As we mentioned in our "Link of the Day Monday (see Reuters writes "House panel probes risk council role in SEC money fund rule"), a House committee is investigating improper collusion between the FSOC and SEC under Mary Schapiro. A July 10 letter from Congressmen Darrell Issa and Jim Jordan (obtained by Crane Data but not available yet online) says, "The Committee on Oversight and Government Reform is conducting oversight of the Financial Stability Oversight Council (FSOC or Council). The Committee is concerned that the Council may be structured and operating in a manner that vitiates the independence and core competence of the Council's constituent regulatory bodies. As part of the Committee's oversight of the Council, we are writing to request more information about the Securities and Exchange Commission's (SEC or Commission) participation in FSOC activities."

The letter explains, "The Dodd-Frank Wall Street Reform and Consumer Protection Act established FSOC with the purpose of identifying risks to financial stability, promoting market discipline, and responding to emerging threats to the stability of the United States financial system. Given the breadth of this mission, the Act structured the Council to include a broad swath of federal financial regulators, including: Department of the Treasury; Office of the Comptroller of the Currency; Federal Housing Finance Agency; Consumer Financial Protection Bureau; Federal Reserve Board of Governors; Securities and Exchange Commission; Federal Deposit Insurance Corporation; Commodity Futures Trading Commission; and National Credit Union Administration."

It tells us, "First, we are concerned about the structure of the Council's voting membership. By the terms of the statute, the Council's voting membership is constituted of the singular top official from each one of the member agencies. This structure is operationally problematic: only in four of the nine constituent agencies is the full authority of the office vested in a single individual. By contrast, the authority of the other five agencies is explicitly and intentionally placed in commission by their respective organic statutes. The chairperson of each commission merely possesses administrative authority and is "first among equals." Because of this distinction, the Council's structure can create perverse results. For example, in Council meetings the Chairman of the CFTC' speaks- and votes- under cloak of the full authority of the CFTC, when in fact the Chairman possesses only one of five equal votes on that Commission.... The Dodd-Frank Act plainly describes the Council's duties in the context of interaction with the member agencies, not the singular officials who serve ex officio."

The Issa letter continues, "Second, we are concerned about the implications of the Council's membership to the political independence of some of its member agencies. The structural threats to the primary financial regulator's independence are most acutely felt by the members of the independent commissions. In a public address, SEC Commissioner Daniel Gallagher explained his concerns with regard to the Council: [T]he structure of FSOC is particularly troubling for an independent agency like the SEC. While the Secretary of the Treasury and the heads of the FHFA and the CFPB may speak on behalf of their agencies -- not to mention the President that appointed them -- the same cannot be said of the Chairman of the SEC. To preserve its independence, Congress created the SEC as a bipartisan, five-member Commission and gave each Commissioner -- including the Chairman -- only one vote. This means that the Chairman has no statutory authority to represent or bind the Commission through his or her participation on FSOC. Yet as a voting member of FSOC, the Chairman of the SEC does have a say in authorizing FSOC to take certain actions that may affect -- and indeed have already affected -- markets or entities that the Commission regulates.... These factors, among others, make FSOC particularly susceptible to political influence which, in turn, can be -- and has been exerted on the agencies led by FSOC's members.""

The House letter adds, "Third, we are concerned about the Council's ability to intervene in the regulatory processes of the independent agencies. Section 120 of the Dodd-Frank Act empowers the Council to formally issue "recommendations to a primary financial regulatory agency to apply new or heightened standards and safeguards ... for a financial activity or practice." Upon receipt of these recommendations, the agency has three months to accept the recommendations or explain in writing why it will not do so. Commentators have observed that through this provision, "traditionally independent regulatory agencies ... are now subject to potentially more direct influence by the Administration and other financial services regulators.""

It explains, "In November 2012, FSOC invoked Section 120 for the first time when it issued formal recommendations regarding money market fund (MMF) reform. These recommendations followed an August 2012 decision by the Securities and Exchange Commission not to pursue a SEC staff proposal advocated by then-Chairman Mary Schapiro. At that time, a bipartisan majority of the Commission determined there was insufficient data on which to advance further changes to MMF regulations. In response to such concerns, staff in the SEC Division of Risk, Strategy, and Financial Innovation prepared a detailed report addressing the Commissioners' questions, and began working with the Commissioners to formulate a workable proposal. Notwithstanding this ongoing deliberative process, FSOC formally intervened."

