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Senate Secures Enough Votes for Financial Reform

WASHINGTON — Senate Democrats on Tuesday secured the 60 votes they will need to ensure passage of the most sweeping changes to financial regulations since the Great Depression, after Nebraska Democrat Ben Nelson said he would vote for a version of the bill hammered out by a House-Senate conference late last month.

Nelson was expected to join 56 other Democrats in support of the measure, as well as Republicans Susan Collins and Olympia Snowe of Maine and Scott Brown of Massachusetts.

The timing of the measure’s final passage through the chamber was unclear as The Bond Buyer went to press Tuesday, but congressional sources said that procedural votes could begin today and set up a possible final vote on the measure Thursday.

The House already passed the conference bill by a vote of 237 to 192 on June 30.

If approved by the Senate and signed into law by President Obama, the bill would significantly alter the way the municipal market is regulated and for the first time allow for the regulation of over-the-counter derivatives. Provisions in the derivatives section of the legislation generally would take effect 360 days from the date of enactment.

In that time, the Commodity Futures Trading Commission would have to write registration rules and business conduct standards for swap dealers and major swap participants in the municipal and other markets.

In addition, the CFTC would have to formulate a code of conduct for dealers that enter into swaps with “special entities,” which would include states, localities, and pension funds. The code of conduct provision was added to the bill during the final negotiations that concluded late last month, replacing a proposed fiduciary duty on swap dealers. Both dealers and issuers warned the fiduciary language would have been unworkable.

The bill generally would require most swaps to be centrally cleared. But central clearing could be avoided if swaps do not fit a list of five factors the CFTC can consider in determining whether they should be cleared, such as whether there exists “significant outstanding notional exposures, trading liquidity and adequate price data.”

Alternatively, swaps could be exempt from central clearing if they are entered into by an “end user” that is not a financial entity, if the swaps are used to hedge or mitigate “commercial risk” and if the end user notifies the CFTC in a manner set by the commission how it “generally meets its financial obligations associated with entering into non-cleared swaps.”

The legislation leaves it up to the CFTC to define “commercial risk” and does not say explicitly if municipal entities would be considered end users.

While the general thrust of the derivatives provisions is to impose more stringent margin and collateral requirements on non-centrally cleared swaps, House Agriculture Committee chairman Colin Peterson, D-Minn., and House Financial Services Committee chairman Barney Frank, D-Mass., clarified during the floor debate that the bill is not meant to impose margin and capital requirements on swap end users. The comments came in response to concerns raised by Sen. Saxby Chambliss, R-Ga., during conference committee discussions late last month.

The clarification came after Chambliss offered an amendment on margin requirements for end users that failed by a vote of 6 to 6. Specifically, the amendment would have clarified that end users would not need to post margin against uncleared swaps.

Meanwhile, the bill would change the composition of the Municipal Securities Rulemaking Board to ensure that a majority of its members consist of “public” officials, and would leave it up to the board to write guidelines concerning the independence of those public officials. The number of seats on the board could expand beyond the current 15 as long as a majority of the members consists of public officials.

In addition, the legislation would give the MSRB regulatory authority over non-dealer financial advisers, including swap advisers and guaranteed investment contract brokers, who would have to be registered with the Securities and Exchange Commission.

Advisers would owe their clients a “fiduciary duty,” which is not defined in the legislation but is generally thought to require that they hold their clients’ interests ahead of their own. The MSRB would have to develop a fiduciary duty rule, as well as compliance examinations, testing, and continuing education requirements for advisers.

The MSRB’s authority to write these rules and make changes to its composition would begin Oct. 1, though the SEC would retain its authority to sign off on most MSRB rule changes. Oct. 1 also coincides with the start of the board’s new fiscal year.

The MSRB also would be able to assist other regulators in the enforcement of its rules and could impose charges on dealers or FAs for late submission of data or other information required by its rules. It could also collect a portion of the fines the SEC and the Financial Industry Regulatory Authority charge for violations of its rules.

The bill would authorize, but not require, the SEC to direct FINRA to collect assessments from dealers to fund the Governmental Accounting Standards Board.

GASB currently is funded through voluntary contributions from state and local governments, as well as by revenue from the sales of its publications. But it is constantly short of funds and its dependence on issuers is seen as a conflict.

GASB reported a $3.83 million budget shortfall for 2009 and projects a shortfall of $4.46 million in 2010, according to the group’s website.

The bill would require that munis remain a top priority of the SEC by mandating the creation of an office of municipal securities headed by a director that reports directly to the chairman of the commission.

Currently, the SEC’s muni office is housed within its division of trading and markets and has two only full-time employees — Martha Mahan Haines, its chief, and Mary Simpkins, senior special counsel. The bill would require the SEC to staff the office “sufficiently to carry out the requirements” of the muni provisions in the proposed legislation.

The provision is designed to elevate muni issues to the position they held under former chairman Arthur Levitt, who headed the SEC from 1993 to 2001. Levitt created the muni office and had its director report to him.

But some market participants believe munis already are elevated in importance. In May, SEC chairman Mary Schapiro announced plans for a series of field hearings throughout the country conducted by commissioner Elisse Walter, who is also working on the first interpretive guidance to address legal ambiguities in the commission’s Rule 15c2-12 on disclosure. In addition, in January the enforcement division created five new specialized units to investigate and develop cases in key areas, including one focusing exclusively on muni securities and public pensions.

The SEC would have to establish a new office on credit ratings and pass rules requiring that rating agencies designated as nationally recognized statistical rating organizations adopt and enforce policies that “assess” the probability that an issuer will default, fail to make timely payments, or otherwise not make payments to investors in accordance with the terms of a security.

The rules also would require NRSROs to apply rating symbols in a consistent manner for all types of securities, though NRSROs would still be able to use special symbols to denote different types of securities. In short, the bill would not require that ratings be based primarily, or at all, on the default risk, a goal of many issuers.

In a blow to the SEC, conferees eliminated language that would have allowed the SEC to self-finance its operations from the fees it collects, meaning that the commission will remain dependent on appropriations from Congress. However, provisions in the bill would allow the SEC to tie its budget requests to such fees.

The bill would require the congressional watchdog, the Government Accountability Office, to evaluate the role and importance of GASB within 180 days of the bill’s enactment.

In addition, it would require the GAO to report to Congress within 18 months of enactment on the municipal market in general, including an analysis of trading. GAO would have to send Congress another report within two years on whether legislative changes are needed to improve muni disclosure.

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