House Financial Services Committee

House Financial Services Committee

Markup of H.R. 3817 – The Investor Protection Act of 2009

October 28, 2009

Members Present:

Barney Frank (D-MA), Paul Kanjorski (D-PA), Melvin Watt (D-NC), Maxine Waters (D-CA), Carolyn Maloney (D-NY), William Lacy Clay (D-MO), Jackie Speier (D-CA), Carolyn McCarthy (D-NY), Paul Hodes (D-NH), Steven Driehaus (D-OH), Ed Perlmutter (D-CO), John Adler (D-NJ), Mary Jo Kilroy (D-OH),Mike Capuano (D-MA), Ron Klein (D-FL), Keith Ellison (DFL-MN), Bill Foster (D-IL), Gregory Meeks (D-NY), Spencer Bachus (R-AL), Jeb Hensarling (R-TX), Scott Garrett (R-NJ), John Campbell (R-CA), Kevin McCarthy (R-CA), Tom Price (R-GA), Randy Neugebauer (R-TX), Christopher Lee (R-NY), Gary Miller (R-CA), Bill Posey (R-FL), Lynn Jenkins (R-KS), Michele Bachmann (R-MN)

Frank: We will begin markups on Tuesday morning for four days on the systemic risk regulation. Since Tuesday is Election Day, we will hold all roll-call votes next Wednesday morning.

(Manager’s Amendment – agreed to by voice vote)

Kanjorski: This makes numerous technical clarifications and substantial changes. With respect to fiduciary duty, it clarifies that investment advice subject to fiduciary duty is on a personalized basis. All brokers-dealers and investment advisers will follow the current standard. It ensures that any whistleblower who makes false statements cannot receive an award. We’ve also made changes to municipal securities.

Bachus: This bill has many provisions that include bipartisan agreement and reflects bills that have been offered by some Republicans. Some elements provide obstacles to bipartisan consensus. It will increase dispute resolution costs for investors with the provisions about arbitration.

(Maffei Amendment to the Manager’s Amendment – agreed to by voice vote)

Maffei: This amendment adds clarity to those offering proprietary products or limited range of products that are not in violation of the fiduciary standard. This legislation would still raise the standard of care for broker-dealers from a suitability standard to a fiduciary standard when they are providing personalized investment advice to a retail customer. To meet the new fiduciary standard, broker-dealers would be required to act in the “best interest.” My language clarifies that in order to meet the best interest standard, broker-dealers will not be required to be knowledgeable and make recommendations to their clients from the universe of all financial products available in the marketplace. It would be impossible for anyone to be knowledgeable of all products in the market.

Watt: I support this, but I have some reservation. My preference would have been to deal with this by striking the language at page 2 lines 6 through 10 as well as leaving out this amendment. We are delegating this authority to the SEC to make these rules, so we’re giving them authority on one hand and then taking it back on the other hand. I think there could be times in which both the things described in lines 6 through 10 and the things exempted and described in this amendment could be situations in which the SEC should come back and say that these violate the rules.

Bachus: It’s not clear that the proposed language in the duty of care standard for broker-dealers contained in the Manager’s Amendment will better protect retail investors. Imposing a new standard on the brokerage industry fails to recognize the complexity of the broker-dealer business. One of the advantages of two different standards for broker-dealers and investment advisers is that broker-dealers can provide retail customers with proprietary products and services, including the ability to conduct trading for customers, as long as the broker-dealer discloses the arrangements to the customer. It would be wrong to assume that the suitability standard for broker-dealers leads to less stringent oversight. It would be wrong to assume that the existence of a fiduciary standard would better protect investors. It is unclear why harmonization of this standard for broker-dealers is necessary. A one-size-fits-all approach for broker-dealers and investment advisers will be harmful to investors.

Clay: What will happen to a small investor who is not willing to pay an annual fee on their account? Frank: A commission type of arrangement would be put into place here.

(Hensarling Amendment to Manager’s Amendment - withdrawn)

Hensarling: This is to preserve the ability to really receive investment advice that is incidental otherwise to a broker-dealer relationship. This is to ensure that new liability standards are transaction-related as opposed to an ongoing relationship. Many people use self-directed investment accounts and cannot afford the fees to having a professional investment adviser. Clearly there would be a fiduciary duty at the beginning of the transaction, but once it’s enacted, the liability standard does not go beyond that standard. My fear is that increasing the liability standard would deny people a service that they value today that would disappear from the market or fees would have to be charged for increased liability exposure.

Kanjorski: I oppose this amendment. It goes to the essence of what we’re trying to do here. We’re not lessening the choice for protection of the investor, but we’re increasing it. We’re trying to create something here that transcends a single transaction. The amendment would set us back entirely.

