Congress: 1, SEC: 0
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.
'Suitability' Rules Rile Brokers
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