WASHINGTON -- Derivatives affiliates of broker-dealers and insurance companies would be regulated by the Securities and Exchange Commission under legislation introduced yesterday by Rep. Edward J. Markey, D-Mass.
If adopted, the bill would subject to SEC oversight the existing derivatives affiliates of six broker-dealers and three insurance companies. Many of these affiliates engage in municipal derivative transactions but are not currently regulated by the SEC.
The bill would also define equity derivatives as securities and bring them under SEC regulation. Equity derivatives, which include stock options and equity swaps, represent only about 5% of the derivatives market, an aide to Markey said.
Markey, who chairs the House Energy and Commerce subcommittee on telecommunications and finance, said the bill is needed "to close the regulatory black hole that has allowed derivatives dealers affiliated with securities or insurance firms to escape virtually any regulatory scrutiny.
"It will give the SEC the tools needed to monitor the activities of these firms, assess their impact on the financial markets, and assure appropriate protections are provided to their customers against any fraudulent or abusive activities," Markey said.
But prospects for congressional action on the bill appear bleak, at least for this year.
The bill was introduced as SEC officials have begun working with the Securities Industry Association and other industry officials to develop informal standards that the affiliates of broker-dealers would meet on a voluntary basis. SEC officials have insisted they have the tools they need to oversee the derivatives markets and that they do not need legislation.
In addition, Rep. John Dingell, D-Mich., the chairman of the full Energy and Commerce Committee, has said he wants to further study the recent General Accounting Office report that called for derivatives legislation before pursuing any legislative measures. Dingell has asked the Securities Industry Association and federal regulators, all of whom are opposed to legislation, for their reaction to the GAO recommendations.
The bill introduced by Markey does not define all derivatives as securities because that would have required banks that engage in interest rate swaps and other derivatives that are not now defined as securities to register with the SEC, a subcommittee aide said.
Instead the measure defines equity derivatives as securities because equities clearly are limited to the SEC's jurisdiction and Markey felt that equity-based derivatives should be subject to SEC regulation and to the anti-fraud and anti-manipulation provisions of the securities laws, the aide said.
The bill, however, would bring most over-the-counter derivative products done by the affiliates of broker-dealers and insurance companies under the jurisdicton of the SEC by requiring the affiliates to register with the agency.
Broker-dealers that are already registered with the SEC would file a "form of notice" with the commission so that their derivatives affiliates would be effectively registered. A broker-dealer's net capital, in such cases, would be based in part on the derivatives activities of its affiliate.
The bill would permit, rather than require, the SEC to write capital standards for, conduct examinations of, and receive financial reports from derivatives affiliates.
The clear expectation is that the SEC will develop standards and regulations for these over-the-counter derivative activities, the subcommittee aide said.
But the bill does not require the derivatives affiliates to meet current SEC regulations, he said, because the commission's net capital rule is considered inappropriate for derivatives and is being modified. In addition, the subcommittee does not want to dictate standards to the SEC, he said.
"We're not micromanaging the SECs rules," the aide said.
The bill calls for the derivatives affiliates to become members of an existing self-regulatory organization or any similar organization that is established for derivatives dealers. The bill would call for such organizations to establish standards governing internal controls and sales practices for the derivatives affiliates and other derivatives dealers.
The measure would also enhance the SECs antifraud and anti-manipulation authorities over derivative dealers, including derivatives affiliates.
The six broker-dealers with derivatives affiliates are: Goldman, Sachs & Co.; Salomon Inc.; Merrill Lynch & Co.; Morgan Stanley & Co.; Lehman Brothers; and CS First Boston.
The insurance companies are: American International Group Inc., the Prudential Insurance Company of America, and General Re Corp.
"This bill is not a radical restructuring of the derivatives market; it is focused laser-like on closing the real gaps that exist in the current regulatory framework," Markey said.
