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May 23, 2016

Financial Reform Newsletter: Special interests love to use popular positions as Trojan Horses…

Special interest deregulation is not the way to promote capital formation, economic growth, or more jobs; the right way is to protect investors while preventing another jobs and growth-killing financial crash:  Special interests love to use popular positions as Trojan Horses, hiding behind them while pursuing just the opposite agenda.  One of the favorites is economic growth and jobs, which was the subject of a Senate Banking subcommittee hearing this week ostensibly about facilitating greater capital formation.  However, the hearing focused on three bills that would actually deregulate parts of finance, including parts that had a central role in causing and spreading the 2008 crash and parts that had to be bailed out.

Deregulating finance, increasing systemic risk while reducing investor protections, and reducing financing for small business lending is simply not going to create jobs and growth or result in more capital formation, as Steve Hall, Better Markets’ Legal Director and Securities Specialist, testified at the hearing.  Mr. Hall focused on these deficiencies in the proposals, some of which had bipartisan sponsors:

–        One would deregulate the money market fund industry, which required an historic $3.7 trillion bailout in September 2008 after the Reserve Primary Fund broke the buck and investors started to run.  The proposal would repeal the SEC’s 2014 rule requiring institutional prime and institutional municipal money market funds to adopt a daily NAV that accurately reflects the asset values in the mutual fund rather than a stable $1 dollar NAV, which is a misleading fiction.  While better than nothing, the 2014 rule was itself an inadequate half-measure that requires strengthening, as we detailed here.  

–        One would weaken the risk retention safeguards that apply to securitizations of commercial real estate loans.  One of the key drivers of the massive fraud that inflated the 2008 subprime mortgage and derivatives bubbles was the gutting of due diligence and underwriting standards because the “originate to distribute” model was upfront fee-driven, which passed the risk of loss to other investors in the securitization process.  A key reform was requiring risk retention (known as “skin in the game”) to prevent that from happening again.  

–        One would deregulate business development companies (BDCs) and move them away from their core function of funding small businesses (while permitting them to double their leverage).  BDCs are tax favored vehicles required to devote at least 70% of their lending to small businesses of questionable credit quality.  The proposal would slash the 70% requirement to just 50% while allowing BDCs to increase investments in high risk financing firms.  Reducing small business lending while increasing leverage and incentivizing investment in finance firms is the opposite of what we need to be doing to get our economy going again. 

You can read Mr. Hall’s opening statement summarizing these positions here, find his full written testimony here, and watch the entire hearing here.

Lastly, if you want to see how a U.S. Senator strips away industry spin by revealing key undisclosed issues and facts, make sure you watch Sen. Elizabeth Warren’s questioning one of the witnesses at 1:30:16 of the hearing here.

Working on ending Wall Street’s too-big-to-fail threat to jobs, growth and Americans’ standard of living by preventing another financial crash: As we have written about before, Neel Kashkari, president of the Federal Reserve Bank of Minneapolis held the second in a series of symposia on exploring possible transformational changes to end too-big-to-fail.    

Following opening remarks, the bulk of the day was taken up with a robust line-up of panel discussions and presentations from a number of academics: John H. Cochrane, Senior Fellow at the Hoover Institution, Stanford University; Luigi Zingales, Robert C. McCormack Distinguished Service Professor of Entrepreneurship and Finance and Charles M. Harper Faculty Fellow at the University of Chicago Booth School of Business; John Bovenzi, Co-chair of the Bipartisan Policy Center’s Failure Resolution Task Force, and many more.

Bovenzi noted that the Dodd-Frank Act has made a significant impact in the regulation of big banks, yet more work remains, saying, “The FDIC, the Fed, and the banking industry need to stay the course.”  He concluded his presentation with an observation very much in keeping with the Better Markets mission – the need for increased transparency and clarity for the American people.

Former Federal Reserve Board of Governor Chairman Ben Bernanke also spoke at the symposium, urging patience and saying that structural changes in the financial industry are still needed to end too-big-to-fail.


Securities and Exchange Commission (SEC) whistleblower program sending a loud and clear message that illegal conduct won’t be tolerated and whistleblowers will be amply rewarded, as they should be:  The SEC recently announced two very large whistleblower awards that should get the attention of those in the executives’ suites of finance as well as those in compliance and working throughout Wall Street.  In one,a whistleblower award exceeding $3.5 million to a company employee who aided in an ongoing investigation of wrongdoing.  Interestingly, the SEC was already investigating the matter, but the whistleblower provided key information that strengthened the SEC’s case and merited this substantial award.

On May 17, the SEC announced that it will award between $5 million and $6 million to a former company insider who provided detailed information that allowed the agency to uncover major securities violations.  The award is the SEC whistleblower program’s third largest since its inception in 2011; since that time, the agency has awarded more than $67 million to 29 whistleblowers.

Many had concerns about whether or not the SEC would ever implement a serious whistleblower program and whether or not the intent of the statue of encouraging whistleblowers to come forward would be realized.  It now seems clear that the program is serious and working.  People should now believe that the SEC will protect the confidentiality of whistleblowers and will substantially reward them for information that relates to illegal conduct.  Importantly, the SEC has also sent the message that it encourages whistleblowers to come forward and report information on securities law violations even if an investigation is already underway.

The impact of an effective SEC whistleblower program will not only help discover and punish wrongdoing, but it should also incentivize companies to have more robust compliance, detection and reporting systems themselves.  Preventing or deterring illegal conduct by the firm in the first instance is best and firms’ identifying, investigating and reporting wrongdoing quickly is second best.  An effective SEC whistleblower program is an essential backstop to what financial firms should be doing already and the SEC appears to have that in place now.



News Section

Better Markets in the News:

Elizabeth Warren could help Hillary Clinton unite Democrats, but her support comes with a price Los Angeles Times by Noah Bierman 5/19/16

News You Don’t Want to Miss:

Deutsche Bank Probes Trades That Made Employees Millions The Wall Street Journal by Jenny Stasburg 5/19/16

Goldman investors revolt over executive pay Financial Times by Alistair Gray 5/20/16

Sources: CFTC to adopt strict swaps margin rule this week Politico Pro by Patrick Temple-West 5/23/16

How Clinton Would Reform the Housing Finance System American Banker by Ian McKendry 5/20/16



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