Bachus: If you create an ongoing fiduciary duty for a discount broker-dealer, I think that’s problematic. If a customer wants more than this type of relationship or trading online, they can get it through an investment adviser, but most people don’t want that. The language would increase liability for discount brokers and would cause fewer choices for investors. If a broker-dealer provides personalized investment advice with that transaction, then the fiduciary duty should apply to that transaction but not beyond that in the future.

Frank: I don’t think the language does that. If sometime later you would call the broker and give an instruction, that would not be covered by a fiduciary duty. Even then, an execution of an order would not pose any restriction. Hensarling: My main concern is on a self-directed account, there will be a fiduciary standard.

(Castle- Speier Amendment – agreed to by voice vote)

Castle: One concern is the close relationship of the SEC and Wall Street. Many people who work in the SEC later are employed on Wall Street. We have employment restrictions with this revolving door issue in Congress. Before we impose employment restrictions that could be harmful to the SEC, we should have a study about this issue.

Speier: A revolving door does exist, and there has been insufficient information about this issue to be able to tackle the problem. From the information the GAO gathers, we can then decide if employment restrictions are required.

(Hodes Amendment – agreed to by voice vote)

Hodes: This amendment is to protect older Americans from unscrupulous broker-dealers. State securities regulators are seeing more bad actors with respect to senior citizens. It will provide grants to states to address these problems. Many states have already adopted rules to address these problems, such as the NASAA model rule. It has been supported as a stand-alone bill.

(Campbell Amendment – agreed to by voice vote)

Campbell: This gives the SEC nationwide subpoena authority.

Frank: I think this a very useful amendment.

(Driehaus Amendment – agreed to by voice vote)

Driehaus: This brings municipal financial advisers under the umbrella of all of the other types of investment advisers we look at in this bill. The SEC will create registration requirements and market conduct rules for municipal financial advisers.

Bachus: I think this is a reasonable amendment. However, the SEC will have many new responsibilities, so it may be appropriate to delegate this examination authority to FINRA. I hope we can improve this amendment by working on this. Driehaus: I would be happy to work on this. The Commission did ask for this authority, so that’s why it’s structured the way it is.

(Price Amendment - defeated)

Price: This amendment would allow the predispute arbitration to go forward. It is fair, efficient, and a less expensive option than litigation. The language in the bill would increase litigation costs. I think it’s a common sense amendment.

Kanjorski: Mandatory arbitration has not always acted in the best interest of the investors. We’ve enlarged the number of choices that the SEC with respect to arbitration. They can limit it or create other alternatives. If this is so beneficial to the investors, then they should have the choice to choose that on their own. We should protect investors with the largest number of choices, so this should not be mandatory.

Frank: I oppose this amendment. I have no objection to arbitration if it is voluntary. We’ve had significant testimony about this issue. I believe that leaving this as a choice and not coercing the investor into doing it is a better way to preserve arbitration.

(Perlmutter Amendment – agreed to by voice vote)

Perlmutter: This amendment involves high frequency trading. It accounts for about 70% of stock trading. I’m concerned about the effect it has on the smaller, long term investors and on making a liquid market illiquid overnight. We suggest that there should be a study done by the SEC to evaluate this.

(Adler Amendment - defeated)

Adler: This would increase jobs and help America’s economy. It would reform the Sarbanes-Oxley Act. A one-size-fits-all approach has hurt small and medium-sized companies. This law has made America less competitive. This will exempt small and medium sized companies from Section 404 B until the SEC issues formal regulation of scaled or proportional regulation for different sized companies.

Garrett: I think this an appropriate approach to dealing with this problem of small and medium-sized companies. We need regulation that fits them more appropriately.

Frank: I oppose this. The financial services authority in England is no longer “light.” So the argument that businesses would go there has been invalid. It is a mistake to exempt people. Many of the companies that would be exempt are already compliant, and there is a compliance cost. This goes much too far. I do agree that the SEC should work on these rules.

Campbell: I support this amendment. It doesn’t change Section 404 A about internal reporting. I think this amendment says that the compliance costs for a small company are the same of large companies in terms of auditing and need to be put in proportion.

Kanjorski: I oppose this amendment. I understand the complications. If we adopt this amendment, we’ll reverse the trend of increasing compliance.

(Maloney-Garrett Amendment – agreed to by voice vote)

Maloney: This amendment would require further study of the impact of Section 404 B of the Sarbanes-Oxley Act on smaller companies, and these are companies that are under $75 million in revenue. These types of companies did not cause the financial crisis. It was larger companies. These companies are an important part of the economy in creating jobs. It would call for a GAO and SEC study that would propose specific legislative and administrative recommendations that could be taken to reduce the compliance burden that Sarbanes-Oxley imposes on small companies.

