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An End to Muni Self-Regulation?

WASHINGTON - The municipal market should no longer be overseen by a self-regulatory organization led by securities and bank dealers, Thomas Doe, chief executive officer of Municipal Market Advisors and a former MSRB board member, told a Senate panel yesterday.

The Municipal Securities Rulemaking Board should be folded into the Securities and Exchange Commission, which should expand its oversight over all financial tools and participants in the muni market, Doe told members of the Senate Banking Committee at a hearing on investor protection and the regulation of securities markets.

"The 34-year era of the municipal industry's self-regulation must come to an end," he said.

Though the hearing focused largely on the establishment of a systemic risk regulator - particularly whether that regulator should be the Federal Reserve - Doe testified that muni regulation would be much better today if its main regulator were "independent of the financial institutions that create financial products and facilitate issuers' borrowing" and if muni regulation was integrated into "the national regime of regulation."

He suggested that self-regulation by dealers is insufficient and told the lawmakers that the regulator of the muni market should have "inspired inquisitiveness and a sense of purpose so that they're eager to pursue and understand the markets that they regulate."

Doe's written testimony stated that MMA also is open to the idea of Congress merging the MSRB into another regulator such as the Federal Reserve or even the Treasury Department.

The MSRB's board is made up of five representatives from securities firms, five from banks, and five members of the public, including at least one representative from an issuer and one from the investment community. But its fee-paying members are securities and bank dealers and its rules apply to them.

Doe's remarks come as MSRB officials have pushed for broader regulatory authority in recent weeks to cover all financial advisers and investment brokers in the muni market and have said that board composition could be altered if the board's responsibilities change.

In a statement yesterday, MSRB chairman Ron Stack said the MSRB believes that SROs should continue to play an important role in the regulatory framework for the securities industry.

"The MSRB reports to the SEC and writes rules for dealers, but has the flexibility to create market-specific rules that exceed basic antifraud protections," said Stack, managing director and head of public finance at Barclays Capital. "The MSRB also operates market information systems uniquely designed for the market."

A market participant who asked not to be identified said the board is working quickly to implement a variety of new systems, including the first phase of a transparency system for variable-rate demand obligations that launches April 1. He said moving the MSRB into the SEC would not result in a "more nimble, responsive regulator" for the muni market. Rather, it would make the MSRB one part of a large bureaucracy, he said.

But speaking to The Bond Buyer after the panel, Matt Fabian, managing director of MMA, said: "The purpose of regulatory reform is to address the systemic risks that have been exposed by this crisis. Our market was affected by the same pressures that addressed the rest of the financial markets, except that our response has been less adept" because munis have always been regulated separately and historically have not been understood by other federal officials.

John Nester, an SEC spokesman, declined to comment on the MMA proposal, but said: "We are committed to working with Congress to protect investors."

Doe's proposal comes as lawmakers are gearing up to consider broad changes to the financial regulatory system, beginning with the establishment of a systemic risk regulator.

All of those testifying before the committee yesterday appeared to endorse a systemic risk regulator, though there was not unanimous support for handing that authority to the Federal Reserve. Banking Committee chairman Christopher Dodd, D-Conn., said he is trying to balance the need for "a solid, sound system that reflects the times we're in" but is not so restrictive as to limit innovation.

In separate remarks yesterday, Fed chairman Ben Bernanke called for a strategy to regulate the financial system as a whole, "not just its individual components," and not just through stricter bank regulations.

John Coffee, a professor at Columbia University Law School who testified before Dodd's panel, endorsed a "twin peaks" model of financial regulation in which the Fed would serve as a systemic regulator and another regulator would serve as a separate investor protection agency.

But because bank regulators are focused on protecting bank solvency and have historically regarded added transparency as inimical to their interests, Congress should not allow the systemic regulator "to override the disclosure regulators on questions of accounting or investor protection," he said.

Investment Company Institute president Paul Schott Stevens suggested that one alternative to creating a new systemic risk regulator is for Congress to establish an independent board, possibly headed by the Fed chairman and with an independent staff, that could coordinate with existing regulators to assess systemic risk.

Stevens also called for a "capital markets regulator" - the result of a possible merger of the SEC with the Commodity Futures Trading Commission - that would have legislative authority to protect investors and the markets by closing regulatory gaps and responding to changes in the marketplace.

Among other things, the capital markets regulator would also be able to improve disclosure in the municipal securities market, he said.

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