Speech by SEC Chairman:
Adoption of Regulation R Final Rules; Temporary Rule Regarding Principal Trades with Investment Advisory Clients

by

Chairman Christopher Cox

U.S. Securities and Exchange Commission

SEC Open Meeting
Washington, D.C.
September 19, 2007

Good morning. This is a meeting of the Securities and Exchange Commission under the Government in the Sunshine Act on September 19, 2007.

The first item on our agenda is a recommendation from the Division of Market Regulation to adopt a new set of rules, which we have worked out jointly with the Federal Reserve, that will finally implement the Gramm-Leach-Bliley Act as the Congress intended.

When the Gramm-Leach-Bliley Act modernized the legal rules governing the financial services industry eight years ago, the new law made it clear that implementing rules would be necessary. And indeed, without them, America hasn't yet fully achieved Congress's intended objectives.

The reasons for doing away with the artificial separations between different parts of the financial services industry in the modern world were obvious. A customer should be able to walk into a financial institution and get any financial product he or she needs — securities, insurance, banking, or trust services. That has been the direction the marketplace has been headed for some time, and investors stand to benefit from more choices, better services, and lower costs.

But Congress recognized that those benefits couldn't be achieved without new ways to safeguard investors that would be consistent with continued innovation. So in the end, the Gramm-Leach-Bliley Act tasked the Securities and Exchange Commission with writing the necessary rules to actually implement many of the law's detailed provisions. Congress recognized how difficult this whole process could be for some banks, and so the law included an 18-month implementation deadline. But that phase-in period was supposed to end in May 2001, a full six years ago.

All in all, the eight-year stretch from enactment of the Gramm-Leach-Bliley Act until today is a huge disappointment for investors, bank customers, and every consumer who's waited patiently for so long to enjoy the promised benefits and synergies that were anticipated when this landmark law was signed. It's high time that clear, final rules are issued under the Gramm-Leach-Bliley Act .

That's why it's such good news that the painstaking process the SEC, the Federal Reserve, and other banking agencies have followed over the last year has been entirely different from what's gone before. Everyone on all sides was committed to implementing the law as it was written, and to providing the reasonable exemptions to promote competition and protect investors that Congress intended. And more than that, this time everyone was committed to getting the job done.

By the time the Financial Services Regulatory Relief Act of 2006 established a joint rulemaking process between the SEC and the Federal Reserve, we and the other bank regulatory agencies were already six months into our work. That's why it was so easy for us to meet the statutory command of a proposed rule by year-end, and why the work product was so solid.

So today, the SEC will take up this historic proposal to enact final rules that we will call Regulation R, to replace the ill-starred proposed Regulation B that was bogged down in inter-agency negotiations for so many years. My fellow Commissioner, Paul Atkins, contends that Regulation B stands for "Regulation Broken" — and the new Regulation R stands for "Regulation Repaired." All of us can be proud that what for eight years has been broken will finally be fixed.

Following our action today, the Federal Reserve Board will take its action on Regulation R at an open meeting on September 24, 2007 — just five days from now. Regulation R will at long last establish clear rules under which banks and securities firms can provide financial services to their customers.

An important provision of the Gramm-Leach-Bliley Act amended the definition of "broker" in the Securities Exchange Act of 1934 so that banks would no longer be completely excluded from the broker-dealer registration requirements. At the same time, the new law created specific exemptions from those requirements. Regulation R will give effect to these bank broker exceptions in a way that accommodates the traditional business practices of banks, and at the same time furthers our goal of better protecting investors.

One of the major promises of the Gramm-Leach-Bliley Act is to stimulate greater competition in the financial services industry, and give investors a wider array of services at lower prices. Much of that has occurred, but not as much as was expected — in part due to ambiguity in the governing legal rules. So today's action is especially important to help bring the legislative promise of Gramm-Leach-Bliley to fulfillment.

This process, which culminates today, has been an arduous one. After a series of interim proposals and regulatory actions that proved mostly fruitless between 1999 and 2005, we made a fresh start of it 18 months ago. Here at the SEC we held the first of a series of meetings that included the Federal Reserve, the Comptroller of the Currency, the FDIC, and the Office of Thrift Supervision — and we pledged ourselves to complete this work at long last, and put final rules in place.

What we have before us today is in every respect a joint work product. There is enormous credit to go around, both here at our agency, and at the Fed and the other banking agencies. In my over 20 years in the Executive and Legislative branches, I have never seen a better example of professionalism, public service, and cooperation than this project that we are finally considering today.

So before I turn it over to the Division of Market Regulation for their legal explanation of the adopting release, let me first personally thank the staff members who have put in so many long hours over so many months to deliver this fine work product. I particularly wish to thank, for your absolutely outstanding and tireless work, Erik Sirri and Bob Colby, who led the SEC effort with superb assistance from Caite Maguire, Linda Sundberg, Joshua Kans, John Fahey, and Elizabeth MacDonald. I'd also like to thank Brian Cartwright, Andy Vollmer, Janice Mitnick, and Owen Donley from the Office of the General Counsel. Special thanks go to Commissioner Annette Nazareth, and before her Commissioner Cynthia Glassman, for helping to lead the principal-level discussions that were so important to getting this major work accomplished.

