Tuesday, October 17, 2006

Congress giveth and Congress taketh away (Part 2): The Financial Services Regulatory Relief Act

As mentioned in my previous post here, two laws recently have been passed by Congress and signed by President Bush that will have a big impact on the regulation of U.S. financial markets. Neither of these laws have received much press, and I suspect that most Congressmen didn't even know what they were voting on when they agreed to them. They don't directly touch on issuers or investors, so, unlike Sarbanes-Oxley, they are pretty much under the radar screen. But they both will have a profound impact on what the Securities and Exchange Commission's Division of Market Regulation does.

The first of these laws is the Credit Rating Agency Reform Act. As I discussed, this new law has plopped into the SEC's Division of Market Regulation broad new powers to regulated some of the most powerful financial firms in the world--credit rating agencies such as Moody's Investor Services and Standard & Poor's. The second new law does the opposite--the Financial Services Regulatory Relief Act takes away a good dollop of the SEC's powers over banks that offer both retail banking and brokerage services (which are most brokerage houses these days). Section 101 contains the really juicy part:


(1) AMENDMENT TO SECURITIES EXCHANGE ACT. Section 3(a)(4) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(4)) is amended by adding at the end the following:

(F) JOINT RULEMAKING REQUIRED. The Commission and the Board of Governors of the Federal Reserve System shall jointly adopt a single set of rules or regulations to implement the exceptions in subparagraph (B)..
(2) TIMING. Not later than 180 days after the date of the enactment of this Act, the Securities and Exchange Commission (in this section referred to as the "Commission") and the Board of Governors of the Federal Reserve System (hereafter in this section referred to as the "Board") shall jointly issue a proposed single set of rules or regulations to define the term "broker" in accordance with section 3(a)(4) of the Securities Exchange Act of 1934, as amended by this subsection.

"Damn!" I can hear you saying. "Nobody told me law stuff was going to be on the exam!" Don't worry, it just means that the SEC has to coordinate with the Federal Reserve when issuing rules and regulations regarding stock brokers. As Jim Hamilton explains here, "The measure is intended to ensure that regulators do not create a new and burdensome maze of requirements that would disrupt or interfere with the business practices of banks and thrifts that offer traditional bank products and services." As Hamilton also explains, this bill has been in the works for several years, as had promises by the SEC to coordinate its brokerage rules with banking regulators. Now, with this new law, it will have 180 days to do so. (You can also check out the SEC's press release on the matter here.)

Cutting through all the legal language and political niceties, what this means is that the SEC will have to coordinate its rules on brokers with the Federal Reserve. And, as all of us know, the Federal Reserve gets to wear the pants in that relationship. (This is the hierarchy in U.S. financial regulation: When the Fed and the SEC are involved, the Fed is butch. Basically, when the Fed is involved with anybody, it gets to be butch. When the SEC and the Commodity Futures Trading Commission are involved, the SEC is the dominant player. When the SEC and the Treasury Department are involved, the SEC stalls until the next election. When any federal financial regulator other than the Fed is involved with a State Attorney General, the federal regulator will get this deer-in-the-headlights look and start arresting or suing everybody in sight.)

There are several reasons for this change (other, that is, than the stated reason Hamilton notes--to cut down on conflicting cross-functional regulation.) The Gramm-Leach-Bliley Act broke down the barriers between retail and investment banking, and since then, every local bank has opened a brokerage arm to sell securities to its customers. (You've probably gotten these brochures yourself when you opened a bank account and were offered "investor services" as well.) All of these local banks are much more comfortable dealing with the Federal Reserve than the SEC. And, let's be honest--so is pretty much everybody else. It's been said that the Federal Reserve is like the Good Samaritan who nurses your wounds after you've been mugged, but lets the mugger escape; the SEC, on the other hand, has been described as the cop who ignores you as you lie bleeding on the floor and instead chases down the mugger and beats him to a pulp. If you are a potential mugger (and, since we're being honest here, most brokers are), who would you prefer to be regulated by?

So the SEC's Division of Market Regulation is very concerned right now that the Financial Services Regulatory Relief Act of 2006 has made them irrelevant. The ironic part about this, of course, is that it is not the Division of Market Regulation that has made the SEC so feared and loathed among bankers-cum-brokers. (That honor goes to the SEC's Office of Compliance, Inspections and Examinations.) If the SEC behaves like a bureaucracy (and I'm guessing it will), this will mean that we can expect the Division of Market Regulation to do everything it can to hang on to whatever power it has left. And this may not be a good thing, if it gets in the way of other reforms designed to improve the competitiveness of the U.S. capital market.

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