Regulation

Is the SEC Putting Itself Out of Business?

Where are the rightwing crackpots denouncing “world government” when you need them? The New York Times reported over the holiday weekend that the Securities and Exchange Commission (SEC) is preparing a series of proposals that would weaken its own control over U.S. financial markets by, among other things, allowing American companies to opt for oversight by foreign regulatory bodies. The step would reportedly be presented as way to enhance the competitiveness of U.S. companies abroad and encourage more foreign investment here.

Critics worry, with some justification, that the move amounts to a transnational form of deregulation, given that securities oversight overseas is generally much less stringent than in the United States. The change could effectively abolish the Sarbanes-Oxley controls that were put in place by Congress after the collapse of Enron and other corporate scandals earlier this decade. The Times quotes Duke Law School securities expert James D. Cox as warning that the shift to international rules amounts to “outsourcing safety standards.” Picking up on the story today, the Washington Post suggested that a vote on the use of international standards could come in a few weeks.

Ceding control to foreign regulators is just one of the ways in which the SEC seems to be chipping away at its own authority. Yesterday, the agency announced it had reached agreement with the Federal Reserve to share information and cooperate more closely. That sounds reasonable, but it comes after the Fed shunted the commission aside and took control of the Bear Stearns crisis back in March. Since then there have been prominent articles, such as one on the front page of the Wall Street Journal, playing up the criticism of SEC Chairman Christopher Cox.

And then there’s the fact that in March Treasury Secretary Henry Paulson proposed an overhaul of the financial regulatory system that gave a diminished role to the SEC. Paulson’s plan has gone nowhere, but it added to the impression that the SEC’s star is waning.

The SEC is hardly a flawless agency, but the alternatives would probably be significantly worse in terms of investor protection and corporate accountability. As much as some of us harp on the limitations of SEC disclosure rules, for instance, there is a lot less transparency abroad. The only other country, to my knowledge, that requires companies to reveal a significant amount about their operations and their finances, and then makes those filings available at no cost on the web is Canada, with its SEDAR system. Allowing U.S. companies to follow foreign rules may or may not help their competitiveness, but it will in all likelihood allow them to operate with a lot less scrutiny.

Would Paulson’s CBRA Have Fangs?

Although anything coming from the Bush Administration has to be regarded with suspicion, one aspect of the Treasury Secretary Henry Paulson’s plan to revamp the regulation of financial institutions is intriguing. As part of the replacement of the current alphabet soup of agencies with a new minestrone, Paulson called for the creation of a single entity to oversee consumer protection issues relating to all regulated financial institutions. Although the Paulson blueprint often refers to this as the “business conduct regulator,” the formal proposed name is the Conduct of Business Regulatory Agency, or CBRA for short.

The new agency would combine selected functions now handled (or neglected) by entities such as the Securities and Exchange Commission and the various bank regulators. Other SEC functions—presumably including oversight of the securities of non-financial companies—would apparently reside in a new agency formed by the merger of the SEC and the Commodity Futures Trading Commission.

CBRA’s proposed mission is described (p.19) as follows:

Business conduct regulation in this context includes key aspects of consumer protection such as disclosures, business practices, and chartering and licensing of certain types of financial firms. One agency responsible for all financial products should bring greater consistency to areas of business conduct regulation where overlapping requirements currently exist. The business conduct regulator’s chartering and licensing function should be different than the prudential regulator’s financial oversight responsibilities. More specifically, the focus of the business conduct regulator should be on providing appropriate standards for firms to be able to enter the financial services industry and sell their products and services to customers… CBRA’s main areas of authority would include disclosure issues related to policy forms, unfair trade practices, and claims handling procedures.

It’s difficult to know how seriously to take this. Is Paulson suggesting that CBRA would be able to establish strict consumer protection standards before a company is allowed to set up shop anywhere in the financial services marketplace? If so, then bring it on.

Also appealing (from a researcher’s perspective) is the emphasis on disclosure, especially relating to information apart from data that Paulson puts under the purview of the “corporate finance regulator.” Today, the disclosure needs of investors are too often put ahead of the disclosure needs of consumers, workers and the general public.

Paulson’s blueprint may go nowhere, but if it does, let’s hope that his CBRA would really have fangs.

Paulson Blueprint Promotes Insurance Industry Shell Game

There’s something peculiar in the report on financial market regulation issued today by Treasury Secretary Henry Paulson. The plan, touted by some as a bold expansion of federal control over capital markets and dismissed by others as a mere rearranging of the deck chairs on the financial Titanic, includes an incongruous section on the insurance industry.

While insurance is a financial service, it hasn’t been at the center of the implosion of the housing market or (aside from the bond insurance crisis) linked to the instability on Wall Street. The Paulson plan, nonetheless, provides a resounding endorsement of a “reform” that key players in the insurance industry have been seeking for at least 15 years—allowing large national carriers to do an end run around the current state-based insurance regulatory system. Such carriers would be permitted to adopt an “optional federal charter” and thereby put themselves under the supervision of a federal regulatory agency that does not yet exist.

Big Insurance has not sought federal oversight because it wants more regulation. After all, this is the industry that pioneered offshoring when some carriers moved their official headquarters to tax havens such as Bermuda. While it is true that many state regulators have been toothless watchdogs, other states have been aggressive in protecting the interests of policy holders and the public.

In fact, the Paulson proposal comes just a couple of weeks after insurers were celebrating the downfall of New York Gov. Eliot Spitzer in a prostitution scandal. During his time as New York’s attorney general, Spitzer pursued major insurance companies such as Marsh & McLennan and American International Group for offenses such as bid rigging. Marsh ended up settling for $850 million in 2005, and AIG paid a whopping $1.6 billion the following year. While it is true that Spitzer went after the industry as a prosecutor rather than a regulator, he did so in the overall context of state oversight.

The insurance industry swears that it supports the optional federal charter in the name of modernization (as does the Paulson report), but it is significant that the reform has been supported by groups such as the Competitive Enterprise Institute and the American Enterprise Institute that are no friends of regulation (some Democrats in Congress are also in favor). When word of Paulson’s insurance proposal leaked out over the weekend, the American Insurance Association rushed out a press release hailing it, saying that the optional federal charter “will be more efficient, effective and rational given the ‘increasing tension’ a state-based regulatory system creates.”

Throughout its history, the insurance industry has avoided “tension” by trying to minimize government interference in its affairs. In 1945 the industry supported the McCarran-Ferguson Act, which responded to a Supreme Court ruling by affirming the regulatory role of the states. In recent times, the industry has wanted the option of federal oversight on the assumption that it would be less onerous. I’ll let the legal scholars decide whether state or federal regulation is inherently more appropriate. The issue is whether an industry not known for generous treatment of its customers (think of Katrina victims denied coverage) is going to be subjected to some strict oversight somewhere.