Crooks and Scandals: Punish One at a Time

In my previous blog I suggested that business regulation is about a decade behind the times for financial services, citing AIG as an example of a company that failed when it overinvested in non-insurance assets. We got into this situation when the Gramm-Leach-Bliley Act of 1999 deregulated financial services but the government structure of oversight failed to change. There is nothing wrong with regulation as long as it reflects the current strategy of an industry. The problem is that Congress has not really adjusted the regulatory responsibilities since the passage of the three securities acts (1933, 1934 and 1940) and the banking acts (1864 and 1913); there never has been federal oversight of the insurance industry.

What we need to do once the dust settles is to refocus on the functions of these industries in the 21st century and not of one, two or even three generations earlier. As I wrote in my book, Is U.S. Business Overregulated? (York House Press, 2008), we need the appropriate level of consolidated regulation, probably by categories of risk. First, each type of investor should receive a directed form of regulation by risk category.

For institutional investors, management of financial services businesses in terms of such risk categories as-

  • Insurance risk for the safety of customer funds that are on deposit with a financial services firm. This would include the segregation of customer funds and administration of account insurance (like the Federal Deposit Insurance Corporation).
  • Business risk to protect the integrity of the intermediation process used by all financial services companies. This would include assurance that adequate collateral exists for loans, that appropriate due diligence has occurred in deciding whether to establish and continue relationships with customers, and that necessary documentation exists to support financial transactions.
  • Systemic risk for the security of the financial system. This would involve uniform capital requirements, payment system regulation, and the monitoring of financial system liquidity.

For individual investors, depositors and consumers, protection for those who are too weak, uninformed and scattered to defend themselves. The securities industry has long recognized that institutions and other sophisticated market participants do not need the same regulatory protections as unsophisticated investors. Financial services for retail customers would be subject to regulation and the protections afforded such investors, policyholders and depositors across product lines. This would include the prevention of deceptive sales practices, credit counseling prior to the acceptance of a loan, and prosecution against the “churning” of securities and of fraudulent profit claims.

The single regulator approach permits financial regulation from the larger perspective of the strategic objectives and decisions of a financial services organization, rather than of specific product lines and operations. The model would be the Financial Service Authority of the U.K. British regulators have learned from long experience that, while there will always be scandals and failures, each should be dealt with accordingly and with remedies specific to the circumstances. This is in sharp contrast to the current American approach to business regulation: that fraud and the misappropriation of company funds can only be prevented by severe civil and criminal penalties. In my next blog, I will discuss some related issues to the current financial situation.


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