The 2,300-page bill includes strict new rules for banks, such as ban on proprietary trading and a consumer financial protection agency.   However, it is not as harsh on hedge funds, allowing banks to invest up to 3% of their capital in alternative investment funds.   The bill also includes a simplified version of the Volcker rule, which was designed to keep banks from putting too much of their money in hedge funds and private equity funds.

More specifically, the high court ruled that the Public Company Accounting Oversight Board (PCAOB) violated the constitutional requirement on the separation of powers among the branches of government.    The court stated the president, or other officials appointed by him, must be able to remove members of a board that was created to tighten oversight of internal corporate controls and outside auditors.

In 2002, in response to the Enron and WorldCom accounting scandals, Congress enacted the Sarbanes-Oxley corporate reform law that established certain accounting and auditing requirements for corporate America.   Further, Congress created the board to replace the accounting industry’s own regulators.   The board has power to compel documents and testimony from accounting firms, and the authority to discipline accountants.

Board members are appointed by the U.S. Securities and Exchange Commission and can only be removed by the SEC for cause.  The board, set up as a quasi-private agency, has the power to impose rules and to inspect and fine accounting firms.    The board is funded through fees it collects from public companies. It inspects thousands of auditors, including the Big Four accounting firms: Ernst & Young LLP, KPMG, PricewaterhouseCoopers and Deloitte & Touche LLP.

Although, the court’s ruling on Monday held that the board violated the U.S. Constitution’s separation of powers principle, it also held that the law does not violate the Constitution’s appointments clause and unconstitutional provisions can be separated from the rest of the law.

Therefore, the Sarbanes-Oxley law will remain in effect with one change.  The Public Company Accounting Oversight Board will continue as before, but the Securities and Exchange Commission now will be able to remove board members at will.

Some legal experts say that this decision could put pressure on Congress to revisit the Sarbanes-Oxley corporate reform law and potentially create changes in the reporting duties of companies.

This decision was based on case brought before the high court in 2006 by Free Enterprise Fund and a small Nevada accounting firm, which argued that the law unconstitutionally stripped the president of power to appoint or remove board members or to supervise their activities.    The recent decision was made by the Supreme Court after a federal judge and a U.S. appeals court rejected the challenge.

The Volcker rule, named after former Federal Reserve Chairman Paul Volcker, has been advocating an aggressive reform for Wall Street: to re-draw the line between commercial and investment banking.

Since the repeal of the New Deal-era Glass-Steagall Act in 2000 deposit-taking institutions have been allowed to make money not only the old-fashioned way — lending it out at interest — but also by running hedge funds and other speculative means.   Mr. Volcker argued that, since their deposits are federally insured, the big banks were encouraged to take bigger risks for which the taxpayers would ultimately take the hit.  He insisted that this incentive structure was not only unfair but also at the root of the current crisis.  Correcting it, he argued, is the key to preventing future crises.

For months, Mr. Volcker’s ideas made no impact on Obama administration policy.  However, recently it is gaining popularity among the lawmakers.   While the specific role of the Volcker rule in final bill is being negotiated, banks are no longer so confident that they’ll be able to hold on to their alternative investment businesses under it.   

In its strictest form, the rule would bar bank holding companies from owning, investing in or sponsoring hedge funds or private equity funds.   Big banks, such as JPMorgan Chase and Goldman Sachs, have hedge fund units that manage tens of billions of dollars.  According to some analysts, this could create a huge fire sale.    

So far, the banks themselves dismissed the idea that the government would force them to sell or unwind their hedge fund and private equity units.   JPMorgan, which has nearly $30 billion in hedge fund and private equity assets, said the Volcker rule would have no impact on its holdings, because both its private equity unit and Highbridge Capital Management hedge fund manage money only for clients.    

However, now, according to various news sources, they sound less confident.   For example, Mary Sedara, a JPMorgan spokeswoman, told Fox that the interpretations of this rule change by the week and different lawyers say different things.    The language as it is now written isn’t definitive.    Others are even more pessimistic, noting that the rule, as currently written, would completely bar banks from any alternative investments activities.

The Financial Crisis Inquiry Commission has made it clear that it is committed to using its subpoena power if firms under review don’t comply with information requests. 

