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Fund Industry Braces For Regulatory Action

Execs Hope Reforms Don't Hamper 'Entrepreneurial Risks'

LAKE BUENA VISTA, Florida - With the one-year anniversary of the collapse of Lehman Brothers finally in the rearview mirror and the economy on the way to recovery, many participants in the financial services industry are questioning whether the industry still needs to undergo substantial regulatory change, and what changes, if any, could be beneficial at this point.

"If you tighten regulations too much, you will clog up the market," said Erik Sirri, the former director of the Security and Exchange Commission's Division of Market Regulation, at the Investment Company Institute's annual Tax and Accounting Conference here. "Innovation occurs at the fringes. We should let the fringes be small and innovative, so that if they fail, they will fail small."

In today's age of BlackBerrys, Twitter and high-frequency trading, innovations can occur so quickly that regulations can't keep up.

The recently beefed-up staff at the SEC has a huge backlog of pending guidance, ranging from target-date funds, money market funds and the advisor custody rule, to updating accounting rules to bring them closer to international financial reporting standards (IFRS).

"The update on IFRS is that there really isn't an update," Richard Sennett, chief accountant of the SEC's Division of Investment Management, told a group of accountants and tax lawyers. "We have been busy with other initiatives."

The SEC is studying issues regarding securities valuation, risk management, derivatives and counterparty exposure, among other things. The SEC is hard at work on these issues, and officials say the industry could see guidance in some areas before the end of the year.

Congress may have been swamped by the healthcare debate all summer, but that doesn't mean it has forgotten about financial regulatory reform. Next year is an election year, and Democrats in particular are determined to show voters they've accomplished something.

At a speech at Federal Hall in New York last week, President Barack Obama said Wall Street should not get too comfortable.

"Unfortunately, there are some in the financial industry who are misreading this moment," Obama said. "Instead of learning the lessons of Lehman and the crisis from which we are still recovering, they are choosing to ignore them. They do so not just at their own peril, but at our nation's. So I want them to hear my words: We will not go back to the days of reckless behavior and unchecked excess at the heart of this crisis, where too many were motivated only by the appetite for quick kills and bloated bonuses. Those on Wall Street cannot resume taking risks without regard for consequences, and expect that next time, American taxpayers will be there to break their fall."

Many mutual fund industry leaders have touted the resilience of mutual funds throughout the recent crisis, and argue that despite having lost assets when the stock markets fell off a cliff, mutual funds did exactly what they were supposed to do and were transparent and well-regulated the entire time.

While acknowledging that all of the problems that triggered the global financial disaster have not fixed themselves, industry experts caution that Congress should not enact any new legislation in haste. Even tiny changes to areas like the monstrous tax code can have thousands of unintended ripple effects to other areas.

"There is no way to write legislation that will prevent all future crises," said Sean Collins, senior director of industry and financial analysis at the ICI. "We have to form legislation that's realistic and helps financial institutions be resilient, and can help institutions take the shocks as they come. If you prevent the formation of capital, you prevent businesses from taking entrepreneurial risks."

Last year's crisis was caused by a colossal failure of leadership among top industry and government leaders, and many of those same leaders are now claiming credit for the recovery, said Andrew Lowenthal, president of Porterfield & Lowenthal, LLC.

"For some reason, we all have the notion that the only people who can save us are the very people who drove us to the brink," he said. "The very people who led us to this are all patting themselves on the back now."

"There is a lack of desire to hold people accountable," Lowenthal added. Now that the worst is over, Wall Street wants everything to go back to the way it was in 2007, he said.

Lowenthal said the financial services industry should not underestimate the public's continuing level of hostility towards it.

Crazy Accounting Rules

Shawn Baker, a partner at PricewaterhouseCoopers LLP, said there is a lot of concern among auditors and some clients over RIC modernization and whether the Treasury and Internal Revenue Service should repeal the preferential dividend rule for publicly offered funds.

Current tax rules are so confusing that mutual funds "are almost statistically guaranteed to have tax issues," Baker said.