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November 21, 2018

Mission Failure as CAT Suffers Failure to Launch

Financial Reform Newsletter
November 22, 2018

SEC Proposing Rules That Will Lead to More AIG/CDS Gambling, Blowups & Bailouts
AIG had a very lucrative business before the 2008 crash of gambling with unregulated credit default swaps (CDS) without setting aside any margin or capital.  Instead, all the profits were put into bonuses for AIG’s executives.

However, when those CDS bets went bad, AIG was bankrupt, but got bailed out by the government with more than $180 billion, some of which AIG then used to pay bonuses to some of the very same people who recklessly sold the CDS in the first place. It is a classic story of privatizing profits and socializing the losses, i.e., sticking taxpayers with the bailout bill while the executives keep hundreds of millions of dollars, fancy cars, mansions, sailboats and so much more.  The American people got the bill in lost jobs, homes, savings and so much more.

The Dodd Frank law said, “never again” and required CDS to be regulated.  Astonishingly, the Trump administration’s SEC is proposing rules that effectively say, “let’s have more AIGs.”  That’s wrong, as we detail in this comment letter.

Better Markets, ISDA, ICI, SIFMA, ICI, MFA, the Chamber and the IIB Request the SEC to Extend the Comment Period on its CDS Proposal

As bad as what the SEC is proposing regarding CDS, it’s even worse that they are trying to jam the rules through on an expedited basis, clearly rushing headlong into a predetermined outcome of letting CDS dealers do as they did before the crash.  Better Markets requested the SEC to extend the comment period, as did the International Swaps and Derivatives Association, Inc. (ISDA), Investment Company Institute (ICI), Managed Funds Association (MFA), U.S. Chamber of Commerce, Securities Industry and Financial Markets Association (SIFMA) and the International Institute of Bankers (IIB).

SEC Investor Advisory Committee Calls for Major Improvements to the misleadingly labeled “Regulation Best Interest”
Focusing on the need to better protect investors from pervasive conflicts of interest among securities brokers, the SEC’s Investor Advisory Committee (IAC) has made four key recommendations for improving the SEC’s so-called Regulation Best Interest (Reg BI), which echo many of the objections Better Markets detailed in its comment letter.

The SEC’s Reg BI and Form CRS proposal was supposed to solve the problem of unscrupulous advisers recommending over-priced and poor-performing investments to their clients so they could pocket handsome fees, commissions, and bonuses, in the process siphoning away tens of billions of dollars in American’s hard-earned savings every year.

The IAC urged the agency to strengthen the rule in four critical areas:

Clarify.  First, the IAC urged the Commission to flesh out what the “best interest” standard really means, since the term that is not defined in the proposal.

Expand.  Second, the IAC urged the Commission to make sure that the best interest standard covers major decisions such as whether to transfer (or “roll-over”) retirement assets from a 401(k) to a new IRA.

Strengthen.  Third, the IAC urged the Commission to clarify that it is a “fiduciary” standard in line with the standard applicable to investment advisers registered under the Advisors Act.

Test.  Finally, the IAC issued a common-sense call to the SEC to subject the disclosure requirements in the proposal to usability testing before finalizing the rule.

This recommendation was aimed specifically at the proposed “Form CRS,” which was meant to provide investors with a client relationship summary to help them better understand the differences between advisers and brokers and how those differences relate to fees, services, and legal duties.

For months after issuing the proposal, the Commission claimed it would be testing the form with investors, yet as time passed no results were made public.   Shortly after Better Markets filed a FOIA request with the SEC to obtain all available data and records related to investor testing of the proposed disclosure requirements, the SEC finally released at least some testing results.  These results, and others, suggest that the Form CRS will do little to help investors achieve clarity about adviser standards.  For example, even investors who apparently liked the form did not actually understand the information the form was supposed to convey.

All of this—along with the many comment letters submitted to the SEC—should send a clear signal that there is a lot of work left to be done on Reg BI and Form CRS.