The request for information shows the FCIC is turning attention to the most profitable firm in Wall Street history after investigating credit-rating companies and banks such as Citigroup Inc. and Bear Stearns Cos. Goldman Sachs has already drawn scrutiny from regulators and lawmakers for packaging mortgages into securities that triggered losses for investors when the housing market collapsed in 2007.

This request followed fraud charges brought by the Securities and Exchange Commission against Goldman Sachs.    The SEC sued New York-based Goldman Sachs April 16, accusing the firm of selling a collateralized debt obligation tied to mortgages without disclosing to investors that hedge fund Paulson & Co. helped pick the underlying securities. Paulson was betting the CDO would fail.  

Goldman Sachs denied charges stating that the suit is unfounded in law and fact.

Federal prosecutors in New York are also investigating transactions by Goldman Sachs to determine whether to bring charges.   The firm hasn’t been accused of criminal misconduct.

That’s a big step forward for Wall Street reform.   Although, the bill would still have to be reconciled with a version the House passed in December, the chances are now good that President Obama soon will be able to sign the legislation into law.    In fact, House Financial Services Committee Chairman Barney Frank, D-Mass., said he expected relatively few disagreements between House and Senate negotiations, and he predicted Obama will have a bill to sign before July 4.    

More specifically, the bill would create a Consumer Financial Protection Bureau within the Federal Reserve, instead of the standalone Consumer Financial Protection Agency that is in the version of the bill that was approved by the House last December.   Public accountants would be exempted from regulation by either the bureau or the agency.

The bill provides the SEC and the Commodity Futures Trading Commission with authority to regulate over-the-counter derivatives.  Derivatives would have to trade over regulated exchanges and cleared through central clearinghouses.

The Sarbanes-Oxley Act would be amended to authorize the Public Company Accounting Oversight Board to share certain information with foreign authorities, and to give the PCAOB the ability to regulate auditors of brokers and dealers.

The bill would also streamline bank supervision by eliminating the Office of Thrift Supervision. The Federal Deposit Insurance Corp. would regulate state banks and thrifts of all sizes and bank-holding companies of state banks with assets below $50 billion.  The Office of the Comptroller of the Currency would regulate national banks and federal thrifts of all sizes and the holding companies of national banks and federal thrifts with assets below $50 billion. The Federal Reserve would regulate bank and thrift holding companies with assets of over $50 billion. The legislation would leave in place the state banking system that governs most community banks.

Hedge funds would be required to register with the SEC as investment advisors and provide information about their trades and portfolios necessary to assess systemic risk. This data would be shared with a systemic risk regulator, and the SEC would report to Congress annually on how it uses this data to protect investors and market integrity.

Shareholders would be given a say on pay with the right to a non-binding vote on executive pay at public companies. The legislation also gives the SEC authority to grant shareholders proxy access to nominate directors, and requires directors to win by a majority vote in uncontested elections. To be listed on an exchange, compensation committees would need to include only independent directors. They would have the authority to hire outside compensation consultants.

The investigation stems from a criminal referral by the Securities and Exchange Commission.   The SEC brought civil charges against Goldman two weeks ago, which followed a highly-publicized questioning of Goldman executives by the U.S. Senate committee.   

The investigation, even though at a preliminary stage, opens a momentous new front in the legal aftermath of the near-meltdown of the financial system.     In the view of some legal experts, the SEC civil fraud case against Goldman — even with the lower required burden of proof than in a criminal case — also could be difficult and faces pitfalls.     To prove it, the SEC must show that Goldman misled investors or failed to tell them material facts that would have affected their financial decisions.

According to some experts, the greatest challenge will be boiling the case down to a simple matter of fraud: the issues involved are so complex that Goldman may be able to introduce enough complicating factors to shed some doubt on the SEC’s claims.

Goldman has denied any wrongdoing, and the firm’s top executives on Tuesday reiterated their belief that the firm did nothing wrong at a Senate committee hearing.

Democrats needed 60 votes to begin the debate, but only 57 senators voted to take up the bill, while 41 voted against it.   All Republicans voted against the bill.  Not voting were Sens. Christopher Bond, R-Mo., and Robert Bennett, R-Utah, who were absent. They would likely have voted against taking up the bill.

