Will the Securities and Exchange Commission be “modernized” out of existence? That’s just one of the numerous questions the corporate world is mulling as it digests the details of the long-awaited Treasury Department blueprint for overhauling regulation of the U.S. financial markets.
Under a controversial plan for modernizing U.S. financial markets regulation unveiled last week by Treasury Secretary Henry Paulson, the SEC, as the corporate world currently knows it, would cease to exist.
As proposed in the more than 200-page report, many of the SEC’s current functions would be merged with those of the Commodity Futures Trading Commission to create a new business conduct regulator; a new corporate finance regulator would assume other functions.
Specifically, the new “conduct of business” regulator would assume the SEC’s current business conduct regulatory and enforcement authority over financial institutions, along with some roles of the CFTC. The corporate finance regulator would have responsibility for general issues related to corporate oversight in public securities markets, including the SEC’s current responsibilities over corporate disclosures, filings, and governance, as well as accounting oversight.
The reforms were proposed as part of a broader Treasury plan to move to a regulatory model based on objectives. The blueprint calls for three principal regulators to focus on financial institutions: a market stability regulator, a prudential financial regulator, and business conduct regulator. The plan also calls for a federal insurance guarantor and a corporate finance regulator.
Dramatic Change for Public Companies
Calls for a merger of the SEC and the CTFC are nothing new. It was proposed in a 1988 report by the Brady Commission, a presidential commission formed to investigate the 1987 stock market crash.
“There have always been calls for a merger between the SEC and the CFTC because it’s so hard to draw a line between securities products and futures products,” says Michael Greenberger, a law professor at the University of Maryland and former director of the Division of Trading and Markets at the CFTC.
Those calls for a merger have grown even louder in recent years as new financial products that blur the lines between SEC-regulated equities and CFTC-regulated futures have increased questions about how best to regulate such instruments. As Compliance Week recently reported, the two agencies signed a memorandum of understanding last month to establish a permanent regulatory liaison between them that includes quarterly meetings of both staffs as part of efforts to increase their cooperation.
“Product and market participant convergence, market linkages, and globalization have rendered regulatory bifurcation of the futures and securities markets untenable, potentially harmful, and inefficient,” the Treasury report states.
The corporate finance regulator would have responsibility for general issues related to corporate oversight in public securities markets, including the SEC’s current responsibilities over corporate disclosures and corporate governance, as well as accounting oversight.
Observers note that the latest call for a union differs from past proposals in a major way: The Paulson plan would keep the principles-based regulatory philosophy of the CFTC and force the SEC to make a number of changes to the way it operates, to pave the way for a merger.
“The historical assumption was that the CFTC would become a division of the SEC and be enveloped by its regulatory format,” Greenberger says. “However, this plan would have the SEC adopt the CFTC’s regulatory format.”
If carried out, the Paulson plan “would be a dramatic change for public companies,” Greenberger says. “The template in the Commodity Futures Modernization Act is essentially, ‘Do whatever you want, so long as you’re arguably in compliance with broad-based principles.’ It’s a much different regulatory approach than that of the SEC.”
To smooth the way for a merger, the plan also calls for the SEC to adopt core principles, modeled after the CFMA, to apply to securities clearing agencies and exchanges. It also calls for legislation to establish a joint staff task force with equal agency representation to harmonize differences between futures regulation and federal securities regulation.
Other recommendations include a rule to streamline the SEC’s self-regulatory organization rulemaking process; streamline the approval for securities products common to the marketplace, expanding the Investment Company Act by permitting registration of a new “global” investment company; and permit all clearing agency and market SROs to self-certify all rulemakings, except those involving corporate-listing and market-conduct standards.
As in the past, Congress remains a major hurdle to a regulatory merger. The two Agriculture Committees have oversight of the CFTC, while the Banking and Financial Services Committees have oversight of the SEC, notes Hardy Callcott, a partner in the law firm Bingham McCutchen and a former assistant general counsel at the SEC.
“Congressional committees don’t like to give up jurisdiction,” Callcott says. “For that reason it is unlikely in an election year that this plan could be adopted this year.”
Even Paulson conceded that his vision is far from becoming reality. “An objectives-based model is substantially different from our current system and, realistically, will not and could not be implemented any time soon … it will take many years to evolve to this model,” he said in his March 31 remarks.
Callcott says the beneficiaries would be firms that seek to hedge their securities positions in the futures markets, since they’d be able to do that in a single account. It would also benefit financial services firms, which could open a single account for customers with both securities and futures positions. Similarly, markets that want to offer new products with both securities and futures features, like single-stock futures or narrow-based index futures, would only need to be approved by one agency rather than two.
Like previous plans to unite the two regulators—and like the overall blueprint in which it is included—the proposed merger drew mixed reactions.
A statement by SEC Chairman Christopher Cox said recent events have provided further evidence that “financial services regulation in the United States needs to be better integrated among fewer agencies, with clearer lines of responsibility.”
Cox said the proposed consolidation of responsibility for investor protection and the regulation of financial products “deserves serious consideration as a way to better address the realities of today’s markets.”
CFTC Acting Chairman Walter Lukken noted that while a unified regulator could bring efficiencies, the tradeoffs “should be weighed carefully.” The CFTC’s “focused mission, market expertise, manageable size, problem solving culture, and global outlook” could be jeopardized with the creation of a larger regulatory bureaucracy, he said.
Lukken suggested that many of the benefits of a unified regulator could be achieved by the recent MOU between the two agencies and urged regulators to give it time to “bear fruit.”
NYMEX, the parent company of the New York Mercantile Exchange, was similarly cautious about a merger, noting that a consolidation of the agencies “does not represent the only way for rationalizing differences between futures and securities regulation.”
Still, if ever there was ever a time for a merger to occur, it is now, says Robert Glauber, who served as executive director of the Brady Commission and is now a lecturer at Harvard University. “The markets have changed dramatically in the last 15 years,” he says. “The need is more pressing for some simplification and consolidation.”
Glauber, who was also former chairman of the National Association of Securities Dealers and a former undersecretary of the Treasury, says the Treasury plan’s broader objectives are “sensible as a blueprint.”
“We have the most complex, fragmented regulation in the world,” he says. “It’s a good time to work on that.”
Greenberger, however, doesn’t expect the plan to gain any traction. “The idea that Congress would be willing to have the SEC adopt principles as opposed to rules isn’t going to happen,” he says. “I think this will long be forgotten as the crisis worsens.”