An Agenda for Change: How the 111th Congress Can Better Protect Investors

News Conference Opening Statement

Fred Joseph
Colorado Securities Commissioner
President, North American Securities Administrators Association

January 29, 2009
National Press Club
Washington, DC 

Good morning and thank you for joining us. I’m Fred Joseph, Colorado Securities Commissioner and President of NASAA, the North American Securities Administrators Association.

Since 1919, NASAA members have been on the front lines of investor protection through their licensing, registration, examination, enforcement, and investor education activities. Many of you know the state securities regulators who make up NASAA’s membership from their leading role in providing relief for auction rate securities investors last year. Or by their pioneering work to ensure that America’s seniors are protected from investment fraud.

This morning, we will outline our legislative agenda for the 111th Congress. Our agenda focuses on the legislative changes that are most relevant to the millions of Main Street Americans who look upon Wall Street, regulators, and lawmakers to help them build and safeguard their financial security.

We believe our agenda responds to President Obama’s call for increased responsibility, accountability, and transparency and offers the 111th Congress a series of positive and proactive policy recommendations to better protect investors and the financial markets that these investors have come to rely on for their long-term financial security.

At the outset, I’d like to thank Delaware Securities Commissioner Jim Ropp, who chairs NASAA’s Federal Legislation Committee, and NASAA Director of Policy Debbie House for their insights in bringing together our agenda.

I also want to recognize the beneficial relationship state securities regulators have enjoyed with legislators on both sides of the aisle during the previous Congress. This relationship is both positive and constructive and provides a strong foundation for the 111th Congress.

In particular, I’d like to thank Sen. Jack Reed for his long-standing support and understanding of the of the important investor protection role of state securities regulators; Senate Banking Committee Chairman Christopher Dodd, for recognizing the importance of the ongoing coordination between state securities regulators and the SEC; Sen. Herb Kohl of Wisconsin, for his leadership on the Senate Special Committee on Aging and his support of NASAA’s Model Rule on the Use of Senior Designations and Professional Certifications. And on the House side, we appreciate the continued support of Financial Services Committee Chair Barney Frank, especially his recognition during the September 18, 2008 hearings on auction rate securities of the leading role states served in the ARS investigations and settlements, and Capital Markets Subcommittee Chairman Congressman Paul Kanjorski for his plan to enhance investor protection.

As NASAA Executive Director Russ Iuculano mentioned, we are living in historic times. The decisions made over the coming months have the potential to fundamentally change how the financial services industry does business. And how Main Street investors are served and protected.

At this critical time, it is imperative that the system of financial services regulation be improved to better protect investors, markets, and the economy as a whole. Main Street investors deserve a regulatory structure that is collaborative, efficient, comprehensive, and strong.

With so much at stake, NASAA’s top legislative priority is to protect investors by preserving state securities regulatory authority over those who offer investment advice and sell securities to their residents. Our agenda also features several additional pro-investor issues that the 111th Congress should consider in order to strengthen investor confidence in our nation’s financial markets and their regulators.

Each of you has a copy of our full legislative agenda and it is on our website, as well (here). As you’ll see, we have framed this year’s agenda in terms of the five “Core Principles for Regulatory Reform” that we introduced last November to highlight the fundamental reforms that are necessary to address the underlying causes of our ongoing financial crisis.

Implementing those changes will require a broad range of actions, both legislative and regulatory, but at the heart of the Core Principles is a call for decisive Congressional action.

The current economic crisis painfully demonstrates that our system of financial services regulation must be strengthened. Regulating our financial markets is an enormous challenge, one that can only be met through the combined efforts of state and federal regulators, working together to protect the integrity of the marketplace and to shield consumers from fraud and abuse. Congress must resist attempts to weaken this collaborative system.

State securities regulators, for example, must not be preempted or marginalized as mere advisers to federal authorities. Particularly in the areas of enforcement, licensing, and compliance examinations, state regulators provide indispensable consumer protections. At the same time, we should look for opportunities within this collaborative framework to make regulation more streamlined and efficient.

In the area of securities regulation, the states have a century-long track record of investor protection, and also serve as a local resource that investors can turn to for help when they have been exploited. And state regulators play a key role in educating investors in communities across the country about the perils of investment fraud.

We all heard President Obama say last week that the key to effective government is whether it works. Just one look at our enforcement statistics shows that state securities regulation works.

During our three most recent reporting periods, ranging from 2004 through 2007, state securities regulators have conducted investigations that resulted in more than 8,300 enforcement actions, which led to $178 million in monetary fines and penalties and more than $1.8 billion ordered returned to investors. And, we are responsible for sending fraudsters away for a total of more than 2,700 years in prison.

Now, just imagine what life would be like without us.

