More than a few critics have called the current system for regulating financial services firms archaic. As hybrid products such as derivatives emerge, they say, it makes more sense to regulate by product than by issuer-be it bank, insurer, securities firm, or futures trader.

But a former top regulator is recommending a different cure.

Steven M.H. Wallman, a Securities and Exchange Commission member until October 1997, says the product-based approach seems like a nice idea. Under it, for example, the SEC would regulate the sale of securities, no matter what type of company sold them.

But that method would not work, he said, because today's financial merchandise defies traditional categories.

"Functional (product-based) regulation is old before it is even born," according Mr. Wallman, who is now a Brookings Institution senior fellow. He presented a paper on the topic last week at a conference sponsored by Brookings and the University of Pennsylvania's Wharton School.

Instead, Mr. Wallman said, regulation should be divided according to four goals: protecting consumers, ensuring institutional solvency, controlling systemic risk, and increasing market transparency. Regulators should forget about traditional divisions between industries and product types, he said.

"No longer would there be insurers or banks or securities firms but providers of financial products," he wrote. "Does the market care if systemic risk is posed by a securities firm as opposed to a bank?"

In Mr. Wallman's world, a different regulator would be responsible for each goal.

An SEC-type agency, for example, would protect consumers of all financial products. An agency similar to the Office of the Comptroller of the Currency would focus on preventing insolvency. Another along the lines of the Commodity Futures Trading Commission would monitor organized markets, such as stock exchanges. And a body similar to the Federal Reserve Board would oversee systemic risk.

Such a system would free firms to create innovative products and services without fretting about "artificial regulatory barriers," Mr. Wallman said. It would be a regulatory revolution matched only by the technological revolution already influencing banking and finance.

But the former Covington & Burlington law partner acknowledged that such a drastic makeover of the regulatory structure would be tough to pull off.

All players-including the industry, investors, and Congress-would need to let regulators focus on larger trends, not just specific aches and pains. In the case of Long-Term Capital Management, for example, Mr. Wallman said the question that should be asked is whether "the regulatory environment itself actually contributed to the potential for harm."

Mr. Wallman's ideas prompted both support and skepticism at the conference. But former comptroller Eugene A. Ludwig, now a vice chairman of Bankers Trust Corp., proposed an even more radical regulatory scheme.

He suggested randomly dividing financial services firms of all stripes among three or four agencies in the hope that the competition among regulators would produce better supervision.

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