At every step, each of you showed an unwavering commitment to the protection of investors and the integrity of our markets. I'm only sorry that the millions of Americans who will benefit from your service could not see personally the extraordinary efforts that you put forward on their behalf.

There is exceptional credit due to our regulatory partners as well, especially Federal Reserve Chairman Ben Bernanke, Fed Governor Randy Kroszner, and before him Governor Sue Bies; the Fed's General Counsel, Scott Alvarez; and Federal Reserve staff members Kieran Fallon, Andrea Tokheim, and Brian Knestout. Equal credit is owed to the Comptroller of the Currency, John Dugan, and his Chief Counsel, Julie Williams; to FDIC Chairman Sheila Bair, and Deputy Chairman Marty Gruenberg; and to the Director of the Office of Thrift Supervision, John Reich, as well as their staffs.

So now I will turn it over to Erik Sirri, the Director of the Division of Market Regulation, for a more detailed description of the proposals.

[After discussion, Regulation B was adopted on a Commission vote of 5-0.]

Next, we will consider rules that affect the choices faced by investors in determining who will manage and provide advice about their investments.

Today, many investors rely on securities professionals to provide services and advise them on the most basic of financial decisions — how to invest their money, how long to keep those investments, and how to re-allocate their investments before and after they retire. In the past, brokers typically provided one main type of service, and investment advisers provided another. But in recent years, those roles have begun to overlap, as investment professionals have offered new payment arrangements for services based on a one-fee approach, rather than a transaction-by-transaction approach. At the same time, many professionals who previously emphasized their role as discount providers of securities transaction services have instead begun to promote their role as all-around financial advisers.

The Commission regulates broker-dealers and investment advisers under two different laws enacted after the Great Depression — the Securities Exchange Act of 1934, and the Investment Advisers Act of 1940. About 50 years after those laws were enacted, financial professionals began to change the way they charge for services. In response to concerns about "churning" in brokerage accounts, brokers began to offer "fee-based" brokerage arrangements. In those arrangements, customers pay a fixed fee, or a fee based on the value of assets under management, rather than by paying for each transaction.

In response to uncertainty about which laws applied to these new arrangements, the Commission in 2005 adopted a rule drawing a bright line between the two regulatory schemes with regard to the fee-based brokerage accounts. Earlier this year, the U.S. Court of Appeals for the District of Columbia Circuit vacated that rule on the ground that the Commission could not except broker-dealers offering fee-based brokerage accounts from the definition of "investment adviser." Today we are considering how best to respond to that decision, in the interest of protecting investors and serving the public interest.

Before us this morning are two rule releases. The first is a temporary rule under the Investment Advisers Act relating to principal trading. After the recent court decision, fee-based accounts are to be regulated under the Advisers Act, and those accounts will now be subject to all of the requirements of that Act. One of those requirements is Section 206(3), which requires trade-by-trade written disclosure and investor consent if an adviser trades on a principal basis with a client. In other words, if the adviser trades on its own account with the client, rather than as an agent of the client, then the investor would have to be specifically notified.

Principal transactions can benefit an adviser's clients, but they also present conflicts of interest. Many firms that offer fee-based brokerage accounts have said that, without the rule we are considering today, the written trade-by-trade disclosure requirements of Section 206(3) would prevent them from engaging in principal trades with their clients. As a result, these firms would not be able to provide the same range of services that they have provided in the past to fee-based brokerage customers who choose to become advisory clients.

The rule we are considering today would provide an alternative means for brokers who are also registered investment advisers to comply with Section 206(3), in circumstances when it is clear that the investor is informed of the potential interests of the adviser in these types of transactions both before and after the trades. At the same time, the rule would not relieve a firm that offers these fee-based accounts from its fiduciary obligations under the Advisers Act, including the obligation to act in the best interests of clients, and provide full and fair disclosure of any potential conflicts of interest. The rule also would provide for the protections that a broker-dealer owes its customers. The rule would sunset on December 31, 2009, unless the Commission takes further action.

The second proposal is an interpretive rule clarifying the circumstances under which a broker-dealer would be eligible for being excepted from regulation under the Advisers Act. The rule re-codifies some long-held interpretive positions that were vacated by the recent court decision, but were not central to the opinion. The rule would, for example, clarify that a broker-dealer subject to the Advisers Act is covered by the Act only with respect to its advisory clients (and not its brokerage clients). It would also clarify that, when the broker provides investment advice on a discretionary basis, it is subject to the Advisers Act.

I would like to thank Buddy Donahue, the Director of the Division of Investment Management, and his staff in the Division, in particular Bob Plaze, David Blass, Daniel Kahl, Matthew Goldin, and Vincent Meehan, all of whom worked long and hard to help bring these releases before us for consideration today. I'd also like to thank the many other staff of the Commission who helped in this effort, in particular, in the Division of Market Regulation, Erik Sirri, Caite McGuire, and Matthew Daigler; in the Office of the General Counsel, Andy Vollmer, Alex Cohen, Meredith Mitchell, Lori Price, and Sharon Zamore; and in the Office of Economic Analysis, Jim Overdahl, Jonathan Sokobin, Stewart Mayhew, and Laurie Walsh.

I will now ask Buddy Donahue to provide more details on these releases.

http://www.sec.gov/news/speech/2007/spch091907cc.htm