Swap Dealers Caught in SEC Clash Over Severity of Bank Penalties

U.S. regulators are again feuding over how far-reaching punishments should be for banks that repeatedly violate securities laws, with the latest debate tied to penalties that could disrupt Wall Street’s trading in the $700 trillion derivatives market.

The battle at the Securities and Exchange Commission revolves around an internal agency policy that will detail when to discipline banks’ swap-dealing units. The five member SEC, which is scheduled to vote on the matter Wednesday, is divided over the rule and negotiations will probably go down to the wire, said three people with knowledge of the matter.

The conflict reprises a long-running fight at the SEC over what’s known as penalty waivers that the agency has granted large banks accused of selling toxic mortgage securities and manipulating benchmark interest rates. Senator Elizabeth Warren and other activists have seized on the once obscure issue to argue that the agency has been too soft on Wall Street.

SEC spokesmen John Nester didn’t return a phone call seeking comment.

The pending SEC vote stems from the 2010 Dodd-Frank Act, which imposed automatic penalties on the swaps businesses of banks that settle enforcement actions. Dodd-Frank permitted the SEC to write guidelines for how firms could obtain exemptions to avoid the additional sanctions.

Flash Point

The granting of penalty waivers, once a routine job handled by SEC staff lawyers, has become a flash point at the agency in the past year. Banks have long been automatically barred from managing mutual funds or raising money for hedge funds if they don’t get the exemptions after settling a case.

Under the proposal that SEC commissioners are slated to vote on, swaps dealers and their employers could appeal an order that bars them from the business. The plan will be open for public feedback before it can take effect.

The SEC’s two Democratic members, Kara Stein and Luis Aguilar, have opposed several waivers granted to banks and brokers recently that they consider to be repeat offenders.

The SEC’s two Republican commissioners, Daniel Gallagher and Michael Piwowar, have generally supported the exemptions. The Republicans are wary of the details of a new policy affecting derivatives when commissioners haven’t resolved their broader feud over how the agency grants waivers, said the people who asked not to be named because they weren’t authorized to discuss internal SEC policies.

SEC chairmen rarely schedule commissioner votes unless they believe they have enough support to advance a proposal. Wednesday’s meeting is a preliminary vote on whether to solicit public feedback, meaning SEC Chair Mary Jo White will probably have to mollify some of the internal disagreements for the proposal to become a formal rule.

Inappropriate Bans

White has typically favored granting waivers, arguing that it’s not appropriate to use bans on certain business practices as an enforcement tool, especially when the underlying wrongdoing was confined to a particular unit within a bank.

One of the biggest fights over the SEC’s latest proposal stems from a provision that allows other regulators to halt automatic penalties, thereby allowing banks to avoid having to seek an SEC waiver. Stein has labeled it a loophole that she wants White to remove, the people said.

Deutsche Bank AG was able to take advantage of a similar measure earlier this year when the Commodity Futures Trading Commission ruled the bank’s involvement in rigging Libor shouldn’t trigger SEC penalties. Stein called the CFTC’s decision “deeply troubling.”

SEC commissioners also are divided over whether to impose a deadline on requests for the swaps waivers. In past cases that have triggered constraints on other business units, banks have been in limbo for months as commissioners debated exemptions, including whether to make them temporary or require a law firm to monitor a lender’s compliance efforts.

Stein has sought a six-month deadline for the waivers, the people said. Banks that don’t get the relief during that window would be denied the exemption, the people said.

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