Statement at Open Meeting on Adoption of External Business Conduct Rule for Security-Based Swap Dealers and Major Security-Based Swap Participants
Commissioner Kara M. Stein
April 13, 2016
I would also like to thank the staff for their hard work in bringing this recommendation to the Commission, including Heather Seidel, Lourdes Gonzalez, Joanne Rutkowski, Cindy Oh, Lindsay Kidwell, Stacy Puente, Devin Ryan, Brian Bussey, Carol McGee, Joshua Kans, Margaret Rubin, Michelle Danis, Adam Yonce, and Diana Knyazeva.
Over the years, many organizations – large and small, sophisticated and unsophisticated, private and public – have suffered losses and even bankruptcy as the result of swap deals gone wrong. These consequences are not just financial abstractions. They have negatively affected the school systems that educate our children and threatened the provision of basic services by local governments.
For instance, the School District of Philadelphia lost over $160 million in connection with complex swap deals. These losses put at risk the education of children in Philadelphia and came at the expense of local taxpayers. Similarly, the residents of Jefferson County, Alabama, faced significantly higher fees for sewer services when their county was sold swaps under questionable circumstances. Even large companies have faced steep losses from complex swaps sold without full and fair disclosure. In fact, the General Accounting Office found that, between April 1987 and March 1997, derivatives purchasers lost approximately $1.7 billion in deals with questionable sales practices.
These problems became increasingly apparent as the financial crisis unfolded in 2008, and the federal government had to step in to avert a deeper economic crisis. The potential failure of AIG, which had sold credit default swaps covering billions and billions of dollars in assets, helped to further a growing loss of confidence in the U.S. and global financial markets. Ultimately, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act to address the abuses that had been uncovered.
Today’s rule spells out some important protections and business conduct standards mandated by Congress in the Dodd-Frank Act. These include anti-fraud rules, a chief compliance officer requirement, and adoption of supervisory systems. It also requires security-based swap dealers and major participants to communicate fairly. They must provide certain basic information to their counterparties so that these counterparties can adequately assess the proposed swap transaction. The rule also includes a requirement that security-based swap dealers act in the best interests of certain special entities, such as municipalities and endowments, when they make recommendations. These protections go to the heart of the abuses that impacted the residents of Jefferson County and the school children in Philadelphia.
In addition to these provisions, Congress also gave the Commission the flexibility to impose additional requirements to protect investors and the public interest. I am pleased that we are using this authority to add a suitability standard, as well as provisions designed to make the Chief Compliance Officer more effective.
In moving from the proposed to the final rule, we also took heed of lessons learned during the interim and strengthened certain provisions. For instance, the final rule limits the use of so-called “institutional suitability” to those investors with at least $50 million in assets. This means that security-based swaps dealers will need to undertake diligence and exercise appropriate judgment for many of their customers.
With these business conduct standards in place, we now need to look forward to completing our remaining security-based swaps rules. There are key elements that remain outstanding, including rules on trade acknowledgement, clearing, recordkeeping, and reporting. Congress intended this new regulatory framework to protect both investors and the economy from the types of abuses that occurred during, and prior to, the financial crisis. We need to adopt these rules as soon as possible in order to realize that purpose. I look forward to the staff’s recommendation on these outstanding items in the near future.
 See, e.g., OTC Derivatives: Additional Oversight Could Reduce Costly Sales Practice Disputes, U.S. General Accounting Office (Oct. 1997), available at http://www.gao.gov/assets/160/156011.pdf; In the Matter of BT Securities Corporation, Admin. Proc. File No. 3-8579 (Dec. 22, 1994); Procter & Gamble’s Tale of Derivatives Woes, NY Times, Apr. 14, 1994, available at http://www.nytimes.com/1994/04/14/business/worldbusiness/14iht-procter.html; Too Big to Trust? Banks, Schools, and the Ongoing Problem of Interest Rate Swaps, Pennsylvania Budget and Policy Center, Sharon Ward (Jan. 17, 2012), available at http://pennbpc.org/sites/pennbpc.org/files/TooBigSwaps.pdf; The Financial Crisis Inquiry Report, Financial Crisis Inquiry Commission (Jan. 2011), available at https://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf.
 See, e.g., In the Matter of RBC Capital Markets, LLC, available at http://www.sec.gov/news/press/2011/2011-191.htm; In the Matter of J.P. Morgan Securities Inc., available at https://www.sec.gov/news/press/2009/2009-232.htm.
 Too Big to Trust? Banks, Schools, and the Ongoing Problem of Interest Rate Swaps, Pennsylvania Budget and Policy Center, Sharon Ward (Jan. 17, 2012), available at http://pennbpc.org/sites/pennbpc.org/files/TooBigSwaps.pdf.
 In the Matter of J.P. Morgan Securities Inc., available at https://www.sec.gov/news/press/2009/2009-232.htm.
 In the Matter of BT Securities Corporation, Admin. Proc. File No. 3-8579 (Dec. 22, 1994); Procter & Gamble’s Tale of Derivatives Woes, NY Times, Apr. 14, 1994, available at http://www.nytimes.com/1994/04/14/business/worldbusiness/14iht-procter.html.
 OTC Derivatives: Additional Oversight Could Reduce Costly Sales Practice Disputes, U.S. General Accounting Office (Oct. 1997), at 72, available at http://www.gao.gov/assets/160/156011.pdf (“Our review identified 44 end-user losses that involved OTC derivatives transactions with U.S. dealers. These losses totaled an estimated $5.4 billion. Sales practice concerns were raised in 18 of these losses, accounting for about 41 percent of the total OTC derivatives losses and covering an estimated $1.7 billion in losses.”).
 The failure of AIG, a company with more than 76 million customers in approximately 140 countries — more than 30 million customers in the United States alone — posed a direct threat to millions of policyholders, state and local government agencies, 401(k) participants, banks and other financial institutions in the United States and abroad, and would have shattered confidence in already fragile financial markets. See https://www.newyorkfed.org/aboutthefed/aig.