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Bank Regulators at the Gates: The Misguided Quest for Prudential Regulation of Asset Managers: Remarks at the 2015 Virginia Law and Business Review Symposium

Commissioner Daniel M. Gallagher

University of Virginia School of Law, Charlottesville, VA

April 10, 2015

Thank you, Andy [Vollmer] for that kind introduction. 

I’m very pleased to be a part of today’s symposium celebrating the 75th anniversary of the Investment Company and Investment Advisers Acts of 1940.  For more than seven decades, these remarkably simple pieces of legislation have provided an efficient regulatory framework for a vital sector of the capital markets.

The 1940 Acts were passed on a largely bipartisan basis following years of study and deliberation – in other words, in a manner completely unlike the Dodd-Frank Act.  After establishing the SEC in 1934, Congress directed Commission experts to conduct a detailed study of the asset management industry.  The SEC spent more than two years creating a comprehensive report to Congress with recommendations that formed the basis of the 1940 Acts.[1]

Within that legal framework, the asset management industry has thrived.  It has grown to an extent that the drafters of the 1940 Acts never could have imagined.  In the first year after the Advisers Act was passed, 701 investment advisers registered with the SEC.[2]  Today, there are 11,611 registered investment advisers with $62 trillion in assets under management.[3]  In 1940, there were fewer than 500 registered investment companies with total assets of approximately $2.5 billion.[4]  Today, that number has grown to approximately 4,100 registered investment companies with $18.2 trillion under management.[5]

For more than seven decades, the 1940 Acts have enabled the SEC to fairly and effectively oversee the asset management industry in a manner consistent with our statutory mission. 

Unfortunately, as is so often the case, Washington hates a good success story.  And so, since the financial crisis, the asset management industry has become a target of both the prudential regulators who performed so poorly[6] – and the policymakers who kept their foot on the credit bubble gas pedal – in the years leading up to the crisis.  Their goal is to subject the so-called “shadow banking” markets, of which the asset management industry is a significant part, to bank-like regulation under the prudential regulators.  And, to be clear, without bold leadership and a dose of regulatory rationality to oppose this effort, it will happen.

Why have the prudential regulators been able to push the envelope of imposing their prudential regulation on capital markets without meaningful challenge?  It is because they, and the policymakers they have captured, adhere to a false narrative of the financial crisis that says capital markets regulators like the SEC failed, and the markets and market participants overseen by capital markets regulators were a major cause of the financial crisis. Forgotten, of course, are the myriad failed banks, the taxpayer dollar “foam on the runway” that propped up too big to fail commercial banks, and – most importantly – the failed federal housing policy that actually did cause the financial crisis.  To borrow a phrase from Al Gore, these were inconvenient truths.  And they certainly haven’t impeded the enlightened progress of the regulatory illuminati.

The worst offenders in this cause are the U.S. Financial Stability Oversight Council, or FSOC, and the Basel-based Financial Stability Board, or FSB.  Together, FSOC and the FSB have launched a series of broad-based workstreams aimed at designating asset managers, or the activities of asset managers, as systemically important in order to subject them to oversight by the Federal Reserve and other prudential regulators.  The Fed, of course, plays a key role in both institutions, operating as the implementation arm of the FSOC and as the chair of the FSB shadow banking workstreams. 

The repeated attempts of the FSB and FSOC to characterize asset managers and their activities as systemically risky is nothing more than a ploy to wrest control of a hugely important sector of the capital markets from the SEC.  For prudential regulators, this is about regulatory power and jurisdiction.  For the ideologues who are cheering them on, it is about central command and control of a large swath of the U.S. economy.  They do not mind making capital markets participants into public utilities like the too big to fail banks.  And, they do not see the peril in reshaping our markets to resemble those of Europe.

* * *

So how did we get to this point?  And where is this debate heading?

