On Wednesday, Wall Street’s top regulator voted unanimously to propose a rule prohibiting traders in asset-backed securities from betting against the very assets they sell to investors, a behavior that became infamous following the 2008 global financial crisis.
The rule is among the last to be passed under the landmark 2010 Dodd Frank Wall Street reform legislation, according to SEC officials. The 2010 legislation aimed to tackle the root causes of the mortgage crisis. An earlier version of the conflicts rule first proposed in 2011 was never finalized.
The sweeping 2010 reforms, named after their sponsors – Senator Chris Dodd of Connecticut and Representative Barney Frank of Massachusetts – aimed to protect investors and taxpayers by preventing the build-up of risk and liability in the financial system.
Among other things, the legislation contained financial stability measures governing banks deemed “too big to fail” and created the Consumer Financial Protection Bureau.
The rule re-proposed on Wednesday is now subject to a public comment period during which industry criticism of certain aspects of the proposal is likely to arise.
In the years after Dodd-Frank’s enactment, Democratic lawmakers complained that the SEC failed to meet a 270-day deadline to issue a rule implementing Dodd Frank’s Section 621. When made effective with an SEC rule, the section would prohibit traders from betting against asset-backed securities they have sold to investors.
According to SEC officials, the rule would prohibit such actions for up to a year after the securities are sold.
In remarks released ahead of the vote, SEC Chairman Gary Gensler said the rule would provide exceptions for legitimate activities, such as hedging to mitigate risk, market making and liquidity commitments.
“Through these congressionally mandated exceptions, the rule would permit these market activities while targeting the conflicts identified by Congress,” Gensler said, adding that the latest version of the rule has been refined in light of public comment. .
But in a public hearing ahead of the meeting, Republican members of the committee raised concerns that the proposal in its current form could hamper legitimate activity.
According to SEC officials, traders who disclosed bets contrary to clients’ investments would still be in violation of the rule.
Without citing significant recent examples of such conflicts of interest in the asset-backed securities market, SEC officials said the conflicts rule was necessary to remove the opportunity and incentive for such conduct. .
In 2010, Goldman Sachs agreed to pay a record $550 million fine to resolve SEC allegations that it misled investors in a mortgage-backed investment vehicle known as Abacus.
A Senate investigation then detailed how, in successive transactions, Goldman had marketed mortgage-backed securities to investors, often without disclosing that the investment bank or others had placed substantial bets that these assets would lose value, which is what they were actually designed to do.
In a civil case brought by the SEC, Fabrice Tourre, a mid-level Goldman trader, was ordered in 2014 to pay $825,000, representing fines and ill-gotten gains.
Goldman did not immediately respond to a request for comment on the specific steps it has taken in the past years to prevent such conduct.