June 29, 2007

SEC Commissioners Discuss Fee-Based Accounts; Muni Disclosures and a Variety of Other Issues in HFSC Appearance

Appearing before the House Financial Services Committee this week, the five commissioners of the Securities and Exchange Commission (SEC) faced questions related to a variety of issues. It was the first time in almost a decade that all five commissioners appeared before Congress together. The Commissioners discussed the SEC's recent decision not to appeal the U.S. Court of Appeals decision regarding fee-based brokerage accounts; the recent SEC roundtable on 12b-1 fees; and the SEC's other investor protection initiatives. Other issues discussed during the hearing, included excessive litigation; the U.S. financial regulatory structure; market data fees; soft dollars; municipal bond disclosures and mandatory arbitration.

SIFMA submitted comments this week in response to the Senate Finance Committee's bipartisan staff discussion draft on basis reporting.

SIFMA joined four other financial industry associations in a letter to the leaders of the Senate Banking and House Financial Services Committees outlining their collective review of market and regulatory responses to address subprime mortgage lending issues.

The House Foreign Affairs Committee approved a bill (H.R.1400) that would impose new economic sanctions against Iran by a vote of 37-1.

The House Financial Services Committee approved a non-binding resolution this week calling on the financial services industry to take active measures to increase the diversity among its employees.

The Senate Finance Committee held a hearing on proposals to reform the alternative minimum tax (AMT).

Issues in the subprime mortgage market continue to be a focus of lawmakers. The Senate Banking Subcommittee on Housing, Transportation and Community Development held a hearing on mortgage abuse this week.

The federal financial regulatory agencies (the Federal Reserve Board, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the National Credit Union Administration) issued a final Statement on Subprime Mortgage Lending this morning, which describes the safety and soundness and consumer protection standards institutions should follow. The Statement says institutions should include a fully indexed, fully amortized qualification for borrowers. Institutions should have clear policies governing the use of risk-layering features, including an expectation that stated income and reduced documentation should only be accepted if there are documented mitigating factors that clearly minimize the need for verification of a borrower's repayment capacity. The agencies encourage institutions to work with borrowers in default or whose default is foreseeable. Institutions should provide consumers with information that enables them to clearly understand the terms, costs, and risks of loan products at a time that will help consumers select a loan product.

Treasury Secretary Henry Paulson announced the second stage of his capital markets competitiveness plan this week, focused on efforts to modernize the regulatory structure for all U.S. financial service providers. The announcement follows Treasury's first set of initiatives announced in May, which focused on strengthening financial reporting. The next steps of the plan include: 1) pursuing a modernized regulatory structure; 2) encouraging development and adoption of industry best practices for asset managers and investors in hedge funds; 3) modernizing Treasury's cash management and debt management systems; 4) completing Basel II rulemaking; 5) improving financial education; 6) encouraging international investment opportunities with recognition of comparable regulatory regimes.

A report released by the Senate Permanent Subcommittee on Investigations recommended Congress eliminate the exemption of electronic energy exchanges from regulatory oversight. The report found Amaranth Advisors had a direct effect on U.S. natural gas prices and increased price volatility in the natural gas market. The report also found current restraints on speculative trading to prevent manipulation and price distortion are inadequate and the Commodity Futures Trading Commission (CFTC) lacks budgetary, staff and technological resources to effectively monitor the energy commodity markets. The report recommended 1) granting the CFTC regulatory oversight of the electronic energy exchanges; 2) the CFTC strengthen its monitoring of the New York Mercantile Exchange (NYMEX) and other energy trading activities on a continual basis, not just when contracts are near expiration and 3) Congress should substantially increase the CFTC budget and authorize user fees to help pay the additional cost of enforcement.

