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House Passes Important Regulatory Changes


     By Fulcrum Inquiry Damages, Appraisal, Accounting & Economics Expert Witnesses

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Expert Witness: Fulcrum Inquiry
The entire House of Representatives will soon consider the Investor Protection Act. We provide a summary of what it contains without the political sound bites that you have already heard (and hopefully dismissed).
The Obama Administration proposed a number of important financial service industry regulatory changes. In November, the House Financial Services Committee approved one of the administration’s proposals, the Investor Protection Act (H.R. 3817). The bill now goes to the full House floor where it is expected to be debated in December.

The Investor Protection Act requires several studies and commissions that provide the window dressing supposedly showing Congress did something, yet avoids any real change. We will not waste your time detailing these studies and commissions. More substantively, the bill would do the following:

1. Impose a fiduciary duty on every financial intermediary who provides advice - Investment advisors already have this duty under the Investment Advisers Act, but brokers do not have this fiduciary duty. The bill would harmonize a fiduciary duty between investment advisors and brokers.

2. Creates an SEC whistle-blower program similar to what the IRS has - Under the bill, if a whistleblower provides information to the SEC that result in penalties greater than $1 million, then the SEC could award the whistleblower up to 30% of the penalty. The program allows for anonymous reports through an attorney. The SEC has complete discretion as to any potential reward, without any judicial review.

3. In an ironic last-minute amendment to this legislation titled the “Investor Protection Act”, permanently exempts companies with a market value less than $75 million from a requirement that outside auditors review and report on a company's internal controls - This requirement comes from Sarbanes-Oxley Section 404(b), but the SEC has extended the required compliance date. Now that the SEC finally indicated no further extensions will be given, the bill will eradicate this requirement for approximately half of all publicly-traded companies.

4. In changes that will certainly not protect investors, alters the regulatory scheme that is now in effect, as follows:

a. Raises the assets under management requirement for SEC jurisdiction from $25,000,000 to $100,000,000. This effectively results in many registered investment advisors being regulated at the state instead federal level.

b. Gives the Financial Industry Regulatory Authority (FINRA) regulatory authority over registered investment advisors who are also dually registered as broker-dealers. FINRA has not been known as an aggressive regulator. The chairman of the House Financial Services Committee indicates that he intends to alter this provision on the House floor to require SEC authority over these entities.

5. Requires financial advisers to municipalities be registered with the SEC.

6. In a clear reaction to the Madoff fraud:

a. Amends Section 206(4) of the Investment Advisers Act making it unlawful for a registered investment adviser to have custody of client funds or securities over $10 million, except in a separate account directly or indirectly titled in the name of the client. The qualified custodian cannot directly or indirectly provide investment advice regarding such funds.
b. Gives the Public Company Accounting Oversight Board (PCAOB) new examination powers over the auditors of broker-dealers

7. In what appears to be window-dressing masquerading as changes for investor protection, gives the SEC the following powers that the SEC already has:

a. End mandatory arbitration of investor claims in customer contracts. The SEC already has the authority under the 1934 Act to ban mandatory securities arbitration if it concludes it is in the interests of investor protection.

b. Allow the SEC to impose proxy access rules allowing shareholders to nominate directors to corporate boards. Regardless of this change, SEC Chairman Mary Schapiro said she is committed to bringing final proxy access rules to the full Commission in early 2010.

8. Doubles the SEC’s funding over 5 years.


Because of its Democratic support, we expect the Senate to pass the more important of these changes.


Fulcrum Inquiry performs damages analysis, forensic accounting, and business appraisals
The Obama Administration proposed a number of important financial service industry regulatory changes. In November, the House Financial Services Committee approved one of the administration’s proposals, the Investor Protection Act (H.R. 3817). The bill now goes to the full House floor where it is expected to be debated in December.

The Investor Protection Act requires several studies and commissions that provide the window dressing supposedly showing Congress did something, yet avoids any real change. We will not waste your time detailing these studies and commissions. More substantively, the bill would do the following:

1. Impose a fiduciary duty on every financial intermediary who provides advice - Investment advisors already have this duty under the Investment Advisers Act, but brokers do not have this fiduciary duty. The bill would harmonize a fiduciary duty between investment advisors and brokers.

2. Creates an SEC whistle-blower program similar to what the IRS has - Under the bill, if a whistleblower provides information to the SEC that result in penalties greater than $1 million, then the SEC could award the whistleblower up to 30% of the penalty. The program allows for anonymous reports through an attorney. The SEC has complete discretion as to any potential reward, without any judicial review.

3. In an ironic last-minute amendment to this legislation titled the “Investor Protection Act”, permanently exempts companies with a market value less than $75 million from a requirement that outside auditors review and report on a company's internal controls - This requirement comes from Sarbanes-Oxley Section 404(b), but the SEC has extended the required compliance date. Now that the SEC finally indicated no further extensions will be given, the bill will eradicate this requirement for approximately half of all publicly-traded companies.

4. In changes that will certainly not protect investors, alters the regulatory scheme that is now in effect, as follows:

a. Raises the assets under management requirement for SEC jurisdiction from $25,000,000 to $100,000,000. This effectively results in many registered investment advisors being regulated at the state instead federal level.

b. Gives the Financial Industry Regulatory Authority (FINRA) regulatory authority over registered investment advisors who are also dually registered as broker-dealers. FINRA has not been known as an aggressive regulator. The chairman of the House Financial Services Committee indicates that he intends to alter this provision on the House floor to require SEC authority over these entities.

5. Requires financial advisers to municipalities be registered with the SEC.

6. In a clear reaction to the Madoff fraud:

a. Amends Section 206(4) of the Investment Advisers Act making it unlawful for a registered investment adviser to have custody of client funds or securities over $10 million, except in a separate account directly or indirectly titled in the name of the client. The qualified custodian cannot directly or indirectly provide investment advice regarding such funds.
b. Gives the Public Company Accounting Oversight Board (PCAOB) new examination powers over the auditors of broker-dealers

7. In what appears to be window-dressing masquerading as changes for investor protection, gives the SEC the following powers that the SEC already has:

a. End mandatory arbitration of investor claims in customer contracts. The SEC already has the authority under the 1934 Act to ban mandatory securities arbitration if it concludes it is in the interests of investor protection.

b. Allow the SEC to impose proxy access rules allowing shareholders to nominate directors to corporate boards. Regardless of this change, SEC Chairman Mary Schapiro said she is committed to bringing final proxy access rules to the full Commission in early 2010.

8. Doubles the SEC’s funding over 5 years.

Because of its Democratic support, we expect the Senate to pass the more important of these changes.

ABOUT THE AUTHOR: David Nolte
Mr. Nolte has 30 years experience in financial and economic consulting. He has served as an expert witness in over 100 trials. He has also regularly served as an arbitrator. Mr. Nolte has achieved the following credentials: CPA, MBA, CMA and ASA.

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While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.
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