A Controversial New Proposal for Regulating Foreign Financial-Service Providers

The Harvard International Law Journal has posted a striking new proposal by two senior SEC officials, Ethiopis Tafara and Robert J. Peterson, on how to regulate foreign financial service providers in U.S. capital markets.  A central issue in the debate over regulation of international financial service providers is whether and how domestic regulations should apply to foreign companies providing those services in domestic markets.  This article argues that, rather than apply SEC regulations to foreign financial-service providers, foreign stock exchanges and broker-dealers should be permitted to apply for an exemption from SEC registration based on compliance with substantively similar foreign regulations.  The authors (and Howell Jackson, in an accompanying analysis of the proposal) refer to their model as a “system of substituted compliance.”

Under this framework, the SEC would retain the ability to pursue violations of fraud-related domestic securities laws by foreign entities.  Rather than oversee those companies directly, though, the SEC would reach an agreement with its foreign counterpart to share enforcement information and to ensure that its counterpart oversees enjoys oversight power and a regulatory philosophy similar to the SEC’s.  In such cases, the SEC would exempt financial service providers subject to regulation by its foreign counterpart from most domestic regulation.

This proposal is likely to be controversial because it eschews the multilateral, single-agency enforcement model the SEC has pursued in the past.  The authors acknowledge that point, but suggest that their model would allow the SEC to meet its regulatory objective of protecting investors by efficiently negotiating bilateral enforcement agreements with foreign counterparts that will meet the SEC’s enforcement standards–while also giving U.S. investors cheaper, easier access to investment in foreign markets.  The authors describe these additional advantages to their model:

–Increased competition in financial services in the United States;

–Reduced transaction costs to U.S. investors interested in buying or selling foreign securities; and

–Providing high-quality (though different) protections to U.S. investors seeking to invest in foreign markets.

An accompanying analysis by Howell Jackson argues that the authors have broken new ground by recognizing that foreign regulatory agencies provide oversight that is substantially equivalent to SEC regulation.  (Howell notes that the proposal calls for selective substituted compliance–that is, substituted compliance only for select jurisdictions where regulatory protections are comparable to those provided by the SEC.)  The new proposal, Howell argues, recognizes that select foreign regulators are adequate substitues for SEC oversight, and offers a clear path for the SEC to take advantage of the regulatory capabilities of foreign governments in order to give U.S. investors access to foreign markets while remaining faithful to its regulatory mandate of protecting investors.

Given the importance of this issue and the controversy likely to surround the substituted-compliance proposal, the new paper and Howell’s response are must-reads for those interested in securities regulation.  Readers may also want to check out this recent post, in which Howell describes a Report posted by the Program on Corporate Governance addressing the wide range of issues raised by international regulation of financial service providers.