Despite yesterday’s procedural and rhetorical setbacks, both sides expressed confidence that a financial regulation overhaul will be passed.    The Senate bill would impose tough new rules on banks, hedge funds and derivatives trading, among other items.   As written, it would require hedge funds managing $100 million or more to register with the Securities and Exchange Commission.   It also includes the so-called Volcker rule, which would bar bank holding companies from owning, investing in or sponsoring hedge funds or private equity funds.

The bill would also empower regulators to unwind financial institutions that have grown “too big to fail” and create a new consumer financial products protection agency. There would also be new rules governing over-the-counter derivatives, securitization and credit rating agencies.

There are differences between the House bill, which has already passed, and the Senate proposal, which would have to be worked out if the latter is passed. The House version requires hedge funds with $150 million or more to register and does not include the Volcker rule.

The allegations of the case can be summarized as follows:  In early 2007, Paulson & Co. hedge fund manager John Paulson believed the U.S. housing market was in a bubble, and wanted to short the entire sector.   Lacking any easy way to do this, he worked with Fabrice Tourre, a London based senior vice president at Goldman Sachs, to draw up a list of mortgage-backed securities that were certain to default. 

Tourre then shared that list of securities with a mortgage analysis company named ACA Management, and persuaded ACA into using that list to draw up collateralized debt obligations Goldman Sachs could sell to investors, CDOs whose value would depend on homeowners continuing to make their mortgage payments.

Tourre neglected to tell ACA or investors that Paulson had pre-selected those securities on the assumption that the homeowners funding them would not continue to make their payments. Paulson, meanwhile, also purchased credit default swaps on those CDOs, betting that they would default. When they did, the investors lost $1 billion. Paulson profited $1 billion. Goldman acted as the middleman for this transaction and collected $15 million in fees.

These are all issues related to disclosure.  Had Tourre disclosed Paulson’s role in this scheme, neither ACA nor any intelligent investor would have purchased the CDOs Goldman was selling. But Goldman had large and lucrative market for these securities, so it omitted material facts about the nature of CDOs in order to sell them.   This is the underlying misconduct the SEC alleges.

The SEC accuses Goldman of violating three specific securities laws:  Section 17(a) of the Securities Act, Section 10(b) of the Securities Exchange Act and Exchange Act Rule 10b-5.  All three essentially forbid anyone from using fraud or deceit, including the omission of material facts, to profit from a securities sale.

The question is whether Paulson’s undisclosed role in portfolio selection was material.   In other words, would a reasonable investor want to know this information before investing in this security?    However, there is no clear and well-defined definition of what material information is and what you have to disclose in this type of transaction. 

Goldman argues that the facts about Paulson weren’t material.    That hedge-fund manager Paulson was nearly unknown when the securities were sold in early 2007, and participants were unlikely to have cared about his role.  Goldman also said in its response that its clients got the material information needed, including the types of mortgages going into the securities.  Finally, it argues that the investors in the CDOs were sophisticated enough to know that for every buyer of a CDO, somebody else out there is shorting that position (which is how these deals work).  

How do legal experts respond to this case?     They seem to be split on the issue.  Some securities lawyers said the SEC’s 22-page complaint offered strong evidence that Goldman should have disclosed information about Paulson.    Other lawyers not involved in the case said those buying the securities were sophisticated institutional investors presumably able to size up a product’s worth and should be judged by a different disclosure standard.

This legal battle is just about to unfold.   Most likely, U.S. District Judge Barbara Jones, who was assigned the case won’t dismiss the SEC complaint because materiality is what’s at issue.  

If the SEC’s case survives a dismissal motion, the case would probably proceed to discovery, when the agency may seek additional testimony or information from the firm. That process could provide incentive for private lawsuits, additional allegations from regulators, or media attention that would further damage Goldman’s reputation.    After that, Goldman’s risk will mount and its negotiating position will weaken.    

Finally, politicians rushed to tie the Goldman case to finance reform.   Lloyd Blankfein and other Goldman executives are scheduled to testify at a Senate hearing next week along with Fabrice Tourre.  The Permanent Subcommittee on Investigations will explore investment banks’ role in the financial crisis at the April 27 hearing.

