Financial Institutions Join Reform Debate

In the year-long parade of plans and proposals for how to ensure the United States retains its competitive edge in the global marketplace, the nation’s leading financial institutions are calling for an overhaul in the regulatory regime.

The Financial Services Roundtable—a think tank with 100 members representing America’s banking, insurance, and investment sector—says America can retain its advantage in world markets if Congress and various regulatory agencies, most notably the Securities and Exchange Commission, reinvent the regulatory approach. The roundtable published its 68 specific recommendations in a 150-page report, titled “Blueprint for U.S. Financial Competitiveness.”

The “blueprint,” named as such because the roundtable wanted to focus on action steps rather than present a wish list of concepts, calls for a more principles-based approach of “prudential supervision” coupled with litigation reform. Prudential supervision means regulation would be driven not by enforcement actions, but by constructive and cooperative dialogue between regulators and the management of financial services firms.

“Prudential supervision is not lax supervisions,” says Steve Bartlett, president and CEO of the Financial Services Roundtable. “It’s putting the regulator right there to assure the rules are being followed. It gets the job done faster.”

Bartlett

Bartlett says the approach is standard in the U.S. banking sector and in other countries abroad, especially the United Kingdom. “It’s a well-established process that could be used, getting rid of the ‘gotcha’ mentality.”

In that respect, the roundtable blueprint echoes other proposals offered in the past several months, including a plan published last year by the Committee on Capital Markets Regulation (the so-called Paulson Committee, after Treasury Secretary Hank Paulson).

Committee Director Hal Scott, a professor at Harvard Law School, says prudential supervisions puts more emphasis on identifying and working out problems than on penalizing infractions.

“It creates a climate in which companies are more open, more willing to reveal their dirty laundry, because they’re not going to be slapped down in a public way,” Scott says. Instead, the U.S. approach typically is to clean up a mess after the fact. “Things happen, then we go after them. It would be better if the things didn’t happen—if it were nipped in the bud.”

Scott’s committee and Bartlett’s roundtable differ, however, in their views on litigation reform. Both agree that aggressive litigation and concerns about legal liabilities are a financial ball-and-chain for American companies compared to their counterparts abroad.

“We both see a problem there, and it’s clear that it has a big effect on our competitiveness,” says Scott. “Whatever we know, in talking to people who are deciding whether to come to the U.S. or not, our securities class action system is a huge negative to them.”

But the groups disagree in their recommended solutions. The financial services blueprint says Congress should reform securities class-action litigation rules to give the SEC the lead in correcting problems. It lists 19 specific recommendations for rules that should be changed to enable and complement a more principles-based approach to regulation and prudential supervision.

“Securities and litigation reform go hand-in-hand,” says Bartlett. “We think the SEC should be the enforcer providing protection for consumers in the event of violations. When we have an active case, then that case should be brought on behalf of the American people. Only if it is dismissed should private class-action lawsuits be invited. It should at best take a second seat.”

TALKING POINTS

Below is an excerpt of the report from the Financial Services Roundtable.

From time to time, Congress and financial regulators have taken steps to attempt to reduce the complexity and cost of financial regulation. A variety of federal laws and executive orders requires federal regulatory

agencies to assess the cost and impact of proposed rules. These laws and regulations include the Regulatory Flexibility Act, the Paperwork Reduction Act, and the Unfunded Mandates Reform Act.

In practice, however, these assessments have had little practical effect on the regulatory process because federal agencies generally underestimate the cost of compliance. Recently, for example, the federal financial regulatory agencies jointly issued a proposal for a model privacy notice to satisfy the provisions of the Gramm-Leach-Bliley Act. The agencies concluded that the proposed notice would

not result in a cost to the economy of more than $100 million, and thus would not trigger the requirement for a cost-benefit analysis. Yet, Roundtable members found that the costs of preparing and mailing the proposed notice would cost several times the $100 million threshold.

The federal banking agencies are also required, by law, to review existing regulations at least once every 10 years to identify any regulatory requirements that are outdated, unnecessary, or unduly burdensome. The federal banking agencies have taken this mandate

seriously, and several regulatory changes have resulted from this requirement. Nonetheless, these changes have been at the margin; they do not represent any fundamental realignment or reduction of regulatory burden imposed on providers of financial services and ultimately borne by consumers.

In summary, our highly complex regulatory system, combined with a prescriptive approach to writing federal laws and implementing regulations, and potential litigation risk have created a strong bias for rules over principles. As described below, the United Kingdom has decided to take a different path—with the intent of making its financial markets and financial firms more competitive and responsible to consumers.

Source

FInancial Services Roundtable

Scott says the Paulson Committee recommends a more market-based approach, encouraging shareholders to decide for themselves whether and how to curb excessive litigation. The committee suggests that shareholders who worry about class actions should work to amend corporate charters company by company to provide alternatives to class actions.

“There was a very heated argument over whether class actions were in the interest of shareholders,” Scott says. “We said let shareholders decide what they want to do about that on a company-by-company basis. There are a number of possible solutions that could all be decided by shareholder vote on an individual company basis.”

More and More Committees

The blueprint offered by the Financial Services Roundtable is the latest in a string of proposals that offer solutions for how to keep America competitive in the global marketplace. In addition to the Paulson Committee’s proposal last fall, other recent plans include recommendations by a bipartisan commission convened by the U.S. Chamber of Commerce and a proposal by New York Mayor Michael Bloomberg and Sen. Charles Schumer, D-N.Y.

Scott says some movement is already afoot that would suggest the United States is ready for more radical change. “One thing that has clearly changed in the year since we issued our report is that people think there is a problem,” he says. “If you went back a year, it wasn’t clear and there was a lot of argument about the competitiveness issue. Now the consensus is there.”

Bartlett says the financial services group is encouraged by some recent developments, including some suggestions that New York’s regulation of insurance should embrace a legislative proposal to create a more nationally cohesive, principles-based approach to insurance regulation. “I think these concepts are gaining a lot of momentum,” he says. “We’ve got a long way to go. We’ve got a big old battle ship that’s been headed in a different direction for 100 years.”

Scott

Scott also points to a number of regulatory developments in recent months that suggest the tide is shifting. The SEC and the Public Company Accounting Oversight Board have redirected Sarbanes-Oxley Section 404 implementation to focus more on a risk-based approach. The SEC also has made it easier for foreign companies to deregister from U.S. exchanges. “If you tell a foreign company they can never leave, they’ll never come in the first place,” Scott says.

Scott lauds early movements toward accounting under International Financial Reporting Standards, with the SEC considering allowing IFRS-based statements without reconciliation to U.S. Generally Accepted Accounting Principles, and he applauds the Justice Department for its recently modified approaches for how it will prosecute corporate wrongdoers.

“From what I can tell, there’s bipartisan interest in solving this, so if there’s a change in administration in the next election, I don’t expect it will mean all this will be thrown out the window,” he says. “We’re headed in the right direction.”