Levitt: derivatives standards are due for affiliates by Thanksgiving.

WASHINGTON -- The Securities and Exchange Commission and industry officials will develop voluntary standards for the unregulated derivatives affiliates of securities firms within two months, SEC chairman Arthur Levitt Jr. told a Senate panel yesterday.

"By Thanksgiving Day they will develop standards relating to capital, internal controls, reporting requirements, and sales practices," Levitt told Senate Banking Committee members at a hearing on the U.S. and international capital markets.

Levitt did not discuss the SEC's municipal bond initiatives with committee members, but mentioned them in his written testimony.

He said the SEC has "made significant headway in severing the pernicious link between political contributions and the municipal bond business."

The commission has also taken steps to ensure that municipal bond investors "know what they are buying, whether and how it is rated, and what they are paying," he said.

He conceded that the SEC's proposed disclosure rules have "generated substantial discussion," but said, "We welcome that discussion. We look forward to working with those interested to improve upon the proposals."

The SEC's municipal bond initiatives, he said, "have already caused the municipal industry to reexamine itself ... and to move itself forward into the 21st century."

After the hearing, Levitt declined to comment on what changes the SEC might make to its proposed disclosure rules and when it might finalize them.

Levitt's remarks on the voluntary derivatives standards came after Rep. John Dingell, D-Mich., chairman of the House Energy and Commerce Committee, warned the SEC and industry officials last month that they had better come up with a "concrete and meaningful" plan to oversee the derivatives affiliates.

Levitt told the committee members at the hearing that the derivatives standards, which the securities firm affiliates will be allowed to voluntarily meet, must be "acceptable" to the SEC and "subject to suitable oversight."

Levitt said the effort to develop voluntary standards is "unique" and a "landmark occurrence" that will give the SEC and the industry "a new pattern of oversight."

"I can't tell you whether it's going to happen the way we expect it to, but we're working awfully hard to get that end accomplished before we go to the next step and either consider regulatory responses or call for legislative help," he said.

Levitt told Sen. Donald Riegle, D-Mich., the committee's chairman who is about to retire from Congress, that he is opposed to derivatives legislation at this time because it would be premature and could have unintended adverse affects on the market.

"I'm hard pressed to understand specifically what kind of legislation we might call for at this time," he said. "I don't know what it would result in and, in the meantime, a lot of mischief could occur."

Sen. Lauch Faircloth, R-N.C., said he feared his colleagues may try to over-regulate derivatives when they do not really understand these products and could cause harm to the market.

Levitt told him, "If the commission and the industry are not able to promptly come up with the kind of regulatory environment that I think would be assuring to the country, and if an accident occurs -- and I promise you an accident will occur at some point in time -- then Congress will quickly address the issue in a way that might create problems you anticipate."

Levitt included derivatives in his list of greatest concerns when Riegle asked him to highlight potential problems looming for the U.S. and global financial systems.

Levitt said he is concerned about the development of a battery of new products, including derivatives, which could have a dramatic impact on the market because of a lack of understanding and sophistication about their use and potential risks.

"To allow the development of this product to go unmonitored both domestically and internationally could create real systemic risks," he said. "We've already seen some warnings," he said, as mutual funds and other investors have racked up losses due to derivatives.

At the same time, Levitt said that derivatives are "an important new product in the arsenal of financial services" that can bring great benefits to market participants as well as risks.

He said it would be "an economic tragedy" and "a terrible mistake" if they disappeared from the marketplace.

Levitt said another concern is that investors are moving their money into mutual funds without fully understanding the risks. Mutual funds are not insured or guaranteed, Levitt reminded committee members.

Levitt said a key goal during his 14-month tenure at the SEC has been to "sharpen the commission focus on the needs of individual investors." To help accomplish that goal, he said, the SEC has restructured and strengthened its consumer affairs office.

Levitt said he will be meeting with groups of investors during the next few weeks and will urge them to use the SEC's new electronic bulletin board and a new toll-free telephone number.

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