The Government Accountability Office (GAO) released a report this week on conflicts of interest related to defined benefit pension plans. The GAO's analysis of the financial returns of pension plans assisted by 11 pension consultants that disclosed conflicts of interest and of plans assisted by 13 consultants who had material conflicts of interest they did not disclose, found the plans using the 13 consultants had annual returns that were 1.2 to 1.7 percentage points lower in 2000-2004 than the plans using the 11 consultants. The GAO said that because many factors can affect returns and modeling limitations limit the ability to generalize and interpret the results, these findings should not be considered as proof of causality between consultants and lower rates of return. The GAO recommended the Pension Benefit Guaranty Corporation (PBGC) assess the risks from conflicts of interest; the Employment Benefits Security Administration (EBSA) expand enforcement to include a focus on PBGC-identified plans; and for each agency to share data on conflicts. The GAO also recommended Congress consider amending the Employee Retirement Income Security Act (ERISA) to expand the Labor Department's authority to recover losses against non-fiduciaries. The report was requested by House Labor and Education Committee Chairman George Miller (D-CA) and Rep. Edward Markey (D-MA). The House Labor and Education Committee will likely hold a hearing on conflicts of interest in July.

Sen. Tom Harkin (D-IA) introduced legislation (S.1725) to require corporations who provide deferred-compensation plans for executives to also provide a guaranteed defined benefit pension plan for all employees. The Restoring Pension Promises to Workers Act of 2007 would prohibit the elimination of accrued benefits during mergers and acquisitions; prevent a plan participant from paying for a plan's calculation mistake if it would cause significant hardship to the individual; prevent plans from cutting benefits for people who retired before the cutbacks were adopted by the plan; and protect pensions for surviving spouses of deceased federal employees and former spouses of federal employees.

The Social Security Number Online Protection Act (S.1691), introduced by Sen. Charles Schumer (D-NY), would restrict the display of all of or a portion of a person's social security number on the Internet by state or local governments.

Rep. Greg Meeks (D-NY) and Rep. Vito Fossella (R-NY) introduced legislation (H.R.2868), which would allow exchanges to establish developmental tiers to expand listing opportunities in the U.S. for smaller companies. Under the bill, all securities listed on a developmental tier would be subject to Securities and Exchange Commission (SEC) oversight and state blue-sky regulations.

Reuben Jeffery resigned as Chairman of the Commodity Futures Trading Commission (CFTC) this week to become the undersecretary of State for Economic, Energy and Agriculture Affairs. Commissioner Walter Lukken was named as Acting Chairman. Also this week, the Senate Agriculture Committee this week considered the nominations of Jill Sommers and Bartholomew Chilton to be commissioners of the CFTC.

The SIFMA Washington Weekly will not publish next week due to the Congressional 4th of July recess. The Weekly will return on Friday, July 13.

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SEC Commissioners Appear before HFSC

The five commissioners of the Securities and Exchange Commission (SEC) appeared before the House Financial Services Committee this week to discuss investor protection and market oversight. SEC Chairman Christopher Cox gave the joint opening statement on behalf of the other commissioners. In the opening statement, Cox outlined the SEC's initiatives including the creation of working groups within the Enforcement Division to focus on hedge fund insider trading, stock options backdating, microcap fraud and fraud in subprime loan securitization packages. Cox also discussed the SEC's initiative to improve the quality and clarity of mutual fund and 401(k) disclosures-including a review of 12b-1 fees. The SEC is also exploring areas where regulatory convergence and harmonization in the global marketplace are possible. House Financial Services Committee Chairman Barney Frank (D-MA) said the Committee will focus on market harmonization in the coming months.

Chairman Christopher Cox said the SEC did not appeal the U.S. Court of Appeals decision regarding fee-based brokerage accounts, because its lawyers said the case would not be reviewed by the Supreme Court. Chairman Cox said the SEC asked for a stay through October, because that is the amount of time they believe is needed to address the Court's decision. On the issue of market data, Chairman Cox said the SEC is currently reviewing fee proposals and will make decisions within a matter of months. Responding to questions about his recent letter calling for a revision or repeal of the soft dollar safe harbor, Chairman Cox said there is no question the SEC's 2006 Interpretative Guidance on soft dollars has provided clarity. However, the SEC is limited statutorily from doing anything more to address conflicts of interest and high brokerage fees related to the use of soft dollars. On the issue of 12b-1 fees, Cox said the 12b-1 rule was created when the industry was in its infancy and it is time now for a top to bottom review. Responding to a question about the recent SEC Roundtable on 12b-1 fees, Cox said the SEC learned a great deal during the roundtable and is currently reviewing the information. According to Cox, rumors the SEC was going to require mandatory arbitration for securities class actions were just rumors-there are no proposals pending.