The future of Goldman Sachs still uncertain, but it certainly will shape the future of the financial industry in the United States.

More specifically, regulators say Goldman allowed Paulson’s $32 billion hedge fund to help design a financial investment known as CDO built out of a specific set of risky mortgage assets—essentially setting up the CDO for failure.    Paulson played a significant role in picking the residential mortgage-backed securities included in the CDO.   Paulson then bet against it, while investors in the CDO weren’t told of Paulson’s role or intentions.    “The product was new and complex, but the deception and conflicts are old and simple,” said Robert Khuzami, the SEC’s enforcement chief.

On Friday, Goldman Sachs denied charges.  In a press release, Goldman called the SEC charges “completely unfounded in law and fact” and promised to “vigorously contest them and defend the firm and its reputation.”    Goldman argued that “the portfolio of mortgage-backed securities in this investment was selected by an independent and experienced portfolio selection agent,” ACA Management, “after a series of discussions, including with Paulson & Co., which were entirely typical of these types of transactions,” the firm said. “ACA had the largest exposure to the transaction, investing $951 million.  It had an obligation and every incentive to select appropriate securities.”

Also, in its press release Goldman said that it never told or implied to ACA that Paulson would not be betting against the CDO.   However, it did make clear that Goldman was not shorting the vehicle.    “The transaction was not created as a way for Goldman Sachs to short the subprime market,” it said.  “To the contrary, Goldman Sachs’s substantial long position lost money for the firm.” Goldman said it lost more than $90 million; Paulson paid it $15 million to structure the transaction.  

Paulson and his firm aren’t named as defendants. The hedge-fund firm said in a statement that it wasn’t involved in marketing the bonds to third parties. “Goldman made the representations, Paulson did not,” Khuzami said.  Paulson took home $4 billion in 2007 for correctly betting on a housing collapse.

The SEC suit charges only Goldman and a vice president who handled the Abacus transaction, Fabrice Tourre.  But, according to The New York Times, the executive involvement in Goldman’s housing bets went much further up the corporate ladder, though the SEC didn’t specify how high up it believes the knowledge extended.    The firm’s top executives, including CEO Lloyd Blankfein, CFO David Viniar and President Gary Cohn, were active in overseeing Goldman’s mortgage unit, the Times reports.    And it was those executives who eventually agreed with Tourre that housing prices were likely to fall.   Goldman said that none of its senior leadership was involved in the Abacus deals.

Despite its robust defense of itself, Goldman may soon find itself in hot water in multiple jurisdictions. Both British and German regulators are looking into the case and may bring charges of their own.    British Prime Minister Gordon Brown, with an election just weeks away, told the BBC that he wants the U.K. Financial Services Authority to look into the CDO transaction. “There is a moral bankruptcy reflected in what I am reading about and hearing about,” he said.   Meanwhile, across the North Sea, Germany’s BaFin has sought details about the SEC’s lawsuit from the regulator itself, Bloomberg News reports.

The SEC lawsuit likely strengthens the position of President Barack Obama as he tries to push financial-overhaul legislation through Congress. He vowed Friday to veto any version of the bill that doesn’t bring the derivatives market “under control.”

Goldman’s shares fell 13%, one of the steepest slides since the firm went public in 1999, erasing some $12 billion of market capitalization.

Michel Barnier, the EU’s internal markets commissioner, reassured U.S. Treasury Secretary Timothy Geithner in a letter last month that “discrimination has no place in the emerging regulatory framework.”     Barnier further wrote that “by providing a level playing field for domestic and foreign players alike, we eliminate opportunities for regulatory arbitrage and create the conditions for fair competition.”

However, Geithner appears to have been unconvinced by Barnier’s assurances.     A week after Barnier wrote his letter, Geithner responded, again urging four European finance ministers to reject any legislation that would “discriminate against foreign firms.”

In a letter to four of the EU’s finance ministers, Geithner said the U.S. was working on its own hedge fund rules, and lobbied them to drop a proposal that could block U.S. hedge funds from Europe.      “As you consider how to design this important set of reforms, I hope you will keep in mind our shared commitment to create regulatory reform that does not discriminate against foreign firms,” he wrote to Britain’s Alistair Darling, France’s Christine Lagarde, Germany’s Wolfgang Schaeuble and Spain’s Elena Salgado Mendez.     Geithner said U.S. reforms would be similar to those called for by the Group of 20.

