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SEC Promises Fixes for Exemption Process: Regulator Also Plans Cost/Benefit Analysis Review

PHOENIX - After a sustained period of devoting resources to what its highest officers characterize as "frenetic rulemaking," the Securities and Exchange Commission is now prepared to conduct a comprehensive review of its exemptive application process and its approach to cost/benefit analysis.

Both areas have been points of frustration for the money management industry in recent years. As an industry that relies heavily on delivering the right product to consumers at just the right time, some of its timeliest innovations, insiders say, have been bogged down in an exemptive application process that's been neglected by the SEC. Its cost/benefit analysis, other say, is flawed and has led to the adoption of rules whose costs go far beyond what the regulator anticipated.

At the Investment Company Institute's 2006 Mutual Funds and Investment Management Conference, held here recently, SEC Division of Investment Management Acting Director Susan Wyderko said the regulator is sympathetic to the industry's dissatisfaction.

"We need to take a look at some housekeeping matters," Wyderko admitted during a panel discussion on the regulatory outlook for mutual funds. "We need to make sure that our exemptive rule process is running in an appropriate fashion, that people are able to get a response from the SEC in a timely fashion."

In short, an exemptive application is a request by a financial services firm to "exempt" a certain person, transaction, security or class of security from the law. The goal of the process, according to the SEC, is to determine whether the exemption is necessary or appropriate in the public interest and is consistent with the protection of investors.

A "no-action letter," a separate procedure that's often spoken of in the same breath as an exemption and seeks to achieve the same end, is a clarification from the SEC on the legality of a particular product, service or activity. If granted, it says the SEC would not take enforcement action against the requester based on the facts described in the request.

Whatever the technical distinction, critics argue that both processes are anything but timely.

"If you took a survey of people at this conference, particularly the practicing outside lawyers, their No.1 gripe, next to other lawyers, would probably be the exemptive process and no-action process," said Barry Barbash, a partner with Willkie, Farr & Gallagher in Washington.

For lawyers, the processes are essential tools in advising their clients. Perhaps more importantly, however, they're critical to industry innovators, who might have a great new product but are afraid it would dance too closely to the edge of a securities law.

Barbash cited money market funds as one product that required the exemptive process and eventually made a big splash in the market. But the process is so slow nowadays, he said, that people in the industry have a perception that exemption applications "go into the bowels of the SEC and never move."

"You can't sign off on just any idea," he added. "But the exemption process must be used, and it must be used effectively. There are some entrepreneurs out there who come up with some good ideas that ought to be able to go forward."

According to the SEC, it concluded 420 exemptive relief requests in 2005 and estimates it will handle 325 in 2006 and another 325 in 2007. The SEC could not provide a tally of the current backlog of exemption applications.

While Barbash readily concedes that the SEC's post-scandal rulemaking and enforcement has indeed been time-consuming, he thinks the backlog on exemptive applications is due to the review process.

"We need to take a look at a period of time when exemptions were more forthcoming," he offered. As a former director of the SEC's investment management unit, however, he said he knows firsthand that the process is one of its most thorniest duties.

"Essentially, the division is being asked to say yes when the statute says no," he said. "There isn't a lot of job satisfaction from saying yes and then finding that there's a problem."

Michael Koonce, general counsel to the Evergreen Investments unit of Charlotte, N.C., banker Wachovia, said a little communication would go a long way. Sometimes, he said, the SEC's viewpoint on a rule changes, but the regulator fails to disseminate that decision to the industry. He cited closed-end funds with a managed distribution policy. A setup the SEC approved in a 1997 exemption, it was recently reconsidered after a review by the SEC's Office of Compliance, Inspections and Examinations.

That about-face came much to the surprise of many funds.

"It's a fairly clandestine process," Koonce remarked. "If the SEC is going to stop issuing exemptions on a subject, they should tell people." Even a "no" would be better than "no answer," he joked, because then at least "you could continue the conversation and maybe get a yes."