SEC Commissioner Gallagher Asserts Serious Flaws in Systemic Risk Designation Process

At a symposium celebrating the 75th anniversary of the Investment Company and Investment Advisers Acts (the “1940 Acts”), SEC Commissioner Daniel Gallagher discussed the “misguided quest” of the U.S. Financial Stability Oversight Council (“FSOC”) and the “Basel-based” Financial Stability Board (“FSB”) to regulate asset managers.

Commissioner Gallagher stated that the 1940 Acts enabled the SEC to effectively oversee the asset management industry, though that success has been overlooked. According to Commissioner Gallagher, the attempts of prudential regulators, particularly the FSOC and the FSB, 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.”

Commissioner Gallagher discussed the history of these regulators, including their subsequent attempt at “concocting fictions to justify systemic risk designations.” Commissioner Gallagher is concerned that the FSB has been attempting to expand its focus to non-bank, non-insurer entities. He noted that in 2013, FSOC commenced a review to determine whether certain asset management firms should be designated as systemically important financial institutions (“SIFIs”) subject to enhanced prudential standards and supervision. He stated that “it would be foolhardy to expect the FSOC and FSB to stand down” in these endeavors against the asset management industry.

Commissioner Gallagher pointed out that each time the FSB made a policy decision affecting non-bank financial institutions, “the FSOC has followed suit.” He stated that FSB’s designation of AIG, Prudential, and MetLife as SIFIs was closely followed by FSOC’s designation of AIG and Prudential as SIFIs, and a commencement of a review of MetLife. According to Commissioner Gallagher, “it is plain to see that 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.” Commissioner Gallagher argued that it is time to 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.”

Lofchie Comment: There is nothing in the legislative history of Dodd Frank to suggest that Congress conceived that the FSOC would regulate investment managers and private investment funds as systemically significant. Nor are there even ex-post legislator statements to confirm that Congress anticipated such a result.

Leaving aside the question of written legislative intent or a history of relevant debate or discussion preceding the adoption of Dodd-Frank, there are any number of questions to be asked about the SIFI process. Here are three: (i) what is the expertise of the FSOC group in regulating private investment funds, as opposed to banks?; (ii) are there other factors besides systemic risk, such as economic growth, that FSOC should consider in determining whether private investment funds may be designated as SIFIs?; and (iii) does FSOC plan to assert authority over individual investment funds on the theory that in the aggregate, investment funds are systemically significant?

Given the boundless authority that FSOC possesses, or seems to want to possess, it is only reasonable for Congress to answer these questions, or at least pose them to FSOC representatives.