SEC Readies Wall Street ‘conflicts’ Rule, A Decade After First Try

By Douglas Gillison

(Reuters) -Wall Street’s top regulator on Wednesday was set to unveil a rule barring traders in asset-backed securities from betting against the very assets they sold to investors, behavior that became infamous in the wake of the 2008 global financial crisis.

In Washington, the U.S. Securities and Exchange Commission’s five members were due to vote on whether to propose the rule formally at a meeting set to begin at 10 a.m. EST.

The rule is among the last yet to be adopted under the landmark Dodd Frank Wall Street reform legislation of 2010 that sought to address the root causes of the mortgage crisis, SEC officials said.

The sweeping reforms, named for sponsors Senator Chris Dodd of Connecticut and Representative Barney Frank of Massachusetts, aimed to protect investors and taxpayers by preventing the buildup 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.

An earlier version of the conflicts rule first proposed in 2011 was never finalized.

In the ensuing years, Democratic lawmakers complained that the SEC had 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 sold to investors.

According to SEC officials, the rule would ban such actions for up to a year following sale of the securities.

In prepared 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, marketmaking and liquidity commitments.

“Through these congressionally mandated exceptions, the rule would allow these market activities while targeting the conflicts that Congress identified,” Gensler said, adding that the latest version of the rule had been refined in light of feedback from the public.

According to SEC officials, traders who disclosed bets contrary to clients’ investments would still run foul of the rule.

Without citing prominent recent examples of such conflicts of interest in the asset-backed securities market, SEC officials said the conflicts rule was needed to remove the opportunity and incentive for such conduct.

In 2010, Goldman Sachs agreed to pay a record $550 million penalty to resolve SEC allegations that it had misled investors in a mortgage-backed investment vehicle known as Abacus.

A Senate investigation later detailed how in successive deals that Goldman had marketed mortgaged-backed securities to investors, often without disclosing that the investment bank or others had placed substantial bets that these assets would lose value, something they were in fact designed to do.

In a civil case brought by the SEC, Fabrice Tourre, a mid-level Goldman trader, was in 2014 ordered to pay $825,000, representing fines and ill-gotten gains.

Goldman did not immediately respond to a request for comment.

(Reporting by Douglas Gillison; Editing by Bradley Perrett and Alexander Smith)