Recently, President Obama unveiled his proposal for a new system of financial regulatory oversight. To many, the proposal may seem overdue. To others, it may be overreaching.
My opinion is that we need quality and constructive regulation rather than more or less regulation. It is important that we maintain an environment of productive economic growth and innovation while protecting the individual and markets from abusive practices. That is one of the reasons I have been pushing for the reinstatement of the
oversight of leveraged exchange-traded funds.
Before we see where we're going, we should understand what the current banking and investment regulatory landscape looks like. It would be an understatement to say that the current regulatory system is convoluted and lacking in certain areas. Let's begin with a brief overview of the major financial regulatory agencies:
1. Securities and Exchange Commission
: the SEC was created by the Securities Exchange Act of 1934 (commonly referred to as the "34 Act" by attorneys and investment professionals). The SEC is primarily responsible for overseeing and enforcing the Securities Act of 1933 (the "33 Act"), the Investment Company Act of 1940 (the "40 Act") and the Investment Advisors Act of 1940.
What is important to understand is that the SEC is responsible for investment and investment vehicles considered to be "securities." For the most part, securities are stocks, bonds and mutual funds. Products traded on the
or CBOE are regulated by the SEC. The SEC chairwoman is Mary Schapiro, a former Commodities Future Trading Commission chairperson.
2. Commodities Futures Trading Commission
: The CFTC has its roots in the Commodity Exchange Act of 1936. The CFTC is responsible for the regulation of commodity, futures and options on futures. (Options on stocks and stock indexes fall under the jurisdiction of SEC.) Products traded on the Chicago Mercantile Exchange or Nymex, both owned by the CME, are regulated by the CFTC. The CFTC is currently headed by Chairman Gary Gensler, a former
3. Federal Reserve System
: The Fed, as it is commonly known, is the central bank for the U.S. Part of
is to conduct monetary policy for the country. This function is handled by the Federal Open Market Committee. The Fed also acts as a depository institution for banks. Furthermore, the Fed is responsible for supervising and regulating the banking and financial system. Lastly, through a series of regulations, the Fed oversees rules for the extension of credit by banks and broker dealers. The most important of these rules for investors is Regulation T, which sets forth the rules for the extension of credit to investors. The Fed is headed by Chairman Ben Bernanke.
4. Federal Deposit Insurance Corporation
: This agency is responsible for insuring bank deposits, for managing failed banks that have been put into receivership and for bank examinations. While it may appear that the FDIC has many similar responsibilities to that of the Fed, the two remain independent of one another. The FDIC is headed by Sheila Bair, another former chair of the CFTC.
5. U.S. Treasury
: The U.S. Treasury is one of the oldest institutions in the Federal government, having been provided by an act of Congress on Sept. 2, 1789. The Treasury is responsible for public debt, currency issuance and control, Federal budgeting, the Internal Revenue Service and the Secret Service. Secretary of the Treasury Timothy Geithner is the fifth in line to succeed the president in the event of a vacancy in that office.
A problem we now face is that many financial products have managed to slip through the regulatory cracks, as a result of financial innovation and the inability of those regulatory bodies to move in an expedient and proactive way. Furthermore, there have been unscrupulous actors who have either skirted rules or been able to navigate the system to the detriment of the public.
So what are some of these products and issues that have come together to create the financial and regulatory mess that President Obama and Congress seek to fix? Here are a few glaring examples:
: I created and managed the equity swaps department at Merrill Lynch well over a decade ago. This product was in a regulatory no-man's land. We tried our best to stay within the regulations promulgated by the SEC, Fed and SROs (self-regulating organizations, another quasi-regulatory function, which are the exchanges such as the NYSE or
However, in the past few years, the explosion of credit derivatives, especially credit default swaps, created a huge amount of financial assets and liabilities that were off-balance-sheet, off exchanges and unregulated. Actions are now being taken to clear and monitor these products on a central exchange and clearinghouse.
: Mortgages and loans are not considered securities. However, bundling and securitizing mortgages or loans creates securities. These are called asset-backed securities and go by many acronyms. The problem lies in the fact that there was little to no regulation surrounding the mortgages embedded in the asset-backed securities. While the securities industry has two levels of registration -- national and local -- mortgage brokers and lenders had little to no regulation, and neither did their products.
3. Leveraged and Inverse Exchange-Traded Funds (ETFs)
: These securities were registered and approved by the SEC and are extensions of credit as defined by the Fed. However, the Fed did not opine on leveraged or inverse ETFs in the SEC registration process. Thus, a chasm in the regulatory environment needs to be filled.
: Insurance is regulated on a state-by-state basis. However, many financial products have complex security-like structures. Just ask anyone who dealt with
American International Group
. The question is going to be whether or not to place federal oversight on the insurance industry
5. Hedge Funds and Private Equity Funds
: These operate outside of the realm of regulation. The funds and managers are not subject to either of the 40 Acts. There will be pressure to bring these operators and their fund structures under the auspices of the SEC. Unfortunately, an attempt to regulate this industry fell on deaf ears in Congress several years ago just as the financial bubble was gaining steam.
The lists I provided above are not exhaustive. The problems are far more complex and pervasive. No matter what solutions are enacted on Capitol Hill, I can ensure you that they will not be comprehensive, and smart minds will figure out other ways to arbitrage the new system.
At the time of publication, Rothbort had no positions in stocks mentioned, although positions can change at any time.
Scott Rothbort has over 20 years of experience in the financial services industry. In 2002, Rothbort founded LakeView Asset Management, LLC, a registered investment advisor based in Millburn, N.J., which offers customized individually managed separate accounts, including proprietary long/short strategies to its high net worth clientele. He also is the founder and manager of the social networking educational Web site
Immediately prior to that, Rothbort worked at Merrill Lynch for 10 years, where he was instrumental in building the global equity derivative business and managed the global equity swap business from its inception. Rothbort previously held international assignments in Tokyo, Hong Kong and London while working for Morgan Stanley and County NatWest Securities.
Rothbort holds an MBA in finance and international business from the Stern School of Business of New York University and a BS in economics and accounting from the Wharton School of Business of the University of Pennsylvania. He is a Term Professor of Finance and the Chief Market Strategist for the Stillman School of Business of Seton Hall University.
For more information about Scott Rothbort and LakeView Asset Management, LLC, visit the company's Web site at
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