Commentary: The Magic of Self-Regulation
Traders Magazine Online News, July 7, 2010
The Conference Report on what has become the "Dodd-Frank Wall Street Reform and Consumer Protection Act" has been released and approved by the House of Representatives. After the Independence Day week-long break, the Senate is widely expected to vote in favor, sending the most important legislation dealing with the financial services industry since the 1930s to President Barack Obama to sign into law.
Self-regulation shows up in several sections of the Act.
First, the legislation requires the General Accounting Office to conduct a study on the feasibility of forming a self-regulatory organization to oversee private funds. The GAO will report the results of this study to the Senate Banking Committee, now chaired by Sen. Christopher Dodd, and to the House Financial Services Committee, chaired by Rep. Barney Frank, within one year after the Act's enactment.
Second, the Act requires the SEC to conduct a study considering whether designating a self-regulatory organization to oversee investment advisers would "improve the frequency of examinations of investment advisers." This report is due within 180 days after the Act's enactment.
You heard it here first. The GAO will find that it is feasible to form a self-regulatory organization to oversee private funds. Why on earth wouldn't it be feasible? And, requiring FINRA to augment the SEC's examination cycle will improve the frequency of investment adviser examinations. How could adding additional examination cycles have any other effect than to improve the frequency of examinations?
What is going on here is that the investment management industry is, and always has been, opposed to self-regulation. Industry lobbyists managed to pare down legislation that would have required self-regulation in the earlier drafts of financial reform legislation. But, they weren't able to kill it altogether. So, this will be an issue deferred into the next Congress.
Congress finds self-regulation very attractive because it is a nifty way of requiring the industry to pay for its own regulation. Unlike the SEC, Congress is not required to fund FINRA or any of the national securities exchanges from the public fisc. If a self-regulatory organization needs more money, it submits a rule change to the SEC. The industry can make comments on the rule, but it is very hard for the industry to play "starve the beast" with its self-regulator.
For its part, the SEC has a love-hate relationship with self-regulation. The SEC enjoys being able to influence the industry indirectly by requiring FINRA to adopt rules governing the conduct of its members, rules that often have an adverse impact on industry profits. The hate part finds expression in enforcement actions the SEC brings against self-regulatory organizations from time to time.
The NASD, FINRA's predecessor, and the New York Stock Exchange have each paid staggering fines for dereliction of their regulatory duties. Most of us remember well when a decade ago the NASD was required to pay a fine of $100 million and was subjected to special supervision for its failure to regulate the Nasdaq market-making industry effectively. Among other things, this led to the formation of NASD Regulation, which ultimately morphed into FINRA. The Nasdaq market-making industry was subjected to a plethora of new rules that it had successfully resisted for years. Examinations were transformed during this period from friendly efforts to help firms with their compliance efforts into snarling inquisitions intended to uncover malfeasance at every turn.
For more information on related topics, visit the following channels:
