Thursday, January 29, 2009

SEC/CFTC Merger?

Reform of the financial regulatory system is high on the public policy agenda, since it is widely perceived that the current system has failed us. One of the options that always comes up in these discussions is merging the SEC and the CFTC.

The case for merger is simple. Since the CFTC began operations in 1975, the importance of the financial products it regulates has grown and become the largest area it regulates. In addition, the CFTC and the SEC regulate similar products in different ways. Questions about which regulatory scheme, the SEC’s or the CFTC’s, governs innovative new products as they are introduced have plagued the relationship between the two agencies right from the start and continue to cause difficulty. Would it not be easier to resolve these issues and achieve consistent regulation for similar products if there were only one agency?

This case makes sense, and, if one were to design a regulatory scheme from scratch, one would not create a separate SEC and CFTC. But we are not starting from scratch. Merging these two agencies would require great effort. The politics are difficult, as are the details.

The Paulson blueprint for regulatory reform recommended merging the two agencies as an interim step. It also recommended that the resulting agency become a “principles-based” regulator, on the model of the CFTC after the passage of the Commodity Futures Modernization Act (“CFMA”).

That last recommendation is not likely to fly in the current environment. Recall that the motivation for the Paulson blueprint was the perception of some that London was taking financial business away from New York because the British employed a lighter regulatory touch and did not burden financial intermediaries with too many rules. That perception is debatable, but the current consensus is that the financial regulatory system has been too permissive, not that it has been too tough.

The political problem of going the other way, that is, imposing SEC-type regulation on the futures exchanges, is obvious. There are also a myriad of other issues and details that would need to be resolved in order to accomplish merger.

The SEC and the CFTC signed a memorandum of understanding on March 11, 2008, in an attempt to manage their jurisdictional issues. (I wrote an article about this for the Journal of Taxation of Financial Products, vol. 7, no. 3.) This is an appropriate way for the agencies to manage their potentially overlapping jurisdiction under the current regulatory structure. Moreover, the heated jurisdictional debates between the CFTC and other financial regulators have abated since the enactment of the CFMA. Whatever else one may think about that legislation, it did accomplish that.

At the moment, addressing the failures of the bank regulators and the SEC should have priority over merging the SEC and the CFTC. Given the enormous effort it would take to merge the two agencies, it should not be undertaken except as possibly part of a more comprehensive reform of the financial regulatory system. And before that can be done, policymakers need to decide what they believe financial regulation should do and what it should not do. Then they can think about making changes in how the Executive Branch is organized to accomplish this.

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