By Heidi N. Moore, contributor

The Dodd-Frank financial reform bill (should it ever pass) is supposed to be a victory for the little guy. But what few people know is that it’s also a victory for the little regulators.

Well, they’re not really little; they’re the nation’s 50 or so state securities regulators. And the financial reform act is, for them, a touching story of Washington redemption, a return to some of the power that was stripped for them in a more vengeful political age.

You don’t often hear much of state regulators in the big headlines, because in 1996 they were neatly shunted aside by the National Securities Markets Improvements Act, or NSMIA. It’s usually pronounced “nismia,” and for state regulators, it might as well have been pronounced “miasma,” because that’s exactly what it ended up being.

In a more friendly time — after the Uniform Securities Act of 1956 — state securities regulators were the first line of defense against con men and Ponzi schemers. Their regulations were called “blue sky” laws by Supreme Court Justice Joseph McKenna because the rules were designed to protect investors against mountebanks taking their money for promises as empty as a blue sky.

By the mid-’90s, however, the regulatory tide turned against these state regulators. The SEC was growing more powerful (remember those times?) and Wall Street banks were getting bigger and didn’t want to design securities offerings in compliance with so many different laws. NSMIA took away all authority from the states to regulate offerings that were listed on major exchanges as well as municipal offerings and the commercial paper borrowing that keeps corporate America running.

The state securities regulators theoretically kept the power to investigate and prosecute fraud, but their powers to subpoena documents were drastically reduced. The state regulators remained frustrated until New York State Attorney General Eliot Spitzer’s success in chasing Wall Street’s research problems emboldened other states, including Massachusetts and Utah, to kick their securities investigations into higher gear.

The Dodd-Frank bill gives state regulators a lot of their power back. Street Sweep talked to Texas Securities Commissioner Denise Voigt Crawford, who is also president of the North American Securities Administrators Association, the state securities regulators’ industry and advocacy group. When testifying in front of lawmakers on financial reform, Crawford argued, “There were many reasons for the great recession, but a failure of state securities regulators was not one of them.” The argument seems to have hit home.

Here are a few of the powers that state regulators got back in the financial reform bill:

Reg D: State securities regulators had argued for the return of a “bad boy” provision to the private placement laws. “Bad boys” are those who have been previously accused of securities fraud. After NSMIA, many stock scams and Ponzi schemes were protected by private placement laws that essentially said “anything goes” when it comes to selling securities to sophisticated investors. Now bad boys can’t get involved in that business at all. The bill kicks the final rule-making on this over to the SEC, which would have one year to make the final rules.

The definition of an accredited investor: State regulators wanted to make it harder for people to be considered “accredited investors” if they calculated the value of their homes in their net worth. The regulators’ argument was that many people with little ready money could end up losing their homes if a stock scheme went wrong. Arguing the other side were angel investors, who wanted to be able to fund entrepreneurs without having to be billionaires. Accredited investors can no longer count their home as part of their net worth calculation. (Angel investors did succeed in keeping the “accredited investor” qualification at a net worth of about $1 million rather than the $2.5 million the states wanted.)

Assets under management: Before, investment advisers who had less than $25 million under management registered with their states as their primary regulators, and those with more money registered with the SEC. Now, investment advisers with $100 million under management have to register with their states. If they’re registered in more than 15 states, however, those advisers can be regulated by the SEC.

A seat at the table: The 10-person council that oversees the markets will include, as nonvoting members, one representative each from state securities regulators, state banking regulators, and state insurance commissioners.

There were, however, some delays in the bill that couldn’t be called victories, exactly, for the states:

Mandatory arbitration: State securities regulators wanted to get rid of mandatory arbitration rules, which prevent customers from suing banks. The bill commissions a study of the matter — not a great answer, since there have been plenty of studies already.

Fiduciary duty: Congress decided to commission a study of whether stockbrokers and insurance agents should be considered “investment advisers,” as the states wanted. Doing so would make the stockbrokers and insurance agents subject to the rule of “fiduciary duty,” which means they would have to prove that they are acting in their clients’ best interests — not those of their firms.

Crawford was optimistic that state regulators will be able to catch financial crooks. “There was no area where state
regulators were preempted, no area where authority was taking away and diminished,” she said. “While we didn’t necessarily get every single thing we were seeking, there’s just no talk of pulling back on state securities regulation, and that’s great.”

Of course, the final hurdle is actually getting the Dodd-Frank bill passed. The death of Sen. Robert Byrd and cold feet among other Democrats mean that the bill somehow needs four Republican votes to pass. That’s a big jump from the current Republican vote: zero.

–Heidi Moore is Sweeping the Street for the next two weeks while Colin Barr is on vacation.