So, it is little surprise that our first core principle for regulatory reform is to preserve the role of the states in financial services regulation. But the current financial crisis calls for bold steps and more than just the preservation of state authority alone. That is why we call upon Congress to restore state authority over certain financial products and professionals who share the responsibility for the future financial security and prosperity of this nation of investors.

Since 1996, there has been a steady stream of regulatory, judicial, and legislative initiatives designed to attack the regulatory authority of state securities regulators through preemption. The time has come for Congress to reverse some of these ill-advised actions.

For example, Congress should restore the authority of state securities regulators to license independent agents who sell certain certificates of deposit, including Jumbo CDs exceeding FDIC insurance limits. This authority was preempted in 2004 by an opinion letter issued by the Office of Thrift Supervision.

Moreover, Congress should preserve the authority of state regulators to protect investors from fraud and abuse in the banking and securities areas. This authority was removed in 2003 by the Office of the Comptroller of the Currency, which vested the OCC with all authority over national banks and their subsidiaries.

In both of these examples, Congress can help protect investors by adopting legislation, such as H.R. 1996, the Federalism in Banking Act, introduced by Representative Luis Gutierrez (D-IL). This legislation expressly preserves the authority of state regulators to protect investors within their jurisdictions from fraud and abuse in the banking and securities sectors.

Finally, Congress should amend the Securities Act of 1933 to reinstate state regulatory oversight of private offerings made under Rule 506 of Regulation D. State oversight was removed by the National Securities Markets Improvement Act of 1996, which substantially limited the authority of the states to register certain types of securities, including stocks traded on national exchanges, and mutual fund shares.

While these limitations may have promoted uniformity and efficiency in our national markets, Congress imposed other limitations on state authority that were harmful to investors. A prime example is in the area of private offerings under Rule 506 of Regulation D.

Even though these securities do not share the essential characteristics of the other national securities offerings addressed in NSMIA, Congress nevertheless blocked the states from subjecting them to regulatory review even where the promoters or broker-dealers have a criminal or disciplinary history. These offerings also enjoy an exemption from registration under federal securities law, so they receive virtually no regulatory scrutiny. As a result, Rule 506 offerings have become the favorite vehicle under Regulation D, and many of them are fraudulent.

Although Congress preserved the states’ authority to take enforcement actions for fraud in the offer and sale of all “covered” securities, including Rule 506 offerings, this power is no substitute for a state’s ability to scrutinize offerings for signs of potential abuse and to ensure that disclosure is adequate before harm is done to investors.

In light of the growing popularity of Rule 506 offerings and the expansive reading of the exemption given by certain courts, NASAA believes the time has come for Congress to reinstate state regulatory oversight of all Rule 506 offerings by amending the Securities Act of 1933.

I’ve taken a lot of time to outline the specific legislative solutions available to Congress to advance our first Core Principle for Regulatory Reform. In our remaining time, I will highlight the legislative steps Congress could take to advance our other four principles, which are equally important.

Our second principle calls for closing regulatory gaps by subjecting all financial products and markets to regulation. An enormous amount of capital is traded through esoteric investment instruments on opaque financial markets that are essentially unregulated.

Congress can close this gap by increasing the transparency of derivative instruments. At a minimum, Congress should pass legislation to provide regulatory safeguards making the over-the-counter derivative markets more transparent and subject to effective oversight.

We also urge Congress to authorize the regulation of hedge funds. Advisers to hedge funds should be subject to the same standards of examination as other investment advisers. Congress should give the SEC explicit statutory authority to regulate hedge fund advisers as investment advisers. In addition, Congress should grant the SEC authority to require hedge funds to disclose their portfolios, including positions, leverage amounts, and identities of counterparties to the appropriate regulators. Finally, Congress should appropriate the necessary funds to ensure that the regulators are sufficiently equipped, in terms of personnel and technology, to exercise proper oversight over hedge funds.

Our third principle calls for strengthening conduct standards that apply in all financial sectors and using “principles” to complement rules, not to replace them. There are three ways Congress can help here.

First, we urge Congress to apply the fiduciary duty to all financial professionals who give investment advice regarding securities—broker-dealers and investment advisers alike. This will enhance investor protection, eliminate confusion, and even promote regulatory fairness by establishing conduct standards according to the nature of the services provided, not the licensing status of the provider. For all financial professionals, the interests of the client must come first at all times. Investors deserve no less.

