The End of Supervised Entities – Now What About Swaps?

The U.S. Securities and Exchange Commission [SEC] announced Friday a decision by the Division of Trading and Markets to end the Consolidated Supervised Entities [CSE] program, now that the five participants have collapsed or reorganized.

SEC’s Chairman Christopher Cox in his statement made it very clear that the CSE program was fundamentally flawed from the beginning, since investment bank holding co.’s such as Goldman Sachs (GS), Morgan Stanley (MS), Merrill Lynch (MER), Lehman Brothers (LEH), and Bear Stearns (BSC) could opt in or out of supervision at their discretion – thus significantly diminishing the effectiveness of the program, and practically leaving the SEC or any agency for that matter with no authority to regulate.

“The last six months have made it abundantly clear that voluntary regulation does not work,” SEC Chairman Cox said.

However, Mr. Cox in his statement pointed out that with each of the major investment banks that had been part of the CSE program now reconstituted within a bank holding co., they will all be subject to Federal Reserve’s statutory supervision authority. The Fed from this point forward will be able under the Bank Holding Company Act to impose and enforce supervisory requirements on those entities. Thus, noted Mr. Cox – “there is not currently a regulatory gap in this area”.

Friday’s announcement coincided with criticism by the SEC’s inspector general (Mr. H. David Kotz) of the agency for failing to properly supervise broker dealer risk assessments in a program run by the Division of Trading and Markets. The purpose of this program is for Trading Markets to assess the risks to registered broker-dealers that may stem from affiliated entities, including holding companies and to keep those involved informed of significant events that could adversely affect broker-dealers, customers and the financial markets.

“Trading and Markets [TMs] failure to carry out the purpose and goals of the Broker-Dealer Risk Assessment program”, said Mr. Kotz in his report, “hinders the Commission’s ability to foresee or respond to weaknesses in the financial markets. This may impact TM’s ability to protect customers from financial or other problems experienced by broker-dealers”.

Mr. Cox said the report’s major findings echoed the concerns he expressed to Congress this week. Unfortunately, he added, there is more work to be done. Mr. Cox also reiterated the fact that the approximately $60 trillion credit default swap [CDS] market, still remains unregulated by any agency of the government. He urged Congress to take swift action to address the issue.

Chairman Cox concluded by saying that based on CSE experience, it is critical that Congress ensures there are no similar major gaps in SEC’s regulatory framework in the future.

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