Dodd Reform Bill POV: Harvey Pitt, Former SEC Chairman

There certainly should be no significant financial instruments or services that escape appropriate oversight and monitoring. But, adding private equity funds and hedge funds to the SEC’s responsibilities now has two potential basic flaws. First, the agency should first get data about how these entities function before it crafts regulations that will potentially restrict the ways in which they’re able to do business. Second, it will be impossible for the SEC to examine and assure the compliance of these entities, in addition to the 6,000 broker/dealers and 11,000 investment advisors already registered with it, as well as all the other organizations for which it has examination responsibility.

Entities that take funds from the public, or can have a significant impact on our economy or financial markets, should be examined either every year or, in the case of smaller firms, every other year, to make sure they are doing what they are supposed to be doing. There won’t be enough money, people or expertise to provide the kind of compliance audits the public has the right to expect. That is why the Commission should have been seeking authority to require capital markets firms of all sorts to undergo a compliance audit by an expert, completely independent entity, where the SEC dictates the standards of expertise and independence, as well as the subjects to be examined.

There also should be increased oversight of derivatives. In 2000, Congress prohibited the SEC and CFTC from regulating derivatives, although they were permitted to enforce laws prohibiting fraud. The SEC has a great Staff, but it is an over-lawyered agency. It needs people who’ve actually managed portfolios, traded complex derivatives instruments, and who know first-hand how markets operate. That’s the kind of talent that the SEC is now looking for and that it must obtain. It can’t serve its myriad regulatory functions solely with legal talent, although legal talent is certainly necessary.

Fiduciary Duties for Brokers

I agree with Chairman [Mary] Schapiro’s statement that there should be harmonization of the standards that apply to those market professionals who act on behalf of customers. Brokers should not be held to paternalistic standards in some cases, however. For example, if a client utilizes a broker solely for execution purposes, and expressly disclaims any reliance on the broker’s expertise in selecting the client’s investments or determining its suitability, it seems hard to justify imposing an absolute obligation on the broker to refuse to execute the client’s desired trade. As a general rule, however, those who manage the funds of others, and on whom their clients rely, should be subject to rigorous fiduciary standards and act in their clients best interests, whether they are denominated investment advisors or broker/dealers.

The Dodd bill directs the SEC to study the issue–but the SEC already has examined this issue, and calling for another study only delays action and expends valuable resources that could be devoted to critical problem areas. Mary Schapiro makes a significant point that, at the end of any study, the SEC will need to take action. Yet, neither the Senate nor House bill grants the SEC that authority. Before regulatory reform is enacted, the SEC should be given express authority to avoid lengthy litigation.

SEC Self-Funding

Virtually every SEC Chairman since 1934 has supported SEC self-funding, as did I, for several reasons. Self funding would:

– Create flexibility to respond to unanticipated market developments;

– Permit better market surveillance;

– Enhance the SEC’s technology resources;

– Enhance the agency’s ability to recruit individuals with relevant skill sets;

– Put the SEC on a par with other financial regulatory agencies; and

– Ensure the SEC’s critical independence.

Harvey Pitt is a former SEC Chairman who’s now the CEO of the global business consulting firm Kalorama Partners in Washington.