July 1, 2010
Authored by: Bryan Cave
On June 28, 2010, the House and Senate conferees approved the financial regulatory reform conference report (known as the “Dodd-Frank Wall Street Reform and Consumer Protection Act”), and on June 30, 2010, the House approved a bill that has almost was almost identical to the conference report, except for a change in the so-called “pay-for” amendment (as discussed here). The Senate is now poised to vote on the legislation. As expected, the final version of the bill incorporates provisions to increase investors protections (see Title IX, Subtitle A) and to increase regulatory enforcement and remedies (see Title IX, Subtitle B).
Increasing Investor Protection
The regulatory reform bill would establish within the SEC three new “advocates” for investor protection: the Investor Advisory Committee, the Office of the Investor Advocate, and ombudsman.
The Investor Advisory Committee will advise and consult with the SEC regarding a number of issues related to investor protection, including the regulatory priorities of the SEC; issues related to regulating securities products, trading strategies, fee structures, and the effectiveness of existing disclosure requirements; initiatives to protect investors; and initiatives to promote investor confidence and the integrity of the securities marketplace. This Committee’s members will be appointed for four years and will consist of the Investor Advocate (discussed below), a representative of the State securities commission, a representative of the interests of senior citizens, and not fewer than 10 or more than 20 members representing individual equity and debt investors, and institutional investors who are knowledgeable about investment issues and have reputations for integrity.
The Committee is required to submit findings to the SEC and to make recommendations, including recommendations for legislative changes, to help better protect investors. Given the breadth of areas on which the Committee will advise and consult with the SEC and broad swath of interests ostensibly to be represented by the Committee’s members, it seems clear that the bill is attempting to ensure that the SEC adopts a more expansive and diverse view of its role as a protector of individual investors.
The Office of the Investor Advocate will be headed by the Investor Advocate who will be appointed by the Chairman of the SEC, in consultation with the SEC’s commissioners. The Investor Advocate will be responsible for staffing the Office to assist individual investors in resolving issues with the SEC or with any self-regulatory organization (e.g., the New York Stock Exchange). The Office will also be responsible for identifying areas in which to improve protections for individual investors.
The Investor Advocate will also be responsible for naming the ombudsman. The ombudsman will act as a liaison between the SEC and individual investors to help resolve any issues that an investor may have with the SEC or a self-regulatory organization.
The bill also grants to the SEC the authority to impose on brokers and dealers a fiduciary duty to ensure that the broker or dealer is acting in the client’s or customer’s best interests. To aid brokers and dealers, the SEC will help prepare simple and clear disclosures about the terms of the relationship between a client or customer and the broker or dealer.
In addition to these new investor advocates and the ability to impose a fiduciary duty on brokers, dealers, or investment advisors, the reform bill requires the SEC and Comptroller General (i.e., the head of the Government Accountability Office), to conduct numerous studies, all of which are aimed at ensuring or improving, or both, investor protections. For example, the SEC must conduct studies to do the following:
To evaluate existing legal and regulatory standards of care for brokers, dealers, and investment advisors, to determine whether there are gaps in the protection of individual investors under these standards;
To determine the need for enhanced examination of and enforcement resources against investment advisers;
To identify the financial literacy of investors, the methods for improving disclosures, the most useful and understandable relevant information that individual investors use in making investment decisions, methods for increasing transparency, and effective efforts to educate investors and increase financial literacy of investors to increase improve investor behavior; and
To identify ways to improve access by investors to registration information about registered and previously registered investment advisers, brokers, and dealers.
Further, the Comptroller General must conduct studies to do the following:
To identify existing mutual fund advertising requirements and practices, the impact of advertising, and methods to improve investor protections;
To identify and examine potential conflicts of interest between staff of investment banking and equity and fixed-income securities analysts functions within the same firm to determine whether any potential or real conflicts of interests may harm investors; and
To analyze the effectiveness of state and Federal regulations that are intended to protect investors and other consumers from individuals who hold themselves out as individual planners.
It is clear that these new “advocates,” the potential imposition of a fiduciary duty on brokers and dealers, and the myriad studies that the bill requires will impact the marketplace. However, because of the unavoidable delay between conducting the studies, analyzing the results, making recommendations, and then having the SEC act on those recommendations, the impact of the bill on these matters is unlikely to be felt for some time, and the true significance of the impact will ultimately depend on what further actions the SEC decides, as a result of these studies, to take via its rule-making power.
Increasing Regulatory Enforcement and Remedies
The regulatory reform bill also looks to increase investor protections by strengthening regulatory enforcement and remedies. The most significant step is the creation of potentially significant financial incentives for whistleblowers to report to the SEC violations of securities laws. A whistleblower will receive, in certain circumstances, between 10% and 30% of collected sanctions for actions where the sanctions collected are $1 million or more. The whistleblower is protected from discharge, demotion, suspension, threats, harassment, or other discrimination based on blowing the whistle by creating disincentives for such discrimination. Specifically, a whistleblower who alleges discrimination and prevails is entitled to reinstatement with the same status, two times back pay with interest, compensation for litigation costs, any expert witness fees, and reasonable attorneys’ fees.
Other steps at aimed increasing regulatory enforcement and remedies include the following:
The SEC will have the power to prohibit or impose conditions on the use of agreements by any broker, dealer, or investment advisor that would require a customer or client to arbitrate any future disputes arising under the federal securities laws.
Any person subject to a final order from a regulatory agency that bars that person from associating with a regulated entity or engaging in the banking business, and any person who has been convicted of a felony or misdemeanor involving the purchase or sale of securities or a false filing with the SEC, will be disqualified from participating in any Regulation D offering.
The SEC’s authority to pursue actions for aiding and abetting any person who violated the federal securities laws is strengthened, and the standard of knowledge required to find guilty someone alleged to have aided and abetted is lowered from “knowing” to “reckless.” In addition, aiding and abetting penalties will be the same as those for commission of the actual violation of the federal securities laws.
All persons having custody of securities of a registered investment company (e.g., a mutual fund) are subject to reasonable periodic, special, or other examination requests by the SEC.
These steps to increase regulatory enforcement and remedies are significant and are inline with the many other steps in the bill aimed at increasing protections for individual investors.