Reality Check: Financial Regulatory Reform Off to a Slow Start

25 June 2010 - New York

A preliminary analysis by CFA Institute of the financial regulatory reform bill reveals few significant changes that will improve the integrity of capital markets. In anticipation of votes by the full Senate and House next week, CFA Institute has identified several concerns:

Systemic Risk: The House approach of designating a council of regulators to be responsible for detecting and managing systemic risks in the financial system has apparently prevailed. A truly independent oversight structure with investigative authority and resources would be better positioned to identify mounting systemic risks without the distraction of bureaucratic turf battles.

OTC Derivatives: The instruments at the heart of the financial crisis need much closer regulation than is suggested in the reform bill, which permits many loopholes for continued use and proliferation of OTC products as well as only surface changes in how banks will use them in proprietary trading or hedging activities.

Corporate Governance: The bill affirms the SEC’s authority to determine proxy access rules, but does not impose parameters on any potential new rules. Thus, a full range of opinions can inform the SEC rulemaking process. A provision to require majority voting in board elections did not survive to the final bill, so this remains to be resolved on a company-by-company basis or by amendment to state corporate law.

Auditing of Risk Controls: The bill includes exemption of companies with market value of US$75 million or less from compliance with provisions of Sarbanes-Oxley 404(b), which requires auditors to attest to management’s assessment of internal controls over financial reporting. Investors will be denied this objective review which can identify weaknesses or issues that might otherwise be exploited to perpetrate frauds.

Fiduciary Duty: A decision on mandating a uniform fiduciary standard for those providing investment advice is deferred pending further study by the SEC, despite significant resources already having been devoted to study of the issue. However, the bill does confirm the SEC’s authority to require broker-dealers who offer investment advice to act in their clients’ best interests, a positive step towards a uniform fiduciary standard of care.

“Much of the attention in the past week has been focused on restriction and reform of banks, especially with regard to their proprietary trading and derivatives operations,” noted Kurt S. Schacht, CFA, managing director of CFA Institute. “In the end, we don’t see many consequences for the banking industry. Its lobbying resources were successful in watering down the final package so that it fails to impose any serious change on Wall Street.”

“One issue we thought deserved much more serious effort is systemic risk oversight,” added James Allen, CFA, head of Capital Markets Policy at CFA Institute. “All this bill does is provide a forum for existing regulators to meet with no robust process to investigate, monitor, and mitigate building systemic imbalances. This is very disappointing and may not be enough to prevent a future crisis."

“The good news is that we have at least begun the reform process,” said Schacht. “These efforts take years to get right. Just look at the continued tinkering with Sarbanes-Oxley. What happens next is that investors will turn their focus to the regulatory and standard-setting rulemaking process to ensure that investor and taxpayer perspectives are considered as the new rules are implemented and refined.”

Schacht concluded, “We have a lot of work to do but at least we are on our way to filling regulatory gaps and protecting markets and investors. This is an important development."