Like so many other regulatory messes facing us today, the story begins with the Dodd Frank Act.[7]  Congress’s first order of business in Dodd Frank – literally, in Title I, Subtitle A – was to formally establish FSOC as a federal government monitor and arbiter of purported threats to financial stability.  In the early stages of the legislative process, FSOC was conceived as a collegial council of regulators[8] – an expanded and formalized version of the President’s Working Group on Financial Markets, which had served for over two decades as a consultative group for the harmonization of financial market regulatory policy and the facilitation of communications between U.S. financial regulators.  However, the FSOC that emerged from the final legislation was vastly different.  It is a federal bureaucracy dominated by an executive branch cabinet secretary and prudential regulators with unprecedented and extraordinary regulatory powers.  Perhaps the most pernicious of these new powers is the authority to subject non-bank financial institutions to prudential regulation by the Federal Reserve if such institutions are deemed to pose a threat to the financial stability of the U.S. economy.[9]

A fledgling FSOC wasted little time flexing this newfound muscle when it jumped into the debate about money market mutual fund regulation.  In November 2012, the members of FSOC voted unanimously to approve a proposal that, if adopted, would allow FSOC to issue a formal “recommendation” on money fund regulation to the SEC.[10]  Under Section 120 of Dodd-Frank, an agency that receives such a “recommendation” from FSOC must either comply with it, take alternative steps that yield a comparable result, or explain in writing why it has elected not to carry out FSOC’s wishes.[11]  Fortunately, FSOC’s proposal never advanced to the adoption stage, but FSOC had proven its willingness to cross the Rubicon of imposing its will on an ostensibly independent regulator if its threats were not heeded.

Possibly fueled by money market fund adrenaline, in 2013 FSOC commenced a review to determine whether certain asset management firms should be designated as systemically important financial institutions, or “SIFIs,” and therefore be subject to enhanced prudential standards and supervision.  In connection with this review, FSOC commanded Treasury’s Office of Financial Research to perform an analysis of the asset management industry, including its vulnerability to financial shocks and the potential risks it poses to the financial markets.  In September 2013, OFR released its findings in what has come to be known infamously as the “OFR Report,” a document riddled with fundamentally flawed conclusions that were the inevitable result of OFR’s deeply unsound processes.[12]

OFR’s analysis was so flawed, in fact, that I felt compelled to register my objections in a letter to the comment file that was opened for the study – which, I should note, was only created thanks to Chair White’s insistence on at least some modicum of transparency.[13] As I explained in that letter, not only did the OFR Report inaccurately define and describe the activities and participants in the asset management business, but it made matters worse by analyzing the purported risks posed by asset managers in a vacuum instead of in the context of the broader financial markets.  It offered up speculative conclusions of systemic risk without any reference to the data used to support them – unsurprising, since clearly little if any data was actually considered.  The end product was a botched analysis that grossly overstated – indeed, in many cases simply invented without supporting data – the potential risks to the stability of our financial markets posed by asset management firms.  The mistakes of fact and poor substantive analysis contained in the OFR Report were exponentially compounded by OFR’s brazen refusal to consider the comments and input from the experts at the SEC, the very agency charged by Congress with regulating asset managers for 75 years. 

As bad as it was, the flawed OFR Report is but one symptom of a rapidly spreading disease unfairly targeting the asset management industry.  At the same time FSOC and OFR were busy concocting fictions to justify systemic risk designations in the United States, the FSB was engaging in a similar assault on non-bank financial services companies in Basel.  The FSB, it’s important to note, is made up of representatives from all of the G-20 countries, including such free-market stalwarts as Russia and China.  In voting power, European FSB members have disproportionate influence as the EU is represented at the supranational as well as national levels.  Perhaps we should petition to allow the Great State of Texas to become an FSB member!  In 2010, the G-20 directed the FSB to embark on a process to identify “global systemically important financial institutions,” or “G-SIFIs”.  The FSB’s initial work focused on banking organizations, but its leadership announced early on that it planned to extend its analysis to a wider array of entities, including “financial market infrastructure, insurance companies and other non-bank financial institutions that are not part of a banking group structure.”[14]  After designating 29 banks as systemically important in 2011,[15] the FSB quickly turned its attention to insurance companies, designating nine insurers, including three in the U.S. – MetLife, Prudential, and AIG.[16]

