By John Thackray

Like a terrier with a rat in its jaws, Congress refuses to let the issue of derivatives accounting drop.

Bowing to congressional criticism of the new derivatives disclosure requirements, SEC chairman Arthur Levitt agreed to take an extraordinary step back. In late April, he announced that the rule's impact would be studied a year hence instead of three years, as originally planned. In letters to Sen. Phil Gramm (R-Texas) and Rep. Michael Oxley (R-Ohio), Levitt further promised that in the future the SEC would do a much better job of analyzing the economic impact of its proposed regulations. Levitt was eager to be in compliance with the National Securities Markets Improvement Act, which was passed last year, and which Gramm's Subcommittee on Securities has accused of ignoring when framing its derivatives disclosure rules.

If Levitt imagined that this conciliatory gesture would silence critics on the Hill, he was wrong. An aide to the senator noted that the letter did not really address Gramm's demands-a pilot study and a much more credible cost estimate of compliance. Says the aide: "We are still waiting for a substantive response from them."

Compliance costs are perhaps the most polarized disagreement. The senator and his staff have faith in some users' testimony that the SEC's $8,000 average annual cost is between 10 and 100 times below true costs. This is a tricky figure to arrive at, because it is a negligible increment for a company that is already doing intensive risk management analysis and colossal for one that has to install a derivatives accounting system from scratch. "Eight thousand dollars is where it stands at the moment," says an SEC spokesman.

This standoff could be broken sometime soon. Appropriations season will open in a few months, during which the SEC's budget will be under review. Says Gramm's aide: "This will give us a vehicle to bring up the matter."

It is not just the SEC that has to fear Gramm's flack. He's fired a salvo across the bow of the FASB's proposed derivatives accounting rules, warning in a letter that "the FASB would be making a mistake with serious consequences for the financial markets." The FASB project (five years in the making) will almost certainly fail to make its June 30 deadline. Maybe October. And maybe then it won't be a set of rules but, instead, yet another exposure draft, followed by more public hearings and debate in which preparers will gain ground over the needs of users of financial statements.

The "d" word remains one of the most politically charged in the English language, as the Broker-Dealer Sales Practice Committee of the North American Securities Administrators Association (NASAA) found out last month. For the past two years a NASAA team from this body of 65 state and provincial securities regulators has been working on an update of several existing NASD standards on dishonest and unethical sales practices that bear on investment suitability. Failure to toe the line on suitability can, in theory, give the regulators power to pull a broker/dealer's license.

The NASAA gave birth to an exposure draft that it imagines really noncontroversial. Then bam! It got hit with an overwhelming negative response from groups such as the Security Industries Association, the Public Securities Association, the Investment Company Institute and Merrill Lynch. "We were surprised at the breadth and intensity of the comments," says William Mohr, vice chairman of NASAA's sales practice committee. "I don't quite understand it. There is nothing ground-breaking here: 'suitability' has always been a bedrock of securities law."

Even so, these standards rile broker-dealers in a couple of ways. First, the current patchwork of NASD rules apply in some states and not others. By replicating all of them and lumping them into one unified document, the regulatory net has fewer holes, and it gives more security enforcers and judges a weapon against broker-dealers who sell unsuitable securities. Second, NASAA specifically mentioned the "d" word, which most current NASD standards do not. "Recent state and municipal fiascoes involving unsuitable purchases of derivatives, either directly or through mutual funds, warrants [sic] attention to more than the needs of the individual investor," says the NASAA brief.

Little wonder that the Public Securities Association "strongly opposed" the model suitability rule because of its failure to address the different character of the retail and institutional markets. The PSA claimed that "Introducing a new state suitability rule would add to, rather than ameliorate, the complexity, cost and interpretative difficulties that arise due to conflicting state, federal and self-regulatory requirements."

Are broker-dealer groups overreacting? Probably not. "In the coming months "there will be plenty of time to revise and change, if we think it necessary," says Leslie Scott, chairwoman of the drafting committee.

A year and three-quarters after the appearance of the Principles & Practices for Wholesale Market Transactions, one its architects, Ernest Patrikis, first vice president of the Federal Reserve Bank of New York, sent out invitations to a May 8 meeting to discuss a document that has generated an unusual amount of contention. On the agenda were four items: honesty and fair dealing principles, authorization to deal and the appropriate documentation, special policies and documents for dealing with state and local government as counterparties, and principle/agency. "The question in our minds was, Did anyone see the need to improve Principles & Practices? Nothing, after all, is perfect. Everything can be improved," Patrikis observes.

There were a number of invitees, long-standing critics who were dying to express themselves. Alas, the meeting was canceled. According to Patrikis, the scheduled date was in conflict with other meetings, so that a good number of the dealers that were asked couldn't make it. The gathering, he says, will be rescheduled for the fall.

But the plot thickens. Apparently a number of uninvited state and local government groups asked to be included when they heard about the party. Now they have been informed that when the meeting is rescheduled they will be limited to one representative between them.

One source close to the situation speculates that the cancellation could be partially explained by the second and third items on the agenda, namely the "authority to deal" in the case of state and local governments, a particularly hot topic on the conference and seminar circuits lately because of arguments that have been aired in the Orange County case. Airing of the agenda, coincidentally, was just what some broker-dealers didn't want-fearing that it would only inflame the opposition to Principals & Practices. Perhaps that is why the dealers told Patrikis they had other engagements that day.