Deal May Expand Fed's Reach

An agreement between the Federal Reserve and the Securities and Exchange Commission says the agencies will "collaborate and cooperate" when setting capital and liquidity standards, potentially expanding the central bank's reach over brokerage firms.

The agreement, which became effective when regulators signed it Monday, is designed to fill gaps in oversight that became apparent in the wake of the Fed's decision to lend to investment banks in March.

The pact comes amid a broader discussion in Washington over possible legislation that would redraw regulatory boundaries in the wake of the continuing credit crisis. Negotiations on legislation weren't expected to begin in earnest until next year, but House Financial Services Committee Chairman Barney Frank (D., Mass.) has recently suggested that he is open to making short-term changes -- particularly regarding investment banks -- this year if Fed and Treasury officials say such changes are necessary.

Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke are scheduled to testify before Rep. Frank's committee on Thursday. Mr. Paulson, who encouraged the agreement between the Fed and the SEC, has called for the Fed to have broader scrutiny across financial markets.

The new agreement, if successful, could serve as a template for the legislation. It appears to expand the Fed's authority in monitoring Wall Street firms. It also says the SEC, under the supervision of Chairman Christopher Cox, will coordinate with the Fed when "setting supervisory and regulatory expectations" including capital and liquidity standards, and changes to risk-management systems at brokerage firms.

Since March, when the Fed helped rescue Bear Stearns Cos. from collapse, the SEC and Fed have been jointly drawing up different types of market-crunch scenarios -- stress tests, in effect -- to gauge the risk-management systems of banks and brokerage firms. The SEC also consulted the Fed in advising investment banks to seek out different types of funding lines.

The new agreement formalizes that working relationship and is expected to help shore up confidence on Wall Street. It also says the SEC should be consulted before the Fed makes changes to rules that could affect brokerage firms.

The agreement, however, notes the cooperation and coordination shouldn't "diminish or impair in any way the independence" of either the Fed or SEC in rulemaking and supervision. Some observers are skeptical.

"If the Fed says to the SEC, 'The investment banks ought to have higher capital ratios -- what's the SEC going to say, 'No'?" said former Fed attorney Gilbert Schwartz, who is now a partner at Schwartz & Ballen LLP.

The cooperation agreement will continue regardless of whether the Fed agrees to extend its program to loan to investment banks beyond its September deadline. As expected, it also says the Fed and SEC will share data about trading positions and risks taken on by banks and brokerage firms.

Some lawmakers were concerned that the agreement could hamper changes they intend to make. Late last month, Sens. Christopher Dodd (D., Conn.) and Richard Shelby (R., Ala.) flagged concerns about the deal in a letter to Messrs. Bernanke, Cox and Paulson.

"It is Congress's role to determine if and how any alterations to our financial regulatory system should be undertaken," the lawmakers wrote.

On Monday, Sen. Dodd said he was "pleased" with the agreement and noted that it leaves "consideration of any broader reforms to our financial regulatory landscape to Congress."