True to form, the FSB then announced plans to expand its focus to non-bank, non-insurer entities – including asset managers.  In a joint consultation report with the International Organization of Securities Commissions, or IOSCO, issued in January 2014, the FSB released its proposed methodology for extending the SIFI framework from banks and insurance companies to “all other financial institutions.”[17]  Neither surprisingly nor coincidentally, the 2014 FSB report prominently featured many of the characteristics that formed the basis for the findings of the fatally flawed OFR Report.  For example, the 2014 report proposed a wholly arbitrary size threshold of $100 billion in assets under management for an individual investment fund to be considered systemically important – a number, by the way, that would have captured 14 investment funds, all of them American.  Like the OFR Report, the 2014 FSB report also seized on bank regulation-oriented concepts as potential indicators of systemic risk transmission mechanisms for investment funds. 

In response to this report, the FSB received a raft of comment letters thoughtfully explaining the fundamentally different risk profiles of asset managers and banks.[18]  Nevertheless, last month the FSB and IOSCO issued a second consultation paper that is even more flawed than the first.[19]  The March 2015 report still contains the $100 billion size threshold for individual investment funds, but goes even farther afield by adding thresholds for asset managers of $100 billion in balance sheet assets or $1 trillion in global assets under management.  Based on the global assets under management threshold, four American asset managers would be considered systemically important versus – wait for it, wait for it – zero foreign asset managers.  The report also continued to emphasize concepts such as interconnectedness, complexity, substitutability, and cross-jurisdictional activities that bear little if any relevance outside the banking sector but serve to justify efforts by the Lilliputian regulators of the FSB to bind the American financial system with their rules.

To move Swiftly, as it were, from one British author to another, the actions and attitude of the FSOC and FSB bring to mind Rudyard Kipling’s famous admonishment to “stick to the Devil you know.”[20]  To the dozens of financial institutions that submitted comments to the FSB, the SEC and its fellow capital markets regulators are, indeed, the devil they know.  But far more importantly, we are the devil that knows them.  They are all too aware that the banking mandarins who have anointed themselves as the modern-day Gods of the Market Place are selling a false bill of goods: a promise that if we only give them the authority they ask for, they can stave off financial crises indefinitely.  In the spirit of Kipling, they are essentially telling us, “If we take the advisers and insurers, and treat them as if they are banks, investors will never face danger, and you’ll shower your rulers with thanks.”

Turning back to prose, it’s important to note that the focus on designating individual firms as G-SIFIs and SIFIs is only one element of the ongoing FSOC and FSB campaign against the asset management industry.  Late last year, the FSOC announced that it was shifting its attention to the products and activities of asset managers, issuing a notice and inviting public comment on “whether asset management products and activities may pose potential risks to the U.S. financial system in the areas of liquidity and redemptions, leverage, operational functions, and resolution, or in other areas.”[21]  And, as surely as day follows night, early this year the FSB reportedly began developing and considering work plans for an activities-based review of its own.  It remains to be seen whether this purported shift in focus to products and activities represents an expansion or a retrenchment in the quest to import prudential regulation to the asset management industry.  But, if past behavior is any indication of future performance, it would be foolhardy to expect the FSOC and FSB to stand down.  The FSB certainly has shown no signs of doing so as it marches full steam ahead on parallel tracks, continuing to target individual firms in its consultation report with IOSCO while at the same time launching a separate review of asset manager activities.[22]

As demonstrated by its assault on asset managers, the work of the FSB has been tailored to legitimize the FSOC’s efforts to import prudential regulation to the U.S. capital markets through the designation of non-banking entities as SIFIs.  Drawing its authority from the supra-national, inherently political mandates of its G-20 creators, the FSB is endeavoring to force a prudential, bank regulatory construct into the capital markets.  Conveniently, most of the European members have no capital markets to worry about!