The British government is currently blocking the adoption of the rules by the bloc’s finance ministers, demanding that the bar on foreign funds be removed.    And U.S. lawmakers have threatened to shut European firms out of the American market if the regulations as written become law.

In a 2,200 page report, Lehman’s bankruptcy examiner said the firm used repurchase agreements to hide some of its mounting debt before it collapsed in 2008.    The firm hid the full force of its leverage by giving sale treatment to assets it had an obligation to repurchase, shuttling off the balance sheet as much as $50 billion in failing assets.

More specifically, the SEC’s Division of Corporation Finance send a letter to a few dozen banks and insurance companies asking for specific information on how they account for repurchase agreements, securities lending transactions, and other transactions that involve the transfer of assets with an obligation to repurchase them.   

Further, the letter asks for a long list of detailed information about such transactions if they received sale treatment, how much in each quarter for each of the past three years, how a repurchase qualified for sale treatment vs. a collateralized financing, how it was analyzed, what business reasons were behind it, how it affected key ratios that indicate financial performance, and plenty more.

The SEC didn’t name specifically who received the letter, but it posted a copy of the letter to its website.   The letter doesn’t mention Lehman Brothers, but those are precisely the transactions Lehman stretched to the point of abuse in its desperate lunge for survival.   SEC Chairman Mary Schapiro has said the agency is “looking broadly” at the financial sector to determine whether other companies may be using a similar technique.   

The SEC asks for a written response in 10 days. “Upon our review of your responses to these questions, we may have additional comments that we will provide to you with any other comments we may have on your Form 10-K,” the letter promises, signed only “Senior Assistant Chief Accountant.”

The bill proposed by Democratic U.S. Senator Christopher Dodd includes a provision permitting regulators to implement so-called “Volcker rule.”  The Volcker rule was suggested earlier by former Federal Reserve Chairman Paul Volcker.   It includes provision barring banks from proprietary trading or from mergers that would give them more than a 10% share of the U.S. banking system.   As the result, the Volcker rule would forbid bank holding companies from owning, sponsoring or investing in hedge funds.  

The bill passed the Senate Banking Committee on Monday, March 22, 2010 without any Republican support.    Despite the setback, lobbyists are urging lawmakers to leave out the final decision about whether to adopt the Volcker rule.

According to various news sources, Scott Talbot of the Financial Services Roundtable told Bloomberg News that “we believe the regulators should have the discretion to deal with the situation on a company-by-company basis.   You can’t have a blanket prohibition on proven risk-management techniques.”  “Our hope is that they change ‘must’ to ‘may,’” Talbott added.

However, that argument may not carry much weight with the Republicans.   The Dodd bill gives “too much power to the regulators,” Republican U.S. Senator Judd Gregg told Bloomberg. But both he and Republican Senator Bob Corker, who had been working with Dodd on a compromise bill, have expressed support for the Volcker rule provisions.   Also, both also say that a financial services reform bill will pass this year, potentially without Republican support.

The EU rules would impose strict new reporting and custody requirements, as well as possible leverage limits.    A draft of the legislation is under review by EU finance ministers.   If passed, the legislation would make it extremely difficult for foreign alternative investment funds to serve European clients.   A version of the rules under consideration in the European Parliament would be somewhat less burdensome.

Schumer’s own proposed legislation would be very similar to the EU, barring funds from outside the U.S. from marketing or raising money in the country, and mandating the use of U.S. banks for custody.  Schumer stated that “just as EU-based funds and custodian banks currently have full access to our market, U.S.-based funds and custodian banks should similarly not arbitrarily be denied access to the European market.”

EU officials have previously warned that they will not be bullied by Washington, and it is unclear what effect, if any, Schumer’s threat would have.   The vast majority of European hedge funds and private equity firms are based in the U.K., which already opposes the proposed rules.   It is still unclear what effect, if any, Schumer’s threats would have.

The SEC stated that it plans to hire 18 people on the enforcement side, where it currently employs about 150 people in New York, and add 15 people to its examinations staff, which currently numbers about 210 in New York.

