Background
The U.S. Treasury Department recently released its Blueprint for a Modernized Financial Regulatory Structure, which is designed to boost Wall Street’s competitiveness, not investor protection on Main Street. Given the strains on our current financial markets, it is clearly important to examine our current regulatory structure in order to prevent similar problems from occurring in the future. However, no restructuring should come at the expense of investor protection, which state securities regulators have effectively provided consumers for nearly 100 years.
The current crisis in the nation’s financial system did not result from a failure of the state regulatory system, yet Treasury seeks to reduce state regulatory authority – long a goal of Wall Street.
In essence, the Treasury Blueprint appears to call for a long-term or “optimal” strategy that we believe would eliminate many of the essential functions that state securities regulators perform in protecting Main Street investors from fraud.
For example, Treasury’s plan would eviscerate the authority to license stockbrokers, investment advisor firms and investment professionals; register certain securities offerings, and enforce fraud within our state’s borders.
This strategy reveals Treasury’s apparent disregard for the vital role state securities administrators perform in our complementary system of market regulation and investor protection.
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Key Points
Treasury’s Blueprint Designed to Boost Wall Street Competitiveness, Not Main Street Investor Protection
>> The Treasury’s blueprint should not be read as a way to build the foundation for economic recovery. It is essential to remember that Treasury’s proposals are the byproduct of a year-long effort led by Treasury Secretary Paulson to increase the competitiveness of U.S. capital markets by “streamlining” financial services regulation, not to provide additional protections for investors.
>> Treasury’s call for a monolithic U.S. financial regulator does little, if anything, to increase protections for the 100 million Main Street investors who drive the economy. The current crisis in the nation’s financial system did not result from a failure of the state regulatory system, yet Treasury seeks to reduce state regulatory authority – long a goal of Wall Street.
>> The proposals offered in the Treasury’s blueprint, such as consolidating financial services regulatory agencies, would do little to restrict the practices that led to recent turmoil in financial markets. Treasury’s blueprint should be read carefully and acted upon cautiously to ensure that investor protections are not weakened in the name of “reform.”
>> Treasury avoids calling for tighter regulation of Wall Street investment banks and hedge funds and would not curb risky practices associated with the housing and mortgage crisis. As the New York Times correctly points out, Treasury’s plan “does not recommend tighter rules over the vast and largely unregulated markets for risk sharing and hedging, like credit default swaps, which are supposed to insure lenders against loss but became a speculative instrument themselves and gave many institutions a false sense of security.”
>> Treasury’s plan weakens the Securities and Exchange Commission, the federal regulatory charged with protecting investors, and strengthens the Federal Reserve, the central bank of the United States. The SEC's Office of Compliance Inspections and Examinations, which has been the target of criticism from the securities industry, could be stripped of much of its power if it ends up ceding its examinations to the Fed.
State Securities Regulators Support a Strong and Effective Financial Services Regulatory Structure
>> Such a structure requires preserving the authority of state securities regulators, the local cops on the securities beat. It also requires a strong SEC to properly implement the laws, and it requires a strong SRO for efficient compliance. It takes all three working in equal partnership to maintain investor confidence in the world’s deepest and most transparent markets.
>> State securities regulators favor prudent changes where necessary to preserve or enhance the health of our markets. However, regulatory “reform,” as the concept is currently framed, must be preceded by two conditions: Proof that the current system is ineffective and the superiority of the proffered alternative. To date, neither of these conditions has been met.
States Must Retain a Prominent Role in Financial Services Regulation
>> It is appropriate and wise for states to continue to play an integral role in the regulation of financial institutions that do business within their borders. States are well suited to provide both prudential investor protections and effective regulation.
>> While there is a need to ensure that regulations are not literally duplicative, it seems unwise to artificially divide state and federal regulations along systemic and consumer protection lines when both are inextricably linked and states clearly have a compelling interest in all aspects of financial services regulation.
>> States should be equal participants in all areas pertaining to the regulation of securities and/or futures within the states. Investor protection would be seriously imperiled if states do not maintain their role as regulator and supervisor of all state licensed institutions and individuals.
>> One of the hallmarks of our system of securities regulation is its effectiveness in early detection of misconduct, both large and small. A cornerstone of this effectiveness is the traditional cooperation between state securities regulators and the SEC. The combination of complimentary yet unique skills and strengths works as a multiplier for efficiency and effectiveness.
Principle vs. Rules Based Regulation: Separating Rhetoric from Fact
A common argument put forward to justify regulatory restructuring is that our capital markets cannot maintain competitiveness because markets abroad are asserted to be more reasonably regulated. Some of these foreign regulators operate under “principles-based” regulations, which is distinct from our system of rules.
U.S. Markets Remain a Magnet for Capital
>> The cornerstone of the principles argument – a claim of decreased foreign IPOs on U.S. markets – is questionable, at best. In 2007, U.S. IPOs reached a record high, not seen since the year 2000, bringing in $54 billion, and including a large number of foreign IPOs from China.
>> Claims that the Sarbanes-Oxley Act (SOX) has driven away foreign companies that are unfounded. Currently, record IPO numbers in themselves argue against this claim. SOX is revered worldwide and SOX-inspired legislation has appeared in several foreign regimes, following the U.S.’s lead.
>> Foreign investors, counter to popular argument, are indeed drawn to U.S. listings due to the low cost of capital, high financial returns and premiums on home-market listings, and the fact that U.S. markets serve as a proving ground for foreign companies, which must demonstrate to investors and the financial community that they meet the U.S.’s high standards of investor protection and financial integrity.
Are there regulatory lessons to be learned from foreign regimes?
>> There are few lessons to be learned from alternate, foreign regime systems of financial services regulation. No regulatory model is perfect; none has been universally chosen. Each, as it exists, is a mix of principles and rules. Each has flaws and quirks.
>> The principles-based Financial Services Authority (FSA), for example, has recently begun to move towards more rules due to, among other things, complaints of a lack of clarity on the part of regulated persons and entities regarding permissible conduct.
>> Recently, the FSA issued a report regarding the collapse and subsequent nationalization of Northern Rock. The report identified four key failings of the FSA generally, and specifically in the case of Northern Rock:
- A lack of sufficient supervisory engagement with the firm.
- A lack of adequate oversight and review by FSA line management of the quality, intensity and rigor of the firm's supervision.
- Inadequate direct supervision the firm.
- A lack of intensity by the FSA in its analysis of risk management data.
Can principles-based regulation be applied to the U.S.?
>> Along functional lines, basic guiding principles can be useful. Applied universally, across functional lines, however, principles must necessarily be as broad as possible. As observed in alternative regulatory regimes, such breadth leads to uncertainty by market participants and overall market inefficiencies.
>> It is premature to conclude that the structure of financial regulation is an impediment to the efficiency or effectiveness of the financial regulations themselves or to the wider economy.
Main Street Investors Lose in a Race to the Regulatory Bottom
>> Recent regulatory restructuring recommendations share a universal set of “improvements” that would offer industry less bureaucracy, fewer constraints, and wide latitude in matters of conduct.
>> Individually and collectively, these changes would weaken essential investor protections while providing Wall Street with a “regulation-light” playing field for the sake of enhanced profits and competitiveness.
>> Securities regulators are troubled by the lack of discussion about the effects such a restructuring would have on Main Street investors. In the current rush to enhance market competitiveness, the proven investor and consumer protections of the U.S. capital markets regulatory system must not be sacrificed. How can we ease regulatory requirements without entering into a race to the bottom in regulatory protections?
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