Each time the FSB has made an important decision or announced a policy affecting non-bank financial institutions, the FSOC has followed suit.  For example, in November 2012, the FSB endorsed a recommendation to subject money market mutual funds to capital requirements unless they adopted a floating net asset value.[23]  The very next day, the FSOC issued a public report in which it pressured the SEC to adopt either floating NAV or capital buffer rules.[24]  And in July 2013, the FSB designated AIG, Prudential, and MetLife as SIFIs.[25]  That same month, the FSOC designated AIG as a SIFI.  Two months later, the FSOC added Prudential to its list of SIFI designations and commenced a review of MetLife that led to its designation in 2014.[26]

The FSOC has consistently taken steps to carry out the FSB’s policy objectives without seeking approval from Congress.  And recently, FSB Chair Mark Carney effectively declared the FSB view that its edicts are binding on its members.  We all know, of course, that there is no basis in law for the assertion that decisions of the FSB are binding on U.S. regulators.  Nevertheless, it is plain to see that the FSOC has entered into an insidiously symbiotic relationship with the FSB, supporting its actions on the international stage while using those actions to justify regulation at home.  This sets a dangerous precedent that not only places unfair burdens on participants in our capital markets, but also threatens the integrity of our constitutional system of government.[27]

* * *

It is especially fitting to explore this topic here on the grounds of this storied institution founded by Thomas Jefferson.  In his first inaugural address, Jefferson famously said that “a wise and frugal Government, which shall restrain men from injuring one another, shall leave them otherwise free to regulate their own pursuits of industry and improvement, and shall not take from the mouth of labor the bread it has earned. This is the sum of good government[.]”[28]

Since the passage of Dodd-Frank, our government’s approach to financial regulation has been neither wise nor frugal.[29]  Participants in the capital markets have not been free to regulate their own pursuits of industry and improvement and have been forced to pay far more than a pound of bread in the form of hugely burdensome regulatory costs, ultimately to the detriment of the U.S. economy. 

The decisions made by post-financial crisis star chambers like FSOC and the FSB take place behind closed doors, with no checks or balances.  This opacity masks a blatant regulatory creep.  It is high time we all acknowledge that the systemic risk designation process itself is far more dangerous to our financial markets than the purported risk factors it was created to address.

Thank you for your time today.  It is a real honor to be here. 

[1] U.S. Securities and Exchange Commission, Investment Trusts and Investment Companies (1939).

[2] U.S. Securities and Exchange Commission, Seventh Annual Report of the Securities and Exchange Commission, at p. 33 (1942),  available at

[3] SEC Investment Adviser Registration Depository, data as of February 2, 2015. 

[4] Supra note 2 at p. 9.

[5] RIC data derived from EDGAR filings as of December 31, 2014.

[6] See, e.g., Peter Wallison, The Fed Needs More Than an Audit, Wall. St. Jrnl. (Nov. 27, 2014) (observing that the Gramm-Leach-Bliley Act “made the central bank the closest thing to a ‘systemic regulator’ of the U.S. financial system, with the ability to oversee the work of other financial regulators such as the Securities and Exchange Commission.  The Fed clearly failed in this role before the 2008 financial crisis, but in typical Washington fashion the 2010 Dodd-Frank Act enlarged the Fed’s powers. It now has authority to supervise all of the large nonbank financial firms that are designated as systemically important financial institutions by a council of regulators.”); Peter Wallison, The Fed Fails Upward, American Spectator (May 2009) (“If the Fed had wanted to control the risk-taking of the largest banks—the institutions most likely to be declared systemically significant— it could have done so through its control over their holding companies.  However, the Fed has not exercised this authority…. Despite these failures, Chairman Frank and many others see the Fed as the right agency to take on the role of systemic regulator. Strange, but as I say, not surprising.”).

[7] Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (July 21, 2010).

[8] See Benton Ives and Phil Mattingly, Geithner Outlines Regulatory Overhaul, CQ Weekly (Mar. 28, 2009), available at 2009 WLNR 6351182 (discussing Senator Dodd’s call for “a council of regulators” that could “watch for systemic risks” with the help of “a professional staff that could analyze systemic risk”); see also Industry Backs Multi-Agency Approach on Risk, Compliance Reporter (May 22, 2009), available at 2009 WLNR 26668110 (noting that certain ex-SEC officials and senior industry professionals “backed a council of regulators approach for overseeing risk”) (noting one idea for “a framework in which a council of agencies could act more as an oversight body than as a regulator”).