The SEC plans to hire more lawyers, accountants and even former traders comes at a time that the agency is seeking to become more aggressive in going after the bad guys on Wall Street.

Two months ago, the SEC created specialist units including one for asset management and it will focus on investigations involving investment advisers, investment companies, hedge funds and private equity funds.

For the SEC, the financial crisis that led to heavy layoffs on Wall Street may be a boon because it will let the agency hire savvy investment professionals, including former hedge fund traders currently without a job.

The SEC attorneys said such expertise will be put to good use right away because hedge funds are using increasingly complicated trading strategies involving derivatives, such as credit default swaps, to make money.   The regulators said one thing they also are on guard for is funds that have had an uncanny record of success and consistency over the years.

U.S. Bankruptcy Judge Burton Lifland ruled that trustee Irving Picard is correct in denying claims from investors who profited from Madoff’s scheme.

Picard argued that only the “net losers” — those who deposited more into their account than they took out — should be reimbursed, while “net winners” — those who made money on the fraud — should not recover anything.      The recent ruling is a defeat for Madoff investors who withdrew more from their Madoff accounts than they put in.

Lifland wrote in his ruling, “while the court recognizes that the outcome of this dispute will inevitably be unpalatable to one party or another, notions of fairness and the need for practicality also support” Picard’s method of determining claims.

Lifland also said “the plain meaning and legislative history” of the law allowed Picard to deduct withdrawals from cash deposits in determining who gets what.    “Because securities positions are in fact nonexistent, the trustee cannot discharge claims upon the false premise that customers’ securities positions are what the account statements purport them to be,” the judge ruled.

Picard’s methodology was backed by Madoff’s less fortunate victims, the so-called net losers, who stood to receive much less if the net-winners were included in the pool, as well as the Securities and Exchange Commission.

The new disclosures rules are aimed at giving investors more of the information they need to hold companies to account. Currently, Japanese companies are allowed to withhold information that is taken for granted in the United States.

Companies will have to reveal the names of any directors earning more than Y100 million ($1 million) and give a breakdown showing salary, bonus, stock options, and pension payments. The same applies to “statutory auditors,” who are the Japanese equivalent of non-executive or supervisory directors.

Companies will also have to disclose the roles of their independent directors, whether they have any financial or accounting expertise, and the details of their relationship with the company’s internal audit function.

The FSA also wants to make companies report more about the outcome of resolutions put to their annual shareholder meetings. Currently, Japanese companies only have to report if a resolution was passed or not. In the future, they will have to reveal the number of votes cast for or against and the number of votes withheld.

The FSA stated that more detailed voting disclosures, “will give a clearer picture of the decisions made by shareholders, which will entail a better functioning of the market pressure over the management.”

The proposals are subject to consultation until March 15 and will take effect on March 31.

Rakoff had previously described the August 2^nd, 2010 start date of his trial as “firm and fixed.”   However, he did not did not indicate at a court hearing when he would rule to set the new date for civil trial.   U.S. prosecutors, lawyers for the SEC and defendants are all in favor of the criminal trial going ahead first.

Usually, when there are parallel cases brought by criminal prosecutors and the SEC, the criminal case takes precedence.   However, Rakoff quickly set a civil trial date and denied initial requests to wait for resolution of the criminal matter.

U.S. prosecutors have described the case of Galleon Group founder Raj Rajaratnam as the biggest-ever U.S. hedge fund insider-trading scandal.   More than 20 traders, lawyers, executives and firms have been charged in a probe that stretched from Wall Street to Silicon Valley.

Rajaratnam is accused of making as much as $49 million in illegal profits between 2003 and 2009 on tips he received from business associates and friends on forthcoming mergers and acquisitions.

The cases are USA v Raj Rajaratnam et al, U.S. District Court for the Southern District of New York, No. 09-01184 and SEC v Galleon Management et al, No. 09-08811

The SEC is expected to meet on Wednesday, February 24^th2010, to vote on rules that would restrict short selling in a company’s stock if that stock fell by more than a certain percentage, such as 10 percent.