Chairman Cox agreed the U.S. financial regulatory structure is balkanized and could pose challenges as markets integrate globally. Cox suggested Congress conduct an inter-committee, bipartisan, bicameral review of the current U.S. regulatory scheme to rationalize the regulation of products that are increasingly competing with one another. The SEC hopes to put out a concept release on principles v. rules-based regulation this summer to see what the marketplace thinks about the issue. Responding to questions on municipal bond disclosures, Cox said he was concerned with the use of swaps by municipalities. Cox said unfortunately, the SEC only has enforcement authority over the municipal bond market. He also suggested improvements can and should be made to municipal bond disclosures to make them more "user friendly."

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SIFMA Submits Comments on Basis Reporting Proposal

SIFMA submitted comments this week on the Senate Finance Committee's bipartisan staff discussion draft on basis reporting released May 20. The proposal would expand gross proceeds reporting requirements for brokers and require brokers to report the adjusted basis of securities sales to taxpayers and the Internal Revenue Service (IRS). In its comment letter, SIFMA offers specific recommendations it believes are necessary to implement effective basis reporting systems that improve on today's "best efforts" practices. Specifically, SIFMA strongly opposes the proposal to extend gross proceeds reporting (and adjusted basis reporting) to corporate customers and recommends this proposal be dropped. Corporations are currently exempt from gross proceeds reporting because the information reported by brokers and their corporate customers will often differ due to timing and accounting differences, which could lead to numerous mismatches, making it difficult for the IRS to identify actual noncompliance. SIFMA recommended the Secretary of the Treasury be granted broad regulatory authority to implement the new reporting requirements and to provide safe harbors, uniform adjusted basis calculation rules, simplifying assumptions and limited exceptions if justified.

In its comments, SIFMA also recommended making the new reporting requirements effective for securities acquired 18 months after the Treasury regulations are finalized (rather than 18 months after date of enactment). The Senate Finance Committee proposal creates some uncertainty as to for what securities adjusted basis reporting is required. SIFMA said the definition of "applicable security" should be clarified. SIFMA also suggested incorporating the Reduce Wasteful Tax Forms Act (S.636), introduced in February by Sen. Charles Schumer (D-NY), into the proposal. S.636 would delay the filing deadline for 1099 statements by two weeks from January 31 to February 15. This extension would reduce the number of corrections needed, mitigate challenges raised by post-year-end reclassifications and facilitate other requirements under the basis reporting proposal.

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Financial Industry Associations Call for Balance

SIFMA, the American Securitization Forum (ASF), the Mortgage Bankers Association, the Financial Services Roundtable and the Housing Policy Council sent a letter to Senate Banking Committee Chairman Chris Dodd (D-CT), Ranking Member Richard Shelby (R-AL) and House Financial Services Committee Chairman Barney Frank (D-MA) and Ranking Member Spencer Bachus (R-AL), outlining their collective review of market and regulatory responses to address subprime mortgage lending issues. The associations say any policy changes should seek to balance personal accountability among borrowers with appropriate regulation of originators and lenders and the need to protect consumers with a desire to ensure a free flow of reasonably priced capital to worthy borrowers and continued innovation in consumer lending products. The groups caution over- or unclear regulation of the subprime mortgage lending market or the imposition of unquantifiable liability on lenders or investors will result in less capital availability for qualified borrowers.

