|July 12, 2013
I’m going to be brief, in part because the CFTC’s probable demonstration of lack of gumption is still in play, while the SEC’s was expected but nevertheless appalling. But the bottom line is that even though we seem some intermittent signs of the officialdom recognizing that big banks remain a menace to the health and well-being to the general public*, the measures to constrain them continue to be inadequate.
As readers may recall, CFTC chairman Gary Gensler was in a position to stare down bank efforts to water down critical provisions of Dodd Frank on derivatives (see here for details of the issues at stake). The short version is that Gensler did not have the votes among his commissioners to support his position since the Administration had managed to appoint a bank stooge as one of the Democrats. However, Gensler controlled the agenda. That meant he had the option of not putting the matter to a vote of his fellow commissioners at all, which meant Dodd Frank would become effective as written (mind you, normally legislation does legitimately require some tweaking since the legislative language may be imprecise or not mesh well with existing rules).
What appears to have forced Gensler to relent was not the CFTC politics, but bank refusal to prepare, which meant they could stamp their feet and say if Gensler did not back down, the markets would blow up and it would all be his fault. From the Financial Times:
It was billed as the mother of regulatory crunches, the day the world’s regulators would part ways on policing derivatives. They would prevent clearing houses handling some US business and force dealers to apply conflicting rules.
In the event, on the eve of a deadline when the US would withdraw exemptions for foreign dealers, a landmark transatlantic accord has been sealed that calls a truce in a turf war that has threatened to disrupt financial markets…
The breakthrough starts putting together a jigsaw sketched out by global regulators, which united after the 2008 financial crisis to impose order on derivatives markets with common principles for clearing, trading and reporting. Through exemptions and accords, it sets a path for the EU and US to recognise rules so there is no need for either authority to enforce them outside their own jurisdiction…
There was palpable relief in the industry. Yet while the most worrying threats of a confrontation have receded, the road to regulatory convergence remains long…
Behind the numbingly complex detail of cross-border derivatives guidance, a bigger issue was at stake: whether Washington could trust Europeans to enforce financial rules designed to protect US taxpayers..
Mr Gensler had previously insisted that any transaction with a US counterparty fell under Dodd-Frank. Now the CFTC has determined that because EU and US rules are “essentially identical”, market participants can “determine their own choice of rules” when transacting privately negotiated swaps..
Swap transactions executed on what CFTC calls “foreign boards of trade” will also be allowed.
Mr Gensler, meanwhile, won a firm commitment to define US-based hedge funds incorporated offshore as American, ensuring their derivatives trading is subject to oversight.
This all sounds ducky, right? Um, the triumphal tone should tell you who won. This terse assessment from George Bailey of Occupy the SEC:
Looks like Gensler lost.
US based branches of foreign banks won’t have to comply with CFTC rules/deadlines.
Hedge funds may be considered US persons but if they deal through London they’ll escape CFTC rules, at least untill Europe finalizes their comparable rules.
Non US swap dealers will not need to comply with CFTC requirements/deadlines from this point.
Now the deal is still not final and the deadline is Friday, but with so much allegedly at stake, I’d expect this to at worst be ironed out by the end of the weekend
As for the SEC, we have the continuing disgrace of the ignominious Jumpstart Obama’s Bucket Shop Act, which has sent investor protection back to the ugly days of the Roaring Twenties. The SEC passed three measures. One was an embarrassingly watered-down version of a Dodd Frank requirement to restrict the involvement fo felons and other bad dudes in Regulation D offerings. Another to make the Reg D forms better (but whether they actually get around to figuring that out is another matter; the SEC has a sorry history of leaving important business like this unfinished).
But the ugly piece de resistance was to allow general solicitations to “accredited investors” of private funds (meaning soi disant hedge funds) and startups. The problem is that “accredited investor” is defined strictly in terms of money, not sophistication: $1 million in net worth OR $200,000 in income. Doctors (think surgeons) are perfect marks. They fancy themselves to be savvy investors because they had advanced degrees and were used to having nurses and patients defer to them. Lawyers and retirees are also prime targets (remember, if you had a semi-decent pension at a mid or upper level corporate job, lived modestly, or happened to land in a decent real estate market, it’s not hard to have a $1 million net worth, and widows who get decent inheritance are prime targets for unscrupulous investment managers). In other words, the people who will be targeted will be the mass affluent, and unlike the really rich, serious losses could wipe them out. SEC Commissioner Luis Aguilar stresses that this population isn’t necessarily all that savvy:
By e-mail, Barbara Roper of the Consumer Federation of America described how the SEC didn’t even bother going through the motions of subjecting the general solicitation proposal to proper study:
One of the (many) things that is troubling about this action is that the Commission finalized this rule based on a proposal that did not even pretend to follow the Commission’s guidelines for economic analysis. That should resolve any questions about whether economic analysis is really a tool to improve regulations or just another way to hand the drafting pen to industry lobbyists. I know, you’re asking whether that was still an open question in anyone’s mind. But this action provides conclusive proof. Two of the key points of evidence:
· The “baseline” discussion which is supposed to describe the state of the market prior to adoption of a rule is eight sentences long. It did not include any information about issuers who raise capital through Reg D offerings, investors who purchase such offerings, evidence of fraud in the market, the state of SEC oversight of the market, the adequacy of the accredited investor definition to identify a pool of investors who are capable of fending for themselves without the protections afforded in the public markets.
· The SEC assiduously avoided any consideration of alternative regulatory approaches, even though its guidelines for economic analysis require it to consider, and put out for comment, all reasonable regulatory alternatives submitted to the Commission. There were a number of such suggestions included in the record before the SEC ever drafted its rule proposal.
This is a textbook example of corruption. The SEC wouldn’t dare skip the economic analysis step if it were to take the out-of-character step of making life difficult for the securities industry; it would need to take these steps to withstand a legal challenge. But the Supreme Court has raised the bar very high for public advocacy groups to obtain standing to oppose these measures. And with weak rules in place, there’s no harm, no foul. For instance, one of the legitimate reasons it’s been hard to sue financial firms for all the toxic CDOs they created was that they (not unlike these JOBS Act offerings) were not registered securities but were private offerings, and so were not subject to the high disclosure standards of public offerings. So the SEC is not only making it easy to commit what by common sense standards is fraud by allowing well off but not necessarily sophisticated people to be hawked risky investments, it’s also making it hard for them to sue if they are misled, not by being lied to but by having important information withheld.
While this mess started on Mary Shapiro’s watch, Mary Jo White owns it. White could told the Republican commissioners that she wasn’t going forward unless there were adequate investor protections. It would have been easy to use their own arguments against them – that the rule proposal was clearly legally deficient, that she had pledged to follow guidelines on economic analysis, and that this proposal was way out of line with those procedures. The result would have been a compromise rather than an abject sellout to the industry. It is now no longer possible to pretend that the SEC is an investor protection industry. It might as well throw out the SEC logo and put the Chamber of Commerce’s on its door. At least we’d have some truth in advertising.
*For the record, some of the latest include the identification of SIFIs, or systemically important financial institutions, which will be subject in some respects to more stringent regulation than other firms, along with Daniel Tarullo of the Fed’s proposals that large banks hold considerably more capital).