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News August 31, 2015 Issue

Stand Strong against Prudential Regulators, Gallagher Tells SEC in Swan Speech

Daniel Gallagher took advantage of what he said will likely be his final formal speech as an SEC commissioner to urge the SEC and its Division of Investment Management to hold off other regulators that seek to encroach on the SEC’s role in regulating capital markets.

The SEC commissioner, who built a reputation during his four years to date on the Commission as something of a firebrand when making his arguments, also used the speech this month before the U.S. Chamber of Commerce to reinforce his past calls for the agency to "tread carefully" when bringing enforcement actions against compliance personnel, as well as making sure that the Division of Enforcement’s increasing use of administrative proceedings to try cases will continue to provide respondents with their due process rights. And he saved lots of words for what may be his least favorite piece of legislation: the Dodd-Frank Act and the resulting threat of prudential regulation.

"After four years of sprinting through a marathon course, my time at the Commission is drawing to a close," Gallagher said, in remarks that presaged his departure. "It has been an honor and a privilege to serve as a member of the Commission, and I hope my contributions have helped further the debate on how best to accomplish the mission of the SEC."

An early leave from the Commission by Gallagher, whose term actually expires in 2016, has been the subject of press speculation and industry scuttlebutt for several weeks. His remarks "indicate that he does not plan to stay at the Commission much longer," said Ropes & Gray counsel David Tittsworth. "I would be surprised if he leaves his position at the SEC before his replacement is nominated, but it is possible. For political reasons, it’s almost a sure bet that the White House will pair the nominations of the two people who are selected to replace commissioners Gallagher and Aguilar," whose term expires this year.

"It strikes me as the consummate swan song speech," said Willkie Farr partner and former SEC Division of Investment Management director Barry Barbash. "He touched on most of the major issues he raised during his time as a commissioner, ratcheting up the rhetoric a bit. He’s been a stalwart in support of the asset management industry as not being at fault for the problems of 2008 and 2009, and has served somewhat as a counterweight to those who want to see more regulation."

The SEC’s role

"The Commission needs to continue to assert itself as a competent and effective overseer of the asset management industry, which has been under attack from the prudential regulators since the financial crisis," Gallagher said. The Financial Stability Oversight Council and the Financial Stability Board – two of the prudential regulators that he said seek to have the government, rather than the market, dictate risk levels, as they do with banks – have not "abandoned their quest to de-risk the industry with prudential regulatory tools like capital requirements, which serve absolutely no purpose in an agency business," he said.

"The attempts by our prudential regulators and their international counterparts to de-risk the U.S. capital markets and make them look like the banking markets are not just philosophically wrong – they are an attack of U.S. competitiveness," Gallagher said. He later added that "when the SEC rotely rubber stamps the work of the prudential regulators and their umbrella organizations FSOC and FSB, we get less vibrant markets, more government backstops, more potential bailouts."

"For the sake of the millions of investors who depend on our asset management industry, the Investment Management Division must stand its ground and defend its purview," he said. He also praised the Division for adopting a "nuanced" money market fund rule and proposing new rules that would gather "better and more useful data" from funds.

"There is no doubt that the current rulemaking agenda of the Division of Investment Management is being driven by the SEC’s desire to bolster its data gathering and risk assessment activities related to the investment management profession," said Tittsworth. "This is one of the few issues where there appears to be unanimity among all of the SEC Commissioners – the SEC should retain its primary regulatory oversight of the investment management profession and resist efforts by the Fed and international banking regulators to assert prudential regulatory jurisdiction in this area."

Caution on enforcement

While urging the Division of Investment Management to be stronger in certain areas, Gallagher called on the Division of Enforcement to be a bit gentler in others – specifically in pursuing cases against compliance officers and staff, and the Division’s well-publicized use of administrative proceedings, rather than federal district courts, to hear cases.

He noted that he has repeatedly called on the SEC to use caution when bring enforcement actions against those with compliance responsibilities, "who are often the only line of defense we have in detecting and preventing violations of the federal securities laws. Recent enforcement actions holding compliance officers to a standard of strict liability will only serve to chill talented professionals from playing this vital role."

As for the ongoing debate over the Division of Enforcement’s increasing reliance of administrative proceedings, he noted that "we … need to remain focused on affording respondents the due process rights to which they are entitled." While noting that recent attention on the SEC’s use of administrative proceedings has brought about a healthy debate, "I am confident the Enforcement Division will heed outside voices calling for introspection, such as the [U.S. Chamber of Commerce’s] recent report in this area."

That July 2015 report, from the Chamber’s Center for Capital Markets Competitiveness, called on the SEC to adopt a policy that would, among other things, have the effect of limiting the use of administrative proceedings to certain circumstances, allow respondents to challenge the choice of forum, and allow any party named in an administrative proceeding that desires a jury trial to file a notice to remove the procedure to a federal district court.


Gallagher also made a point of praising the rise of the Division of Economic and Risk Analysis at the SEC, saying that DERA staff "is critical to analyzing the costs and burdens associated with the Commission rulemakings, which all too often have failed to accurately take into account the crippling and cumulative costs being placed on issuers and market participants." He said he would like to see DERA grow even further, bringing on more staff and further integrating "into the sausage making factory called SEC rulemaking."

As for the Office of Compliance Inspections and Examinations, Gallagher spoke in favor, as he has in the past, of third-party examinations, a concept recently backed by SEC chair Mary Jo White (ACA Insight, 3/23/15) this past March. Noting that OCIE has "come a long way since its low point following the financial crisis," he said that it, along with DERA and the Division of Enforcement, "must continue to work with the policymaking divisions, and resist the urge to undertake rulemaking through examinations."

Gallagher "cannot resist a gentle reminder of his personal support for third-party examinations of investment advisers," Tittsworth said. "It is not clear to me whether the SEC is actively working on third-party exam rulemaking and whether other commissioners would support such a proposal. If so, the rulemaking appears to be taking a back seat to rules designed to counter prudential regulation."

Dodd-Frank and prudential regulators

But perhaps Gallagher’s harshest words were aimed at the Dodd-Frank Act, which he said has "impaired the work of the SEC by placing it at a decided disadvantage to prudential regulators. "Dodd-Frank’s jurisdictional grants of authority to bank regulators were in large part the result of an unwitting Congress buying into a narrative contrived in large part by those very same regulators. The narrative held that, unlike clunky capital markets regulators like the SEC, prudential regulators were good enough and smart enough to run our economy – and doggone it, the 111th Congress liked it! [emphasis Gallagher]."