The SEC Commissioners Speak: Part II

by Dorsey & Whitney LLP

Yesterday’s article reviewed the remarks of SEC Chair Mary Jo White and Commissioner Kara M. Stein at SEC Speaks. The article today reviews the remarks at the conference of Commissioners Michael S. Piwowar and Daniel M. Gallagher. Collectively, the comments of the Commissioners provide insight into the future path of the agency.

Commissioner Michael S. Piwowar discussed the overall path of the SEC moving forward through the lens of its mission regarding the markets – to be fair, orderly and efficient. First, the Commissioner discussed “fair” in the context of rule making as well as litigation. Fairness in rule making demands that the SEC not act arbitrarily or capriciously. Accordingly, the agency “must ensure that the rules do not change day-to-day on the whims of the Commission and/or its staff. This means that under the Administrative Procedure Act the Commission must not adopt an new rule or rule amendments without proper notice and the opportunity for comment by the public. The corollary of this principle is that the Commission and its staff must not engage in rule making by enforcement or through examinations of regulated entities. For example, we must resist the temptation to include undertakings in enforcement settlements or principles in examination reports that serve as de facto rule requirements.”

Fairness also dictates that in rule making the Commission examine the length and complexity of its releases for new rules. Many of these run 500 or 1,000 pages and are extremely complex. Such releases suggest “that rather than merely explaining our rules, those documents now include extensive guidance akin to rule making, which can create entirely separate fairness concerns. For example, the most recent amendments to our money market funds include key guidance akin to rule making for all mutual funds, not just money market funds, which was buried in a footnote within an almost 900 page release,” the Commissioner noted.

“Our enforcement program could also benefit from a look through the lens of fairness,” Commissioner Piwowar stated. Recently, the staff indicated that they will recommend instituting more enforcement matters as administrative proceedings, including insider trading cases. “Announcement of this plan to increase the use of administrative proceedings in insider trading cases followed the Commission’s loss in two insider trading cases in federal district courts. Regardless of whether these circumstances are linked, this change has the appearance of the Commission looking to improve its chances of success by moving cases to its in-house administrative system,” according to the Commissioner. To avoid the perception that the Commission is taking its tougher cases to in-house judges “the Commission should set out and implement guidelines for deterring which cases are brought in administrative proceedings and which in federal courts.”

The imposition of corporate penalties and the issuance of waivers are two additional areas which would benefit from the consistent application of public guidelines. While the Commission offered guidance on corporate penalties in 2006, recent remarks by the SEC Chair raises doubts about those guidelines which are often ignored in staff recommendations. Likewise, Commissioners have been ignoring the established staff guidelines regarding waivers. While staff guidance need not be followed, where there are established practices they should be followed.

Orderly means that the Commission must at times prioritize its agenda in areas such as rule making, enforcement and inspections. To function efficiently the agency should prioritize its rule makings. In the area of enforcement it means that the “broken windows” approach does not work. By making regulatory compliance its most important objective the approach unnecessarily delimits important economic activity. Rather, enforcement efforts should be “closely aligned with the priorities developed by out policy-making division,” according to the Commissioner. In contrast OCIE has made significant strides in developing priorities.

Finally, it is critical that the Commission become more efficient. The increased utilization of technology is one way to help achieve this goal. Another is by “[e]ngaging with academics, attorneys, and others from the securities industry who work outside the SEC [and who] could greatly enhance our ability and effectiveness in identifying changes to improve our regulatory regime.”

Commissioner Daniel M. Gallagher centered his remarks on efforts to create a uniform fiduciary standard to which he is opposed. Recounting the history of these efforts, he noted that in 2010 the Department of Labor issued a proposal for such a standard. The proposal, which would have radically changed the law, according to Commissioner Gallagher, would have broadly defined the term “fiduciary” under ERISA to include any person who provided investment advise to plans for compensation. Following largely negative comments the proposal was withdrawn. In reformulating its proposal (which was recently issued) it did not consult with the SEC Commissioners.

In 2011 the SEC staff issued a study under Section 913 of Dodd-Frank calling for a uniform fiduciary standard for investment advisers and broker- dealers who provide investment advice regarding securities to retail customers. Two Commissioners opposed the proposals, noting that it did not adequately identify the issues to be addressed through additional regulation.

Recently a White House paper called for a similar standard. It was built on three basic principles. First, consumer and investor protections are inadequate. This point is not supported by any analysis, according to Commissioner Gallagher.

Second, the current regulatory environment “creates perverse incentives” that cost savers billions of dollars. At the same time, according to Commissioner Gallagher, there are SEC and SRO rules which address these issues. Finally, the White House memo states that academic research has established that advisors often act “opportunistically to the detriment of their clients” because of conflicts. Again, the point ignores current regulation. Accordingly, the White House position paper on this point is seriously flawed, the Commissioner concluded.

At the same time the extent of the SEC’s investment adviser examinations is “unacceptably narrow” which impacts SEC policy making in this area. Last year only 10% of the advisers were examined. This low rate of examinations can hinder the SEC’s work since the “purpose of an active and well-resourced examination program is an informed policymaking function, not a large, attention-grabbing number of enforcement referrals.” This limited focus also impacts the enforcement actions brought by the agency.

In the end fiduciary is supposed to mean that the adviser acts in the best interest of its client. It does not mean “that all models where financial professionals are not fiduciaries are flawed,” the Commissioner noted.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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