Second, the regulation of short sale transactions must be strengthened. Legitimate short selling plays an important role in the market, including contributing to efficient price discovery, increasing market liquidity, and facilitating hedging and other risk management activities. However, naked short sales can be used to manipulate the market and drive down the price of shares. To minimize the potential for abuse, NASAA believes Congress should:

Prohibit shares from being pledged to multiple parties;
Urge the SEC to reexamine its elimination of the uptick rule, which was implemented to limit rapid selling of borrowed shares, which contributes to market volatility; and
Consider adopting as a permanent disclosure rule the SEC’s emergency order requiring certain institutional money managers to report their new short sales of certain publicly traded securities.
Third, update and strengthen the accredited investor definition. Raising the net worth and income standards for individual investors will provide greater protection for investors and will aid state regulators in enforcement activities by allowing more accurate suitability determinations for those who choose to take greater risks. It may be appropriate for Congress to reexamine the fundamental assumptions underlying the accredited investor test. Congress should at least amend the Securities Act of 1933 so that it quantifies and raises the accredited investor standard and provides for automatic adjustments keyed to inflation.

Our fourth Core Principle calls for improving oversight through better risk assessment and interagency communication. Here, we urge Congress to eliminate conflicts within nationally recognized credit rating agencies and review and increase the transparency of regulatory initiatives that impact investors.

The SEC has taken constructive first steps to curb conflicts of interest and increase transparency and accountability with credit ratings agencies. But Congress should consider legislative solutions that are beyond the reach of the SEC’s regulatory authority. In developing those solutions, Congress must carefully examine the models that rating agencies use, the assumptions they rely upon, and the compensation they receive, to ensure that ratings are objective and accurate.

We also ask Congress to examine a number of significant recent SEC policy initiatives in financial services regulation, some of which were launched without the input of a formal public comment process.

For example, the SEC has entered into a mutual recognition arrangement with a foreign government and its self-regulatory body and has taken actions to implement mutual recognition agreements with other countries. We think Congress should explore the potential implications for individual investors when foreign financial intermediaries are permitted to have access to our markets under a selective mutual recognition system. We are particularly concerned because this system inappropriately eliminates the role of states as gatekeepers over securities professionals who provide services to investors and raises significant concerns regarding the ability of a state to take action against those who would violate securities laws.

In another example, Congress should carefully review the activities of the SEC in relation to ts proposed “roadmap” for moving from U.S. Generally Accepted Accounting Principles (GAAP) to International Financial Reporting Standards (IFRS). Congress should make sure that any final “roadmap” does not diminish existing levels of transparency and ensure that the independence and due process of the International Accounting Standards Board is in compliance with the Sarbanes-Oxley Act.

Our final principle – toughening enforcement and shoring up private remedies – is essential to investor protection. Congress can increase protections for senior citizens; reexamine and remove some of the hurdles facing private plaintiffs seeking damages for securities fraud; and restore fairness and balance in the securities arbitration system.

Specifically, we ask Congress to:

Reintroduce and enact S. 2794, the Senior Investor Protection Act of 2008, introduced by Senator Herb Kohl (D-WI), and S. 3219, the Senior Investor Protections Enhancements Act of 2008, introduced last year by Senators Bob Casey (D-PA) and Herb Kohl.
NASAA strongly supports the Senior Investor Protection Act, which is based on NASAA’s Model Rule on the Use of Senior-Specific Certifications and Professional Designations and would provide grants to states to enhance the protection of seniors from being misled by false designations.
We also strongly support the Senior Investor Protections Enhancements Act of 2008, which would place higher penalties on those who target seniors with abusive sales tactics. this legislation would impose additional penalties when violations are directed against seniors.
Congress should also hold hearings to examine whether private plaintiffs with claims for securities fraud have fair access to the courts. In that process, Congress should re-evaluate the Private Securities Litigation Reform Act and should consider reversing some of the Supreme Court’s most anti-investor decisions. Over the last 15 years, Congress and the Supreme Court have restricted the ability of private plaintiffs to seek redress in the courts for securities fraud and the pendulum has swung too far in the direction of limiting private rights of action.
Finally, Congress should review how securities arbitrations are conducted to determine, among other things, if there is sufficient disclosure of potential conflicts by panel members; if the selection, qualification, and composition of the panels is fair; and if the system is fast and economical for investors. Members of Congress have seen that the scales of justice have tilted away from consumers in arbitration proceedings and attempted to rectify this situation in the last session of Congress with S. 1782 and H.R. 3010, the “Arbitration Fairness Act of 2007,” introduced by Senator Russ Feingold (D-WI) and Congressman Hank Johnson (D-GA) respectively. NASAA supported this legislation and looks forward to its reintroduction, with an amendment to clarify that its provisions extend to securities arbitration.
Taken together, the legislative priorities we have outlined today represent positive and progressive change in the financial services industry for the benefit of Main Street investors. They seek to increase the accountability and transparency upon which President Obama has based his call for change in the way Wall Street does business and in the way that business is regulated.

NASAA is committed to working with the Obama Administration and the 111th Congress to ensure that the nation’s financial services regulatory regime undergoes the important changes that are necessary to enhance Main Street investor protection, which state securities regulators have provided for nearly 100 years.

Thank you.

January 29, 2009

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