Proposed Change in Global Trading Rule Raises Risks

By Jane Bryant Quinn
Sunday, July 6, 2008

The Securities and Exchange Commission has proposed a new rule that might have passed you by. I'm alerting you here because it speaks volumes about where trading is going in the United States. For many, it offers new opportunities. We'll also be importing new risks, in the future, that we may regret.

The proposal allows overseas broker-dealers to solicit business directly from U.S. clients -- individuals as well as institutions -- with $25 million or more to invest. That's down from $100 million under the current rule.

Any broker-dealer will be able to join the fray as long as it's regulated by a securities administrator in its home country. The broker-dealers won't have to register with the SEC and won't be regulated for net capital and other requirements under U.S. rules. They will be able to pitch any debt, equity and derivative security listed on their home exchanges, even though those securities aren't registered with the SEC.

Before you say, "That has nothing to do with me" and scroll on, note the implications: The door is opening to more direct global trading. This first step simplifies cross-border selling and reduces costs for large investors who are already trading abroad. Smaller U.S. broker-dealers will be able to open electronic windows to world investing for larger clients.

All this is good.

In the background, however, something is happening that we need to think about. We're injecting other countries' accounting, disclosure and regulatory standards into our system, on the theory that they are good enough, although generally not as rigorous as our own. It's an unstated form of financial deregulation that Wall Street has been pushing for some time and has strong support in the SEC.

The proposed new rule affects high-dollar clients who are presumed to be able to look after themselves. They accept the risks of dealing with overseas brokers who operate under different standards than prevail in the United States.

The next question will be whether overseas brokers should be able to deal directly with retail customers -- you and me. "Whether for good or for bad, it's going to happen eventually, because the SEC is being overcome by a tsunami of globalization," said Jim Cox, a law professor at Duke University in Durham, N.C.

The problem is that, overseas, the culture of investor protection isn't as strong as in the United States. On paper, the rules may look the same, but enforcement isn't, said John Coffee, a professor at Columbia Law School in New York.

Take Britain, whose securities laws most closely resemble ours. The Financial Services Authority (the British equivalent of the SEC) spends only 8 percent of its budget on enforcement, compared with 40 percent in the United States, Coffee said. He called Europe "an enforcement-free zone" compared with the United States.

Coffee said it's unlikely that retail investors would be allowed to open foreign brokerage accounts. That's because there's no way they could sue for infractions, such as selling unsuitable investments or engaging in fraud. He especially fears "affinity fraud," with dishonest brokers from the home country soliciting their own nationals in the United States.

The SEC could require arbitration agreements from brokers soliciting in the United States, but where would they take place and under which country's laws? And which foreign regulator would take up a U.S. investor's cause?

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