Mission Failure as CAT Suffers Failure to Launch
It is inexcusable that the SEC cannot monitor or supervise the securities markets today because it doesn’t have the technology.  Described as the “Hubble telescope of the securities markets,” the Consolidated Audit Trail (CAT) is supposed to be that mission-critical technology and was poised to finally come to fruition on November 15th, as we said here.    However, the Wall Street Journal reported that the CAT data repository will fall far short of its full functionality including limits on a user’s ability to search it.

Simply put, this is an unacceptable and inexcusable mission failure.

The SEC erred in 2012 when it outsourced the building and operating of this game-changing tool to CAT NMS LLC, an industry consortium that should have brought the CAT online a full year ago.  The missed deadline should be no surprise, however, since the CAT will enable the SEC to monitor and police those very same industry participants, many of whom enrich themselves in today’s opaque and fragmented markets and some of whom engage in predatory if not illegal conduct.  It is like asking bank robbers to provide the police with a get-away maps app.  It’s not in their interest to do that.

Anywhere else, these people would all have been fired and replaced a long time ago.  Excuses, infighting, conflicts of interest and foot-dragging have resulted in an outcome too many in the industry wanted all along:  a broken tool that falls short of promises and expectations, leaving investors at the mercy of predators and the SEC blind to do anything about it.

If the SEC is ever going to be able to properly protect investors, markets and our economy, it needs 21st Century technology like the CAT, an essential tool for the SEC to supervise and police the securities markets.

A New Ally for Community Banks and the Real Economy
Late last week, the United States Senate confirmed the appointment of Michelle Bowman to the Federal Reserve Board of Governors, to serve in a critical position as the community banking representative.

As a 5th generation community banker from Kansas, Michelle Bowman knows the key role community banks play in supporting the real economy and will no doubt bring that perspective to the Federal Reserve Board. Whether it is a mortgage, small business, education or personal loan, community banks provide the fuel that keeps the engine of the real economy going and helps their neighbors achieve the American Dream.

That’s why it’s so important for a community banker to be on the Federal Reserve Board. While the biggest banks merit sustained and rigorous supervisory and regulatory attention, that shouldn’t come at the expense of the experience and knowledge of community banks, which now finally have a seat at the table. We wish Ms. Bowman well and know that the decisions of the Federal Reserve will be more informed and more representative of our diverse financial system. That should help to ensure that the Fed focuses on promoting broad-based growth as well as economic security, opportunity and prosperity for all Americans.

Better Markets Expands Team With New Hires in Derivatives, Banking and Legal
As we continue to fight for consumers and investors as well as a financial system that supports the productive economy, jobs and growth, we have brought on additional expertise and firepower in derivatives, banking and law.

Joseph Cisewski is our Senior Derivatives Consultant and Special Counsel, along with Jack Reidhill, who is our Chief Economist and Senior Banking Consultant, and Jason Grimes has joined as Senior Counsel.

Cisewski will be focused on the Commodity Futures Trading Commission and all things derivatives and commodities.  Before joining Better Markets, Joe was the Global Head of U.S. Securities and Derivatives Advisory within the global banking and markets division of HSBC Bank plc, and was a member of a global derivatives advisory and compliance team at J.P. Morgan Chase & Co.  He also served in a number of roles at the CFTC, including as the agency’s Co-Chief of Staff and Co-Chief Operating Officer and as Senior Special Counsel to CFTC Commissioner Mark P. Wetjen during the agency’s implementation of the Dodd-Frank Act.

Jack Reidhill served as a federal bank regulator serving for 33 years at the Federal Deposit Insurance Corporation (FDIC) as a policy and research economist.  He will focus on banking issues at the Fed, OCC, FDIC and Treasury.  While at the FDIC he led research and policy groups and most recently served as Associate Director of the Center for Financial Research Branch in the Division of Insurance and Research.  He was a principal co-author of a joint FDIC/Bank of England paper explaining how to resolve systemically important, complex international banking firms.

Jason Grimes will be contributing to all facets of Better Markets’ activities, focusing on legal research and analysis, as well as amicus briefs, reports, and pleadings.  Jason most recently was as associate at Covington & Burling, where he worked on compliance with regulations, as well as regulatory inquiries and investigations primarily from the CFTC, CFPB, and the banking regulators.  He was also a clerk for Judge Roger W. Titus, in Maryland.



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