(Article published in the Aug 2, 2006
issue of Manila Standard Today)
the young Francis E. Lim was at the University of Pennsylvania Law School
for his Masters of Law degree, “functional regulation” was already a
securities industry mantra in the United States.
Consequently, it is not surprising that, many years later, as the
current Philippine Stock Exchange President and chairman of the Technical
Working Group (TWG) of the Senate working on Senator Osmeña’s bill for
a Revised Investment Company Act (RICA), he was open to the idea of
including the Investment Trust Funds (UITFs) in the bill’s coverage.
After all, there is a lot that may be said, as proponents of functional regulation insist, in favor of subjecting the same activity under the regulation of the same government authority, regardless of who, or what the entity is that, conducts such an activity. With the emotional winds packed by the slogan, “leveling the playing field”, at its back and the undeniable loss sustained in May by UITF “investors” who in unison put up the usual cry-baby claim that they were “not properly protected” by the system, it really seems reasonable to conclude argue that both mutual funds and UITFs, apparently being of the same activity, ought be subjected to the same rules.
Historically, “functional regulation” was disputed territory in the turf war between the banking and the securities industry regulators in the US. It was first articulated by then US SEC Chairman John Shad in his testimony in 1982 before the Senate that was then conducting hearings on a proposal by the Reagan Administration to enable banks to engage in a wide range of securities activities through subsidiaries regulated by the SEC. Mr. Shad cites four advantages of functional regulation, namely, that it (a) allocates jurisdiction to the government agency that knows the activity best; (b) consistency with regulatory philosophy; (c) minimizes regulatory duplication, overlap and conflict; and, of course, (d) establishes conditions for equal treatment of competitors. This last one, obviously, is the “level the playing field” battle cry heard at the TWG discussions.
contextually “functional regulation” would have the effect of diluting
the bank regulators’ imperium
over their subjects, its opponents were those who stood to lose. They maintain that, for banks, entity and not functional
regulation is the best approach. The
then US Comprotroller of the Currency Eugene Ludwig in 1994 for his part
stated the position en contra.
single regulator,” says Mr. Ludwig,” is in a better position to
evaluate risks across product lines, to assess the adequacy of bank
capital and operational systems to support all of the activities of the
bank, to take integrated supervisory and enforcement actions that address
problems affecting several different product lines, and to identify and
deal with emerging supervisory issues.
This strength of the institutional approach is particularly
appealing in an era when supervisors more and more are finding that many
risk factors, market risk, interest rate risk, legal risk, and so on,
exist across product lines and are interconnected.” The fall of Barings is an example of the real world of the
folly of not looking at an institution as a whole.
regulation” was early on frowned upon by the US courts (American Bankers
Ass’n v. SEC, 804 F.2d 739). But
when the views pro and con clashed once again during the deliberations on how to modernize
the US financial services environment, the US Congress, where academic
disputations are constantly tested in the crucible of political
pragmatics, opted for
functional regulation of sorts. Passing
the Gramm-Leach-Bliley Act which became law on 12 November 1999, the US
Congress repealed the famous Glass-Steagall Act and gave the SEC greater
powers in dealing with the securities activities of US banks. However, of interest to our local trust officers, Section
211specifically carved out common trust funds.
would be sheer colonial mentality to cite the Gramm-Leach-Bliley Act as
basis for not including UITFs (which are the direct progeny of the US
common trust funds). But the
reason why common trust funds successfully withstood the onslaught of the
functional regulation attack is worth examining.
was not political horse-trading, I submit, that resulted in preserving the
banks’ regulatory authority of over the US common trust funds.
It was, the
recognition that while it is good policy, as functional regulation
preaches, to subject all players playing the same game to the same rules,
US Congress acknowledged that common trust funds (a.k.a. locally as UITFs)
are not playing the same game as mutual funds are.
The identical appearance of the hood of the two vehicles, i.e.
pooling of funds, obscures the radically different engines that drive each
of them. But UITFs and mutual
funds perform two distinct
the hood of a mutual fund is a commodity; under the hood of a UITF is
caring, a term which, I submit, has the same root as the ancient virtue of
commodity that a mutual fund peddles is a “security”.
Although broadly defined, a security nevertheless is characterized
by the deliberate bundling of rights and obligations. Thus, it represents
a set of rights which the owner is entitled to enforce against the issuer.
Beyond that set, the owner has no other.
The owner has a set of obligations, too, that he owes the issuer.
But other than those obligations, he has no other.
Deliberate and conscious limits and borders are thus the hallmarks
of a security.
a bond entitles the owner to a return of principal at maturity and
interest thereon. The owner
of a plain vanilla bond thus has no say in the way the money is spent and,
for as long as repayment is assured, could not care less about how the
company performs. An owner of a share of stock has interest in how a company
does, but, really, management of the corporation is not in his hands as
such. He does not even,
unlike the bond holder, have the right to get his money back.
Indeed, there is some truth to a cynic’s definition of a security
issuer as one who is able to take money from your pocket to put in his
without being called a thief.
this reason, the center strategy of securities regulation in protecting
investors is full and fair disclosure.
The consumers must be given the wherewithal to make an informed
choice to acquire or not to acquire a specific security, and if the
former, which specific security to get.
The SEC oversees a market where everything material must be bared
to anyone with legitimate interest and no one who is able must be barred
from honest buying or selling. The
securities market is not a place for the weak of heart, the feeble of
mind, the shallow of pocket, nor the inattentive and distracted.
the market for trusts, and UITFs, is.
A trust is for one who would rather go to church than read the
charts; one who prefers to watch HBO rather than Bloomberg; one who would
count how many angels could stand on the head of pin than compute for the
present value of stream of cash flow promised but not committed.
These people have neither affection nor appetite even for the
fullest and strictest disclosure by the most compliant of securities
For this reason, trustees by all societies have been subjected (long
before the idea of the modern corporation reared its head) to standards of
loyalty so strict as to demand that they act even against their own
self-interest when demanded by the interest of their beneficiaries.
They answer to courts not of law but to courts of the King’s
conscience. They are
fiduciaries par excellence.
regulation that examines each and every nook and cranny of a trustee’s
being is, I submit, the approach to the UITF, not functional regulation
that limits itself to only what he does like the others . For when a man
of means purchases units in a mutual fund, he merely in-vests
in the issuer’s purse. But
when that same man hands his money to a UITF, he en-trusts
part of himself in his trustee’s heart.