The Treasury Department last Friday released a draft bill that would expand the SEC's investor protection authority while granting the SEC broad power to regulate broker-dealers. The "Investor Protection Act of 2009" comes on the heels of the administration's proposed new Consumer Financial Protection Agency, tasked with protecting consumers from largely unregulated financial products. Both proposals are guided by the Treasury Department's white paper of June 17, titled Financial Regulatory Reform: A New Foundation, which detailed the Obama administration's broad reform objectives. As noted below, there are several proposed provisions under the Federal Securities Laws which would strengthen the hand and legal rights of customers against broker-dealers.
Whistleblower Payments and Confidentiality
The bill would allow the SEC to compensate whistleblowers who provide "original information" leading to an action by the Commission that results in penalties of over $1,000,000. In those instances, the SEC would exercise sole discretion to reward the whistleblower with up to "30 percent, in total, of the monetary sanctions imposed in the action or related actions." The bounties would be paid out of the newly-created Securities and Exchange Commission Investor Protection Fund, which would be filled with monies collected via certain SEC enforcement actions. In addition, the bill provides for whistleblower confidentiality, stating that "all information provided to the Commission by a whistleblower shall be confidential and privileged as an evidentiary matter." Notably, the bill removes from judicial review any agency decisions on whistleblower payments made under the new provisions.
Investor Advisory Committee
The bill would make permanent the Investor Advisory Committee, which SEC Chairman Mary Schapiro has already formed. The Committee would be tasked with keeping the Commission apprised of "regulatory priorities and issues regarding new products, trading strategies, fee structures and the effectiveness of disclosures." The Committee, composed of members appointed by the Chairman of the Commission, is unable to bind the Commission: "Nothing in this section requires the Commission to accept, agree, or act upon the findings or recommendations of the Investor Advisory Committee."
Mandatory Arbitration Clauses
The legislation would grant the SEC the authority to invalidate mandatory arbitration clauses in broker-dealer and investment advisory agreements. This broad authority to "prohibit, or impose conditions or limitations on the use of" mandatory arbitration clauses in agreements between customers and any broker-dealer or investment adviser directly reflects concerns articulated in the Treasury's recent white paper, which states that "mandating a particular venue and up-front method of adjudicating disputes - and eliminating access to courts - may unjustifiably undermine investor interests." After years in which mandatory arbitration clauses have been the norm, limiting investors' access to courts, this new tone may signal a larger shift that is in the works.
Investment Adviser Bar
Under the draft bill, investment advisers who have been suspended or barred for securities laws violations would similarly be suspended or barred from acting in other capacities in the securities industry. This would put a stop to such individuals becoming affiliated with broker-dealers, which is allowed under current law.
Imposing Fiduciary Duties on Broker-Dealers and Regulating Conflicts and "Compensation Schemes"
The new legislation would allow the SEC to harmonize broker-dealer and investment adviser regulation, authorizing the SEC to establish through rulemaking new fiduciary duties regulating "brokers, dealers, and investment advisers, in providing investment advice about securities to retail customers or clients." These fiduciary duties would require that the intermediary "act solely in the interest of the customer or client without regard to the [intermediary's own] financial or other interest."
Currently, broker-dealers contend that they owe no fiduciary duty to their customers, absent special circumstances which create this relationship. Presently, only investment advisers have clear fiduciary duties to those they advise in investment decisions or pursuant to discretionary authority. Of note, however, is that the Commission's authority to promulgate fiduciary duties in the proposed legislation is permissive, i.e., even if the law were passed as is, the Commission could decline to exercise that authority, or exercise that authority in a restrained manner.
That power to promulgate fiduciary duties binding on financial intermediaries in general and broker-dealers in particular would be backstopped by the new authority to "promulgate rules prohibiting sales practices, conflicts of interest, and compensation schemes" of those intermediaries. That provision appears to be aimed at specific practices and relationships that pit the intermediary's financial interests against the client's.
As an apparent prompt for the SEC to intervene in the dilemmas that riddle the financial sector, the proposed compensation provision is interesting. It may presage a significantly expanded role the Obama administration is carving out for the SEC in identifying and remedying what it sees as misalignments of interests that create market inefficiencies and unfairness. In particular, the legislation appears aimed at compensation structures that potentially reward intermediaries for short-term gains at the expense of long-term growth.
Aiding & Abetting Liability
The legislation would grant the SEC the authority to pursue aiders and abettors under the Securities Act of 1933, the Investment Company Act of 1940 and the Investment Advisers Act of 1940. Current law only grants the Commission such authority under the Securities Exchange Act of 1934. That authority remains exclusively with the government. In 1994, the United States Supreme Court determined in Central Bank of Denver v. First Interstate Bank of Denver, that private parties did not have a viable claim of aiding and abetting of federal securities fraud in civil actions.
Consistent with the Treasury Department's June white paper, the new legislation is ambitious, but it stops short of proposing a wholesale revision of financial regulation. It harmonizes regulation and priorities in a number of areas, increasing SEC oversight and investor protection. It shall be seen whether less mandatory arbitration is a good thing, or whether a large bounty for whistleblowing will increase the likelihood of the SEC stopping fraudulent conduct sooner. There is, however, little doubt that creating clear fiduciary duties for broker-dealers in all circumstances will result in increased investors' disputes with their brokerage firms.