The letter outlines the organizations' support for clearer consumer disclosure; education; counseling and uniform broker regulation. In the letter the organizations suggest lenders should evaluate a borrower's ability to repay based on the application of prudent, but flexible credit underwriting standards. The organizations believe mortgage servicers should use the latitude they are granted in contractual servicing and loan agreements to modify loan terms for borrowers in trouble to keep their homes. At the same time, however, they strongly oppose mandated loan forbearance or other modifications not supported by loan or service contracts. The organizations also warn imposing assignee liability has the potential to limit the availability of mortgage credit and damage the overall mortgage market.

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House Foreign Affairs Committee Approves Iran Sanctions Bill

The House Foreign Affairs Committee approved legislation (H.R.1400) that would impose new economic sanctions against Iran 37-1. The Iran Counter-Proliferation Act would expand the types of investments subject to sanctions; restrict exports of some U.S. products to Iran; and prevent U.S. subsidiaries of foreign companies that invest in Iran's oil sector from receiving U.S. tax benefits for oil and gas exploration. H.R.1400 would also withdraw the authority of the president to waive sanctions required under the Iran Sanctions Act of 1996 against foreign companies investing in Iran's energy industry. The bill was referred to the House Financial Services Committee; the House Ways and Means Committee; the House Oversight and Government Reform Committee; and the House Judiciary Committee.

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HFSC Approves Non-Binding Resolution Calling for Increased Diversity in Financial Services Industry

The House Financial Services Committee approved a non-binding resolution (H.Con.Res 140) this week, which recognizes the low presence of minorities in the financial services industry and minorities and women in upper level positions of management. The resolution expresses the sense of the Congress that active measures should be taken to increase the demographic diversity of the financial services industry. Committee Chairman Barney Frank (D-MA) said his message to the financial service industry is approval of the resolution is the "first step." Chairman Frank indicated there will be follow-up hearings on the subject.

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Senate Finance Committee Examines AMT

During the Senate Finance Committee hearing this week on proposals to stop the broadening impact of the alternative minimum tax (AMT) on taxpayers, Finance Committee Ranking Member Charles Grassley (R-IA) said he intends to introduce legislation to create a safe harbor for taxpayers who become liable for the AMT for the first time in tax year 2007. Grassley said since Congress has not enacted AMT relief for 2007, his bill will allow taxpayers to disregard the AMT for 2007, if the taxpayer did not have to pay the AMT in tax year 2006. Finance Committee Chairman Max Baucus (D-MT) said he wants to enact a two-year AMT patch this year. Baucus said he is also exploring "politically realistic" proposals to replace the current AMT structure. Dr. Leonard Burman, Director of the Tax Policy Center, Urban Institute and Michael J. Graetz, Justus S. Hotchkiss Professor of Law, Yale Law School, suggested improved compliance through enhanced cost basis reporting as one possible way to pay for AMT reform. Burman, Graetz and Dr. Kevin Hassett, Director of Economic Policy Studies, AEI, suggested Congress eliminate the state and local tax deduction. Burman recommended changing the state and local tax deduction to a tax credit. Graetz recommended capping the state and local tax deduction and limiting the Home Mortgage Interest Deduction to one home. Chairman Baucus said the Senate Finance Committee will hold additional hearings this year on AMT reform.

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Senate Banking Subcommittee on Housing Examines Mortgage Abuse

A Senate Banking Subcommittee on Housing, Transportation and Community Development hearing on mortgage abuse this week focused largely on origination in the mortgage lending process and the role and duty of mortgage brokers. Subcommittee Chairman Charles Schumer (D-NY), who introduced a bill (S.1299) that would establish a fiduciary duty for mortgage brokers and other non-bank mortgage originators, strongly supported 1) requiring loans be written to the fully indexed rate for the life of the loan; 2) requiring escrow to be included in subprime mortgages; and 3) requiring lenders to evaluate a borrower's ability to repay the loan. Subcommittee Ranking Member Mike Crapo (R-ID), cautioned efforts to correct issues in the subprime lending market should try to find the "right balance" so the availability of credit is not compromised. He suggested Congress examine 1) Is there market discipline? 2) Is a regulatory regime necessary? 3) Is legislative authority needed-or can regulation alone be responsive?

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© 2007 The Securities Industry and Financial Markets Association