Danger & Opportunity: The SEC Reformation

Financial services regulatory reform has been bandied about for some time now, but we got a taste of what the Obama Administration and the Securities and Exchange Commission (SEC) actually have in mind when Treasury Secretary Timothy Geithner laid out the Administration’s restructuring plan during testimony before Congress March 26, and SEC Chairman Mary Schapiro told the Senate the same day what revamps the Commission hoped to accomplish.

While it’s still uncertain what changes may actually get approved this year, Schapiro told Investment Advisor in an exclusive interview April 13 that she does believe “we will have some financial services reform this year.” However, she remains unsure whether “it will be the full package of broad sweeping reform or whether it might be more strategic and focused in the initial stages. There are a lot of moving parts here.” Indeed, Geithner said in his testimony that revamping the current financial services regulatory landscape would not take “modest repairs at the margin, but new rules of the game.”

Geithner told the House Financial Services Committee during his testimony that the Administration’s reform plan includes four broad components: addressing systemic risk, protecting consumers and investors, eliminating gaps in regulatory structure, and fostering international coordination. The administration also wants to put tighter controls on large financial institutions and require hedge funds to register with the SEC. Schapiro told the Senate Banking Committee the SEC also plans to ask lawmakers to craft legislation that would require investment advisors to hedge funds, as well as possibly hedge funds themselves, to register with the Commission, and that the SEC should have the power to regulate credit default swaps and municipal bonds.

Washington Bureau Chief Melanie Waddell spoke with Schapiro via telephone on April 13 to get more insight into exactly what reforms the SEC will achieve this year–she thinks harmonizing the rules for broker/dealers and advisors is a longer-term goal–and on what changes she plans to implement at the Commission.

Is something likely to happen this year on harmonizing rules for broker/dealers and advisors? Certainly we’re going to try and fill the gaps, which is how I keep describing some of the issues we’ve been dealing with that affect auditing and custody verification and so forth in the next couple of months. But I think longer term, the bigger question of leveling the playing field between advisors and brokers will take a bit more time.

It seems to be a tough issue to pinpoint. There’s a lot of lore that’s grown up around both advisors and the broker/dealer side of the question, but just because it’s tough doesn’t mean we shouldn’t tackle it. In my view it’s been an issue for a long time and we owe it to investors to ensure we haven’t put them in the position of having to figure out how they are best protected depending on which type of advisor they go to–a broker/dealer or investment advisor. We need to make it clear and simple for investors.

What do you think about a self-regulatory organization for advisors? It’s something we’re going to look at. I think it has to be a component of anything we look at.

Right along with harmonizing the rules? Absolutely. But I’ve said this repeatedly to anybody who’s asked, I have no conclusions drawn in my mind about what the right approach is. I do know, and you’ve heard this undoubtedly as well, that we do not have sufficient resources here to effectively examine the more than 11,000 advisors for whom we have responsibility. That doesn’t necessarily mean that we’ll have to have an SRO, but it does mean we will have to leverage some third-party resources, which is one reason we’re looking at things like audits [and] compliance reviews by third parties.

The compliance burden that we might see for RIAs…that would go into the audit area? I think that’s probably a possibility. We’re going to try and fill some of the gaps that have become apparent over the past year as we’ve dealt with a lot of advisor Ponzi schemes. But one of the good things about how we do rulemaking is [that] everything will go out for comment and we’ll specifically seek comment on the operational costs and burdens of everything we contemplate.