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Securities and Exchange Commission (SEC) to credit for compliance with foreign regulations?

Recent remarks by several Commissioners of the SEC indicate that the agency may adopt a new approach to its regulation of transactions, products and market activities that are subject to parallel regulatory requirements in multiple jurisdictions.

Taken together, the Commissioners' comments suggest the SEC now favors "substituted compliance" as a solution to the problem of conflicting or overlapping rules – a break from past practice with respect to cross-border regulation. In short, substituted compliance would allow foreign issuers and other U.S. market participants, whose transactions are otherwise subject to SEC rules and regulations, to comply instead with comparable regulatory requirements in their home jurisdictions. The proposed solution recognizes that the global marketplace is fraught with peril for financial services firms trying to comply with overlapping (and often incongruous) regulatory requirements in multiple jurisdictions.

The Commissioners believe substituted compliance strikes an appropriate balance between recognizing differences in applicable regulatory regimes and accomplishing the Commission's goals of promoting market stability, transparency and investor protection. In order to make the substituted compliance approach a success, however, the SEC must address attendant implementation and enforcement issues.

The SEC must clarify the circumstances in which it would accept compliance with a foreign jurisdiction's regulatory requirements as a substitute for compliance with its own rules. The Commissioners suggest that a foreign jurisdiction's regulations must be "comparable" to the SEC's for a market participant to avail herself of the substitute compliance theory. Otherwise, the market participant must comply with the Commission's requirements.

While the Commissioners believe certain categories of regulations (eg capital requirements or public transparency requirements) readily lend themselves to substituted compliance, little detail is provided as to how – or by whom – a determination might be made as to: (i) whether a foreign regulation is sufficiently comparable to applicable SEC rules; and (ii) whether a U.S. market participant has satisfactorily complied with the foreign regulation.

Additionally, what is the role of substituted compliance in an enforcement context? In the January 2013 Risk Note, Tim House commented that while harmonization of international regulations "…is a desirable goal at a policy level, at the point of enforcement the picture remains (and is increasingly) fragmented." This observation is particularly apt with respect to substituted compliance. As a policy matter, it may be desirable to acknowledge compliance with comparable foreign regulations, but it is unclear how substituted compliance might influence the enforcement staff's decision to open an investigation or institute an enforcement action. In an enforcement era marked by a stark increase in cross-border enforcement actions by the SEC, substituted compliance could offer useful protection for financial services firms.

The Commission must, however, provide some clear guidance regarding the interplay between a determination of substituted compliance and the staff's prosecutorial discretion.

The Commissioners' discussion of substituted compliance provides useful insight into the SEC's view of cross-border regulation and may foreshadow policies that will take root under the new Chairman, Mary Jo White. However, at least for the time being, it appears regulatory dangers will persist for financial services firms trying to navigate conflicting securities regulations in multiple jurisdictions. From a compliance perspective, participants in the U.S. markets are best advised to take the most conservative approach. 

Legal and Regulatory Risk Note
United States