A flurry of recent events suggest that
many of the provisions of the Dodd-Frank Act are finally being
implemented by rule or coming of age. The June 11, 2013 edition of
the Wall Street Journal lays out some perfect examples of the
regulatory ripple effect of the 2008 financial markets meltdown.
I still recall happening upon a
discussion between a securities regulator from Vermont and a
securities regulator from Utah during the early months of my tenure
as Commissioner of Securities. The two of them were discussing
“naked shorts” and I initially thought I was interrupting a
private discourse. Luckily, I stayed around long enough to learn
about a stock option practice—now restricted—that can be used as
a legitimate equity market hedge strategy or abused as a market
manipulation strategy.
The Wall Street Journal reported on
page C-1 that a SEC administrative law judge had ruled against a
former Maryland banker in finding him liable for “naked short
selling.” As you probably know, a short sale is accomplished by
selling stock you don't own by borrowing it from someone who is
“long” in the stock (owns it). The goal is to buy the stock back
out of the market if and when the stock’s price goes down, and
return the new shares to the original owner. For example—if you
sold the borrowed shares for $10 and bought the replacement shares
for $5, you made a nice little profit. “Naked” short selling
distorts the market price of the shares because the shares being sold
were never actually borrowed. This does damage to current
shareholder's because it creates a negative downward market pressure
on the price of the stock at issue.
The SEC judge in the case also ordered
a brokerage firm owned by Charles Schwab to disgorge $1.6 million in
profits and pay a $2 million fine. The judge even went so far as to
bar the firm's former CEO from the securities industry. It seems the
brokerage turned a blind eye towards the banker's failure to clear
his short sales.
Along the lines of new and tighter
restrictions mandating timely clearance, the same edition of the Wall
Street Journal has an article about the new rules that recently took
effect regarding swaps. A swap is a “derivative” of an actual
equity. Reporter Katy Burne Succinctly explains that:
“Derivatives allow users to protect
against everything from moves in interest rates to the cost of raw
materials, and swaps are more-complex derivatives that have generally
been traded away from exchanges. As of Monday, more are being routed
to central clearing houses, which take fees to guarantee trades in
the nearly $650 trillion global swaps market. The 2010 Dodd-Frank
financial-overhaul law mandated that many swaps be cleared in an
effort to help prevent a financial system meltdown by forcing traders
to post collateral known as margin. When Lehman Brothers Holdings,
Inc. failed in 2008, just a fraction of its multitrillion-dollar
swaps book was cleared. Lehman's failure sent shock waves through
financial markets and accelerated a general pullback by investors
from riskier investment classes.”
I can't say it any better than that.
The same edition covers the rating
agencies’ new-found “lack of sway” (loss of credibility) since
they fell in love with and heaped AAA ratings on mortgage-backed
collateralized debt obligations that were packed with junk.
Journalists Nicole Hong and Carolyn Cui, however, attribute the
diminished influence to factors such as “the prominence of global
economic factors driving bond prices” (as opposed to the intrinsic
credit soundness of the bond issuer I suppose). Finally, the edition
at issue ran a story about another child of the Dodd-Frank Act—the
Bureau of Consumer Financial Protection—scrutinizing bank overdraft
fee practices. And it is about time on that score.
In sum, if you missed the Wall Street
Journal on June 11, 2013, you are lucky you found this blog. Food
for thought.
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