Issa and Jordan write, "On February 20, 2013, a bipartisan group of fifteen former SEC Chairmen, Commissioners, and senior staff expressed grave concerns with the manner in which FSOC exercised its Section 120 authority. The former officials specifically objected to FSOC's intervention as both premature and fundamentally destructive to the Commission's deliberative process: "The Council's authority under section 120, if exercised precipitously or with insufficient deference to the subject-matter expertise of the Commission, could disrupt the long-standing collaborative nature of the Commission's deliberative process. Knowledge that the Council stands ready to circumvent Commission deliberations by asserting jurisdiction over a matter clearly confided to the SEC's jurisdiction ineluctably would undermine the incentives exhibited by Commission Members to labor diligently in search of sound, middle-ground policy outcomes.""

It tells us, "Documents produced to the Committee appear to validate these concerns. For example, emails from June 2012 reveal that a top advisor to then-SEC Chairman Mary Schapiro admonished her colleagues at other Council agencies that "[FSOC's] recommendation [for MMF reform] ... needs to be stronger." Subsequently, this advisor worked closely with a senior official at the Federal Reserve Board of Governors to draft a letter in the Council's name urging the SEC to adopt a MMF reform proposal. The draft letter unsubtly threatens the invocation of Section 120 authority: "However, in the event that the SEC does not act, the Council will have no alternative but to consider the entire range of tools at its disposal to address identified threats to U.S. financial stability.""

The letter says, "It does not appear that this draft letter was reviewed by the bipartisan majority of the Commission who, at the time, disagreed with the Schapiro/FSOC proposal. Further emails shed light on then-Chairman Schapiro's goal: "In the closed session of the FSOC principals meeting on July 18, SEC Chairman Schapiro said that in addition to the recommendations in the annual report, she might want more FSOC support for MMF reform ahead of a SEC meeting scheduled for late August. The meeting is now scheduled, and she would like another statement of support for MMF reform." Consistent with these efforts, it appears FSOC member agencies intervened in internal SEC deliberations. Documents reveal that a high ranking official at the Federal Reserve made red-line edits to the term sheet SEC staff would be using to brief the Commissioners on the proposed rule? Thus, it appears that four SEC Commissioners were presented with what they believed represented the views of the SEC's professional staff, when in reality the document reflected the views of another FSOC member agency and was developed in a non-transparent manner. While interagency cooperation can be beneficial, the Commissioners of an independent agency are indisputably entitled to know the origin of the recommendations presented to them."

It continues, "This is precisely the kind of interference that threatens the independence and core competence of the primary financial regulators. The office of one single Commissioner -- in this case the Chairman -- surreptitiously cloaked its opinions and advocacy in the mantle of FSOC, with the explicit threat to marshal the Council's Section 120 power. Such actions are wholly inconsistent with Congress' intent that the SEC operate as an "independent, collegial body, [and] not [as] an executive department headed by a sole administrator." The heavy-handed and destructive approach exercised by FSOC was neither advisable nor necessary. As observed by one academic commentator: FSOC could have enhanced -- rather than undermined -- the SEC's rulemaking process in two ways. First, it could have encouraged the SEC to use tried and tested regulatory impact analysis tools to identify with precision and transparency the problems to be addressed, feasible alternative solutions, and the costs and benefits of each of those alternatives. Second, FSOC could have marshaled the relevant cross-agency expertise to address ... accounting and tax issues."

Finally, the letter adds, "The Council's decision to proceed through non-transparent unilateral action raises serious questions as to the prudence and desirability of its operative structure. The Committee is concerned that, in the words of one commentator, "a piecemeal approach that allows [an agency's] chairman to outsource the agency's regulatory responsibilities on an ad hoc basis does not benefit investors, other market participants, or taxpayers."" The letter includes an extensive request for documents, so stay tuned for further disclosures in coming months.

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