SEC approves new rules for dealers of credit default swaps; regulators face challenge

April 18, 2012

More than three years after the financial system teetered on the brink of collapse, federal efforts to impose tighter regulation are facing a major challenge.

Business groups that denounce various rules as wasteful and misguided have found a powerful legal tactic to oppose regulators and potentially blunt their work.

Their argument: Rulemakers have done too little to analyze the costs and benefits of the rules, thereby creating an unwarranted drag on the economy and giving courts grounds to intervene.

The counter-argument: Corporate lobbies are using the threat of litigation as a club to block regulators, slow their efforts or scare them into writing softer rules.

A Wednesday vote by the five commissioners at the Securities and Exchange Commission highlighted the issue.

Meeting to publicly approve new rules for the first time since October, commissioners drew lines determining which dealers in financial instruments known as credit default swaps (CDS) would be brought under government supervision. The instruments figured prominently in the financial crisis.

The commission voted to exempt dealers that engage in up to $3 billion of the transactions per year.

That was 30 times higher than the $100 million threshhold the SEC proposed when it issued a draft of the rules in December 2010.

The SEC also decided to phase in the new oversight regime so that initially it only applies to dealers doing $8 billion or more of the CDS transactions per year.

As if anticipating legal scrutiny, officials spent much of Wednesday’s meeting talking about costs, benefits and the SEC’s extensive efforts to analyze them.

“Today’s release should end any doubt about whether we have taken those critiques seriously,” commissioner Elisse B. Walter said.

The rule still will cover “the overwhelming majority” of swap dealing, Walter said.

Just one day earlier, in the latest legal challenge to a financial regulation, the U.S. Chamber of Commerce and a mutual fund group, the Investment Company Institute, sued to block a raft of new requirements ordered by the Commodity Futures Trading Commission.

If allowed to stand, ICI president Paul Schott Stevens told reporters, the requirements “will impose enormous costs and burdens.”

The suit was hardly an idle threat. Last summer, in a lawsuit backed by the Chamber of Commerce and the Business Roundtable, a federal appeals court overturned one of the SEC’s biggest initiatives in years, a rule that would make it easier for shareholders to oust members of corporate boards. The court ruled that the SEC had not done enough economic analysis.

That ruling has sent shockwaves through regulatory offices, setting what some legal analysts call a difficult, if not impossible, standard in some situations.

The challenge stretches to Capitol Hill, where a Republican-controlled House panel called SEC Chairman Mary L. Schapiro to testify Tuesday at a hearing titled “The SEC’s Aversion to Cost-Benefit Analysis.”

It includes senior Republican regulators who have criticized the work of their Democratic colleagues, issuing public statements that could carry weight with judges.

And it extends deep into the bureaucracy, where business groups are putting their concerns on the record while rules are being written. If those formal comments don’t prompt regulators to write less controversial rules, they could serve as the foundation for future lawsuits.

The appeals court decision last year in the Business Roundtable case gives dissenting voices, whether from inside or outside regulatory agencies, more leverage to influence the negotiations that shape rules.

On Wednesday, Republican commissioner Daniel M. Gallagher thanked Schapiro “for your willingness to reconsider at my request certain fundamental aspects of this rule even though you could have easily proceeded without my support.”

In the end, the vote Wednesday was unanimous, with both of the SEC’s Republican commissioners joining the majority.

James Overdahl, a former SEC economist who now works for the firm NERA Economic Consulting, said parties with a stake in rulemaking increasingly approach the public comment period as if it were a legal proceeding. Overdahl said clients have turned to his firm for economic arguments that they can include in letters to regulators.

For some observers, the focus is a healthy development, forcing regulators to weigh the consequences of their actions more carefully. As others see it, it could stall or weaken protections needed to prevent future meltdowns or Wall Street abuses.

The heightened focus on economic analysis has slowed work on what were already complex and contentious decisions affecting broad swaths of the business world, from derivatives trading to stock markets and the use of minerals from the strife-torn Democratic Republic of Congo in consumer products. Comment periods have been extended and deadlines have been missed.

Last summer’s appeals court decision “is playing a harsh to devastating role at the SEC and the CFTC and other places,” Harvey Goldschmid, a Columbia law professor and former Democratic SEC commissioner, said in a recent interview. Rulemakings “are to a realistic degree frozen or moving very slowly at much greater cost than is warranted because of the . . . fears it has created,” Goldschmid said.

Harvey Pitt, a former Republican chairman of the SEC, said it is often very difficult to figure out with any precision what the costs and benefits of a rule will be.

“I think people in the commission are keenly aware of the difficulties,” Pitt said. “Nobody wants to go through all that effort, you know, and then have a rule struck down,” he added.

In March, a business group called the Committee on Capital Markets Regulation sent a warning to lawmakers about implementation of the Dodd-Frank Act, which was adopted in response to the financial crisis and tasked regulators with writing scores of rules.

“It would be an unfortunate outcome if, after the Dodd-Frank rulemaking process has run its course for several years, much of the rulemaking is invalidated because of its inadequate cost-benefit analysis,” the committee said in a letter to lawmakers.

In December, two financial industry groups cited costs and benefits when they sued to overturn a Commodity Futures Trading Commission rule restricting speculation in commodities.

At Tuesday’s congressional hearing, the SEC chairman said the agency is seeking to hire more economists, and it is involving them earlier in the rulemaking process.

The SEC, Schapiro told lawmakers, has “learned valuable lessons.”

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