[9] See Dodd-Frank Wall Street Reform and Consumer Protection Act § 113, 124 Stat. 1376 (2010).

[10] Financial Stability Oversight Council, Proposed Recommendations Regarding Money Market Mutual Fund Reform, (Nov. 13, 2012), available at,%202012.pdf.

[11] See Dodd-Frank Wall Street Reform and Consumer Protection Act § 120(c)(2), 124 Stat. at 1409 (2010).

[12] U.S. Department of the Treasury, Office of Financial Research, Asset Management and Financial Stability Report (Sept. 2013), available at

[13] U.S. Securities and Exchange Commissioner Daniel M. Gallagher, Letter to SEC Comment File on OFR Report (May 15, 2014), available at

[14]  Financial Stability Board, Reducing the moral hazard posed by systemically important financial institutions, at p. 1 (Oct. 20, 2010), available at

[15] Financial Stability Board, 2013 update of group of global systemically important banks, Annex I (Nov. 11, 2013) (list of G-SIBs), available at

[16] G-20 Financial Stability Board Names Nine Insurers Systemically Important, Wall. St. J. (July 18, 2013).

[17] Financial Stability Board, Consultative Document, Assessment Methodologies for Identifying Non-Bank Non-Insurer Global Systemically Important Financial Institutions (Jan. 8, 2014) (addressing high-level framework and methodologies for assessing NBNIs for potential SIFI designation), available at

[18] See generally Financial Stability Board, Public responses to January 2014 consultative document Assessment Methodologies for Identifying NBNI G-SIFIs (Apr. 25, 2014), available at

[19] Financial Stability Board, Consultative Document (2nd), Assessment Methodologies for Identifying Non-Bank Non-Insurer Global Systemically Important Financial Institutions (Mar. 4, 2015), available at

If you are wondering, no, I do not get to vote on these consultation papers.  Perhaps that should change.

[20] Rudyard Kipling, The Gods of the Copybook Headings (1919).  In Kipling’s poem, the “Gods of the Copybook Headings” are a stand-in for simple common sense – that is, the unappealing but unwavering facts of life - while the “Gods of the Market Place” represent the seductive voice of false promise – the wonderful untruths we so often convince ourselves are true.  Kipling wrote of the Gods of the Copybook Headings:

With the Hopes that our World is built on they were utterly out of touch,
They denied that the Moon was Stilton; they denied she was even Dutch;
They denied that Wishes were Horses; they denied that a Pig had Wings;
So we worshipped the Gods of the Market Who promised these beautiful things. When the Cambrian measures were forming, They promised perpetual peace.
They swore, if we gave them our weapons, that the wars of the tribes would cease.
But when we disarmed They sold us and delivered us bound to our foe,
And the Gods of the Copybook Headings said: "Stick to the Devil you know."

[21] Financial Stability Oversight Council, Notice Seeking Comment on Asset Management Products and Activities (Dec. 24, 2014), available at

[22] Earlier this week, we learned that even the IMF is jumping into the debate, calling for enhanced oversight of the asset management industry, with “better microprudential supervision of risks … through the adoption of a macroprudential orientation.”  Just what we needed, more supranational air cover.  IMF, Global Financial Stability Report (April 2014), available at

[23] Financial Stability Board, Consultative Document, Strengthening Oversight and Regulation of Shadow Banking, at pp. 7-8 (Nov. 18, 2012), available at

[24] Supra note 10.

[25] Brooke Masters, Nine big insurers face tighter regulation, Fin. Times (July 19, 2013).

[26] See Financial Stability Oversight Council, Nonbank Financial Company Designations (listing dates of FSOC votes to designate nonbank financial companies as SIFIs), available at

[27] See Peter J. Wallison and Daniel M. Gallagher, How Foreigners Became America’s Financial Regulators, Wall St. Jrnl. (Mar. 19, 2015), available at

[28] President Thomas Jefferson, First Inaugural Address (Mar. 4, 1801), available at

[29]See, e.g., Statement of  SEC Commissioner Daniel M. Gallagher (Mar. 2, 2015) (describing and attaching chart depicting aggregate impact of regulations on financial services institutions since passage of Dodd-Frank in 2010), available at

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