat (“It takes one to catch one,” FDR reportedly said). Kennedy tended to move cautiously on enforcement, focusing on egregious offenders while avoiding a broader crackdown that could spook the already depressed markets.
The SEC took a less conciliatory approach in the late 1930s under William O. Douglas, its third chairman (and later a Supreme Court justice). Douglas placed a new emphasis on the agency’s subpoena power and litigation skills. He also pressed successfully for a reorganization of the New York Stock Exchange (see sidebar “Fight at the Exchange”).
Further legislation in the late ’30s and early ’40s elaborated the new regulatory picture. The Maloney Act of 1938 provided for a national organization of brokers and dealers to create and enforce disciplinary rules; consequently, the National Association of Securities Dealers was set up in 1940, with the SEC empowered to review its decisions.
Also in 1940, the Investment Company Act and the Investment Advisers Act required investment companies and advisors (then commonly spelled “advisers”) to register with the SEC. The legislation contained a fiduciary standard for some advisors but exempted brokers as long as their advice was “incidental” and not given special compensation. That issue would resurface some 70 years later, with the Dodd-Frank law giving the SEC the power to apply a fiduciary standard more broadly.
In the post-World War II years, the SEC settled into a more modest style. That brought worries that the agency was not on top of things. In 1947, a commission headed by Herbert Hoover noted that the bureaucrats had a backlog of unread corporate reports. Budget and staff cuts in the mid-1950s heightened such concerns. “The SEC Is Unequal to the Job,” warned a Time magazine headline in 1956.
In the early 1960s, President John F. Kennedy pressed for a more activist SEC. William Cary, his appointee as SEC chairman, got the institution involved in fighting insider trading, and a study group headed by agency staffer Manuel Cohen emphasized the limits of industry self-regulation. Cohen went on to head the SEC during the go-go years of the mid- to late sixties, working to beef up its enforcement abilities.
There were further expansions of regulatory authority over the next few decades. The Commodity Futures Trading Commission, created in 1974, took on a mission of regulating financial futures as well as commodity ones; the precise boundaries of the CFTC’s jurisdiction vis-à-vis that of the SEC is a matter of ongoing fine tuning.
In 1983, the Insider Trading Sanctions Act enabled the SEC to seek triple damages for profits gained or losses avoided from trading on insider information. In 1990, the Market Reform Act, a response to the 1987 market plunge, gave the SEC enhanced powers to respond to a market crisis. In 1996, the agency created an office of municipal finance to deal with corruption in that area. In 2002, in the wake of Enron and other scandals, the SEC became overseer of a board governing corporate accounting.
There also have been some notable deregulations. New Deal-era interest rate rules were liberalized in the 1980s, opening the way for money market accounts. The Glass-Steagall barrier between investment and commercial banking eroded and fell in the 1990s. Legislation in 2000 kept the CFTC from setting rules on over-the-counter derivatives, stalling a push for substantial regulation of those fast-growing markets.
The Dodd-Frank law marks a sharp swing of the pendulum toward greater regulation. The wide-ranging statute establishes new federal powers to oversee hedge funds, over-the-counter derivatives, rating agencies, corporate executive compensation and more, while revamping the regulatory structure to include new agencies such as a Financial Stability Oversight Council and a Bureau of Consumer Financial Protection.
How dramatically all this will change the day-to-day life of financial advisors depends not just on the rule-writing now underway at the regulatory agencies but also on the overall political climate. The regulatory expansions of the 1930s and 1960s occurred at times of popular enthusiasm for bigger government, and the former came amid strong public antipathy for Wall Street after the Great Crash.
At present, public enthusiasm for bigger government is muted, which may have some moderating effect on how assertively regulators push their new authority and how much prompting they get from elected officials. But importantly, public confidence in the financial sector has been depleted as well, following the last few years of crisis and bailouts, with Wall Street sitting alongside Washington as a focus of popular discontent.
Financial regulators today may not have the prestige and crusading appeal of their predecessors who served in the New Deal or who answered President Kennedy’s call for “the best and the brightest” to serve the nation. But today’s regulators do have formidable powers, built up over decades and now expanded by Dodd-Frank. Financial advisors should expect to spend more time and energy on regulatory compliance than ever before.
Fight at the Exchange
In the late 1930s, the Securities and Exchange Commission, headed by William O. Douglas, pressed the New York Stock Exchange to adopt new internal governance rules aimed at making it more open and accountable. These measures were resisted by an “old guard” of exchange officials.
As negotiations stalled, Douglas warned that the government could take over the institution if adequate reform did not occur. At a heated meeting in February 1938, Douglas had a testy back-and-forth with William H. Jackson, an exchange lawyer.
Jackson: “Well, I suppose you’ll go ahead with your program?”
Douglas: “You’re damned right I will.”
Jackson: “When you take over the exchange, I hope you’ll remember that we’ve been in business 150 years. There may be some things you will like to ask us.”
Douglas: “There is one thing I’d like to ask.”
Jackson: “What is it?”
Douglas: “Where do you keep the paper and pencils?”
As it happened, a major financial scandal erupted in the next few weeks, revealing that Richard Whitney, who epitomized the “old guard,” was an embezzler. Resistance to the SEC’s demands soon crumbled, and the exchange implemented reforms that included revamping its governing board and hiring a paid president and technical staff.