Lawmakers and bank executives blamed short selling for contributing to the downfall of Lehman Brothers and Bear Stearns.   As the result, the SEC proposed a number of measures last year to restrict short selling, where investors bet the stock’s price will fall.   The SEC proposed restrictions that would apply across equity markets as well as curbs that would only apply if a stock fell precipitously.

One proposal was to bring back a version of the uptick rule — a curb that was first adopted after the 1929 market crash.   The SEC abolished the uptick rule in 2007 after concluding that it was no longer effective in modern markets.

According to sources familiar with the SEC plan, the agency is expected to consider a “circuit breaker” measure that would trigger a so-called passive bid test.   A passive bid test would only allow short selling above the national best bid.    Any new rule needs the approval of the majority of the five SEC commissioners.   The two Republican commissioners are not expected to vote in favor of the short sale restrictions.

The goal is to urge firms to develop customized policies and procedures for blogging and social networking, and to ensure that investors are protected from false or misleading claims posted on any social networking sites.    Further, FINRA’s guidance clarifies the responsibilities of firms to supervise the use of social networking sites to ensure that recommendations are suitable and their customers are not misled.   The guidance also addresses recordkeeping and other responsibilities of firms.

Some of the recommendations provided by FINRA include:

• Retain records of communications related to the business made through social media sites;
• NASD Rule 2310 may be triggered if a firm recommends a security through a social media site, depending on the facts and circumstances surrounding the recommendation;
• Firms should consider prohibiting all interactive electronic communications that recommend a specific investment product and any link to such a recommendation, unless a registered principal has previously approved it;
• Firms may also want to maintain a database of previously approved communications;
• Static blog postings are considered advertisements under NASD Rule 2210;
• If the blog includes real-time interactive communications it is considered to be an electronic forum that does not require prior principal approval, but must be supervised;
• Firms must supervise communications on social networking sites under NASD Rule 3010 in a manner that ensures compliance with FINRA’s communication rules; FINRA’s Regulatory Notice 07-59 provides further guidance on supervisory procedures;
• Generally, FINRA does not treat posts by customers or other third parties as the firm’s communication with the public subject to NASD Rule 2210.  However, third-party posts are attributable to the firm if the firm has involved itself in preparing the content or the firm explicitly or implicitly endorses or approved the content.

FINRA says that each firm must develop its own policies and procedures, designed to ensure that the firm and its personnel are complying with all applicable regulatory requirements when using social networking sites.

Some technology providers are developing systems intended to enable firms to retain records of communications made through social networking sites.   In its release, FINRA said it “does not endorse any particular technology to keep such records, nor are we certain that adequate technology currently exists.”

The request to Congress includes nearly $1.3 billion for the SEC in the budget year starting October 1, 2010.    This proposal would allow for 390 hires, which would increase total staff to 4,190 from the current 3,800 at the traditionally low-profile agency, which was heavily criticized in the aftermath of the Madoff’s Ponzi scheme.   This proposal would also include $419 million for more than 100 new enforcement staff to work on the agency’s growing cases on fraud and market manipulation.

With the hires, the SEC estimates it could start 75 additional inquiries, conduct 314 additional formal investigations, file charges in 70 additional civil or administrative cases and conduct 50 additional exams of investment advisors, 25 additional mutual fund exams and 75 examinations of newly registered fund advisors. 

Of the roughly $1.3 billion requested for the SEC, $24 million is tied to the enactment by Congress of a sweeping overhaul of financial regulation. The overhaul would give the SEC new oversight of hedge funds and derivatives, the complex instruments widely blamed for hastening the crisis in the fall of 2008.

The SEC derives its funding from fees that companies pay to register new stock – an estimated $1.7 billion in the 2011 budget year – but the agency is subject to the congressional budget process in the same way as other federal departments.

The 12 percent budget increase for the SEC is significant because the administration’s record $3.83 trillion budget proposes spending cuts in some programs outside of defense and homeland security in order to keep overall non-defense spending frozen for three years. 

It was the first budget proposed for the agency under SEC Chairman Mary Schapiro, who led the agency through its most expansive restructuring in at least 30 years.   “If enacted, the president’s request will do a great deal to help the SEC keep pace with the continuing growth of the markets and provide necessary resources to support important regulatory initiatives in 2011”  Schapiro noted.