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News January 25, 2010 Issue

2010’s New Watchword – Change

This week marks SEC Chairman Mary Schapiro’s first anniversary as the agency’s head. She embarked on a mission of change when she arrived, and change has occurred and will continue. Recently, she hammered home a message that change is here to stay, and we should all embrace it.

On January 20 at the 37th annual Securities Regulation Institute, Schapiro described a dramatically changed market environment and an agency that’s up to the task of regulating it. There’s a new financial reality, said Schapiro, where new products are conjured up every day and sold with lightning speed whether they are particularly understood or not. "The key for all of us — regulators, corporate boards, securities professionals, accountants and attorneys — is to understand this new landscape, respond with vigor and adjust accordingly," she said. That has been the SEC’s mantra over the past year, and the changes have manifested themselves everywhere, from new regulations to new personnel, to new procedures in the examination and investigation process.

There’s more coming, too, she said. "I believe that all of this change is necessary and urge all of us to embrace it — not just that which is coming but that which has already arrived."

So what’s next?

Filling more gaps and strengthening existing standards in need. The recent view that markets are almost always self-correcting and deregulation makes America more competitive led to weaker standards and regulatory gaps that were easily exploited in recent years, said Schapiro. That view must change if we want to thwart another economic crisis.

Hedge Funds. Advisers to hedge funds and other private funds must register with the SEC, she said, and provide information that will enable the establishment of a comprehensive database to monitor private fund activities for systemic risk and investor protection purposes.

Just as importantly, she noted, any legislation "should avoid broad new carve-outs that could become the next safe haven for unscrupulous advisers or manipulative money managers — or that leave gaps in the data available to us." The SEC and the U.K.’s Financial Services Authority are sharing data on hedge funds, said Schapiro. Pooling information will result in a more comprehensive understanding of the overall hedge fund landscape, of which 80 percent operates in the U.S. or U.K. The SEC is also working with international organizations toward gathering consistent and comparable hedge fund data globally.

OTC Derivatives. Originally designed to hedge against risk, during the recent financial crisis derivatives may have exacerbated it, said Schapiro. Because derivatives are "incredibly versatile and can essentially be engineered to achieve almost any financial purpose," they can enable market participants to achieve their goals outside the pathways of ordinary regulation. "When economically equivalent alternatives are subject to different regulatory regimes, individual market participants may migrate to products with lighter regulatory oversight. To reduce this regulatory arbitrage and better ensure market integrity, OTC derivatives should be regulated consistent with their underlying references."

In an effort to fill this gap, the SEC is calling for greater transparency and oversight. Measures that encourage the standardization of products and require centralized clearing to reduce counterparty risks are necessary. "As long as there is a virtual detour to an unregulated world for investment vehicles," said Schapiro, "that road will be taken."

Asset-Backed Securities. The push for increased transparency and regulation is targeted at the asset-backed securities market as well, said Schapiro. The SEC is reviewing the current regulation of the asset-backed securities market and working on proposals that would align the interests of those selling these products with those investing in them.

Schapiro envisions forward-looking proposals that would be more prophylactic than remedial, she said. Such proposals would:

  • Provide investors with significantly more time to carefully analyze a product before investing;
  • Require that loan level data is provided in a format and manner that is accessible by investors;
  • Revise the eligibility standards for "shelf" offerings, including the elimination of using credit ratings as an eligibility standard; and
  • Create a mechanism for ongoing disclosure.

At the time she started, Schapiro pledged to undertake significant change. A great deal of change has already occurred. There are new rules for adviser custody, executive compensation disclosure, and proxy access for shareholders. The agency’s enforcement function has been restructured and delegated subpoena power. A new Division of Risk, Strategy and Financial Innovation has been established, as well as an Investor Advisory Committee and a new web site,

More change is coming, too. Rules for money market reform, reducing reliance on credit rating agencies, improving markets by regulating dark pools and reducing advantaged practices such as flash orders and unfiltered market access are on the way, she said. And also in the future, the agency will be tackling issues involving the municipal securities markets, the relationship between retail clients and their brokers and advisers, the mechanics of proxy voting and the role of advisory firms.

As Schapiro put it, "it has been a whirlwind year."

Get ready for more of the same.