Swap Dealers Eye Relief in SEC Policy Curbing Bank Penalty Scope

The U.S. Securities and Exchange Commission proposed a way for banks to shield their derivatives businesses from disruption triggered by enforcement actions, reprising a long-running fight over how severely the agency should punish Wall Street firms accused of wrongdoing.

The SEC voted 3 to 2 Wednesday to issue a policy that outlines how banks can avoid collateral damage for their derivatives businesses when unrelated units or employees face sanctions.

The 2010 Dodd-Frank law automatically barred individuals or firms that are convicted of a crime or settle enforcement actions with federal or state regulators from working with banks’ swap dealers. Without a waiver from the SEC, swap dealers would have to restructure their derivatives businesses, even if the misconduct didn’t stem from swaps activity or occurred in a market outside the SEC’s oversight.

The granting of penalty waivers, once a routine job handled by SEC staff lawyers, has become a flash point in the past year. Under the policy, SEC commissioners would vote on individual waivers sought by financial firms. Companies would have six months to persuade the SEC to give them a waiver and if they didn’t get it during that time period they would be denied the exemption.

Commissioners were divided over the details of the policy, with Democratic Commissioner Kara Stein saying it may represent a lost opportunity to keep bad actors out of the market. SEC Chair Mary Jo White, who voted to approve it, said the relief is fair and will help prevent swap dealers from suffering collateral damage if a different bank unit, such as one that performs a back-office duty, faces punishment.

‘Flawed Proposal’

The five-member SEC also split over a provision that would allow other regulators to halt the automatic penalties, which would spare banks from having to seek an SEC waiver. Stein, who voted against the proposal, labeled it a loophole that would allow firms “to make an end-run around the commission’s disqualification regime.”

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 responded by calling the CFTC’s decision “deeply troubling.”

Commissioner Michael Piwowar also opposed the policy, but for different reasons than Stein’s. The SEC should only have automatic penalties apply to individuals, not firms, he said. That would make the SEC’s approach consistent with the CFTC’s, which doesn’t automatically ban businesses, he said.

“This flawed proposal took what should have been a straightforward process rule and turned it into another complicated waiver process that is sure to confound future commissions if adopted as proposed,” Piwowar said.

Public Comment

The proposal issued Wednesday called for 60 days of public comment. The SEC could amend the policy based on those comments before moving to adopt the rule.

Separately, the SEC voted unanimously today to approve rules that require banks to register as dealers of security-based swaps. The SEC oversees a small portion of the $700 billion global swaps market, with the CFTC regulating the rest.

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