Frank: I oppose this amendment. It is the wrong approach to begin to cut back the SEC. Once we start giving legislative exemptions, we will get into a dangerous situation.

(Neugebauer Amendment – agreed to by voice vote)

Neugebauer: Resolution of disputes for investors is an important aspect of this bill. This bill gives the SEC the power to prohibit predispute arbitration in securities contracts. I think we should see if the arbitration system is working. I think deleting arbitration provisions penalizes small investors, because they have to go and get a lawyer and sue to take action when they feel that they’ve been defrauded. We should have a GAO study about how beneficial this is to investors and if it’s fair.

Kanjorski: I think this makes a great point for additional study, so I think it’s consistent with getting as much information as possible.

(Kilroy Amendment - withdrawn)

Kilroy: Recently the issue of lost securities holdings was brought to my attention. The total amount of lost securities equals tens of millions. My amendment would facilitate the return of lost securities to their owners. It would include an online database for lost securities.

(Lee Amendment – agreed to by voice vote)

Lee: My amendment would grandfather existing agreements between investors and their advisers or brokers. Contracts are already in place where all participants knew exactly what they were agreeing to.

Frank: I oppose this amendment. I understand the point. It is true that if there is a specific contract, we shouldn’t alter it, but I think the unfairness has been inherent. I will be open to argument.

(Miller Amendment – agreed to by voice vote)

Miller: I’m concerned that these efforts to protect investors will have effects on the liquidity of the market. I’m concerned that there’s a lack of communication between financial regulators. This would create a financial reporting firm composed of PCAOB, etc. to monitor financial reporting.

Perlmutter: How big a role do you see this group playing? There’s systemic risk regulation that’s coming up. Mr. Lucas and I have a bill on establishing an accounting oversight group that will be added to the systemic risk bill. Miller: I don’t think this creates any kind of confusion. Frank: The two bills are going to be merged, so any problems will be resolved.

(McCarthy Amendment – agreed to by voice vote)

McCarthy: This amendment would direct the SEC to do a study on investment adviser examinations. The SEC will consider its congressional authorization to establish a self-regulatory organization for oversight of examinations. Investment advisers are under-examined. This study will provide insight to important changes we can make with respect to these problems.

(Posey Amendment - defeated)

Posey: This amendment would help the SEC enforcement staff in investigating fraud. It helps ensure that collections are made so they have resources available.

Kanjorski: We’ve inquired at the SEC, and they’ve been successful in their collections. They feel they are capable of doing that. They are no longer requesting that authority, so I oppose this bill.

Garrett: This is entirely voluntary for the SEC, and they are not completely perfect with collections yet, so they have a way to go.

Posey: This is taxpayer money that is going uncollected. I think we should do whatever it takes to collect that money. When people can violate the law and know there is no penalty, that just encourages the behavior to continue. We should do everything we can to make them more accountable.

(Perlmutter Amendment – agreed to by voice vote)

Perlmutter: This would require the SEC to complete a study to examine how products are sold to retail customers and what information the customer should receive prior to purchasing. The SEC could then promulgate rules appropriate to this. This would strengthen point of sale disclosures by seeking to ensure that they apply to all appropriate products under the SEC’s jurisdiction. This provides investors with more consistent disclosures.

(Campbell Amendment - withdrawn)

Campbell: SEC rules now require public companies to issue financial reports quarterly. This would change the law to only require semiannual financial reports. It would encourage more long term thinking so companies are not driven by quarter-to-quarter thinking.

Kanjorski: I think this is something to be looked at. I think just to act and change the reporting periods is a radical position to take.

(Ellison Amendment – agreed to by voice vote)

Ellison: This would make explicit what is already implicit in the bill about the fiduciary duty for investment advisers and broker-dealers. It just clarifies the language so the duty applies when providing personalized investment advice about securities.

(Frank Amendment – agreed to by voice vote)

Frank: This has to do with the state authority. We’ve discussed this with NASAA and the SEC, and they’ve all agreed to this that says where a state goes up to $100 million dollars in its registration requirements, this allows the SEC to accept the state’s role rather than having to decide it case by case. So it’s a combination of the SEC and the states, which both parties agree to.

(Foster Amendment – agreed to by voice vote)

Foster: People wonder why there was no independent custodian holding the assets in the Madoff scheme. In a legitimate arrangement, the money manager may buy and sell stocks, bonds, etc. on behalf of his client, but the money manager should not have access to the client’s money. It should be held in a separate custodial account. This makes this mandatory for clients with assets under $10 million. This is subject to an exemption that the SEC can generate. There may be classes of investment advisers that may be exempted without harming investors.

Bachus: Have you been in contact with the SEC? Foster: Yes, they provided the language for this. The changes they’ve made were the exemptions. I can’t say whether they explicitly endorsed it. They did recommend changes.