SEC criticized for poor oversight of brokerage firms

In the wake of a negative report on the Securities and Exchange Commission’s oversight of brokerage firms, the brokerage industry is bracing for tougher regulation.

The report, which was released Sept. 25 by the SEC’s inspector general, found that only one-third of the 146 brokerage firms that were supposed to be filing risk assessment reports were actually doing so. It also found that the SEC regularly conducted in-depth reviews for only six of those firms.

The SEC’s failure “to carry out the purpose and goals of the Broker-Dealer Risk Assessment Program hinders the commission’s ability to foresee or respond to weaknesses in the financial markets,” the 36-page report concludes. “This may [affect the agency’s] ability to protect customers from financial or other problems experienced by broker-dealers.”

David Bellaire, general counsel and director of government affairs for the Financial Services Institute Inc., an advocacy group in Atlanta for independent brokerage firms and financial advisers, worries that the report will lead to overregulation.

“Our fear is that, in a race to reform the system, Congress and the regulators will increase compliance burdens on firms so that it will become too costly to provide support and service to middle-class and lower-middle-class Americans that need those services now more than ever,” he said.

MARKET REFORM ACT OF 1990

The Broker-Dealer Risk Assessment Program was born out of the Market Reform Act of 1990, which was enacted after the failure of New York investment bank Drexel Burnham Lambert Inc. The law requires that SEC-registered brokerage firms file regular reports on their financing, capital, risk management policies and pending legal proceedings. They also must provide the SEC with detailed financial information about their officials and registered representatives.

Brokerage firms with at least $20 million in capital that are part of a holding company are required to register with the SEC. Such firms are responsible for about 64% of all brokerage accounts in the U.S., with the six largest of those firms responsible for housing 43% of all customer accounts, according to the report.

“Congress gave the SEC all of the authority they needed to do risk assessments of broker-dealer holding companies,” Rep. Edward Markey, D-Mass., wrote in an e-mail. “What the SEC [inspector general’s] report shows is that the SEC failed to diligently implement this law … Things need to change over at the SEC, beginning at the top.”

Mr. Markey, who wrote the 1990 legislation, sent a letter to SEC chairman Christopher Cox two weeks ago charging that the SEC’s “inexcusable regulatory failure in this entire area” contributed to the current crisis in the financial markets. “What is the SEC going to do with respect to the firms that remain subject to its oversight?” he said in the letter.

SEC spokesman John Nester declined to comment on the report.

The report on the Broker-Dealer Risk Assessment Program was one of two reports released by the inspector’s general office on Sept. 25. The second report sharply criticized the SEC for failing to oversee The Bear Stearns Cos. Inc. of New York.

Bear Stearns agreed to be sold to New York’s JPMorgan Chase & Co. in March after the firm’s clients began withdrawing assets and it started running out of cash.

RECOMMENDATIONS

“The problems pointed out in [the risk assessment program] are in some ways more relevant than the problems with Bear Stearns,” said one Senate aide who spoke on the condition of not being identified. “The program is still ongoing.”

The SEC’s trading and markets division agreed to most of the 26 recommendations made in the risk assessment report, including a recommendation to raise the capital threshold that triggers the filing requirement.

However, the division did not agree to notify brokerage firms about their responsibility to file the risk assessment reports, saying it is the responsibility of the industry to follow SEC rules.

The SEC frequently uses its resources where it believes the greatest risk is to the public, said Barry Barbash, a partner in the Washington office of New York law firm Willkie Farr & Gallagher LLP, and a former director of the SEC’s division of investment management.

“It’s a question of resource allocation that’s working behind what’s happening here,” he said. However, while the inspector general made valid criticisms of the SEC’s oversight of brokers, “none of the points speak to the issue of whether, had the SEC done any of this, would it have helped the Bear Stearns situation,” he said.

E-mail Sara Hansard at [email protected].