Naked Capitalism: New Blood at SEC?

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SEC Commissioners Kara Stein, Luis Aguilar Hit Bank of America Where it Hurts, in a Revenue Stream

Posted on November 10, 2014 by

SEC Commissioners Kara Stein and Luis Aguilar have found a weapon that looks to have financial firms more worried than being whacked with one-time fines. They are threatening to hit Bank of America in an ongoing revenue stream.

By way of background, Kara Stein, who joined the SEC in April, has gone to war with SEC chairman Mary Jo White over lax enforcement and other types of overly-financial-firm-friendly conduct. It’s virtually unheard of for a commissioner to cross swords with a chairman from the same party.

Stein and her fellow Democratic party commissioner Luis Aguilar have joined forces to stymie a Bank of America settlement they saw as too generous by virtue of waving certain sanctions that would otherwise automatically kick in. Note that it had become routine to issue these “get out of jail free” cards; Stein wanted to see that practice end. We gave an overview in a recent post:

Stein this time has managed to do more than just make speeches about not giving these waivers freely. She’s created some consternation by a bureaucratic maneuver to stymie giving Bank of America one for its $16.7 billion settlement for selling toxic mortgages. First, she and her pro-reform fellow Democratic commissioner Luis Aguilar forced a change in internal policies so that staff could no longer grant these waivers unilaterally; the commissioners had to sign off on them. Normally, that would be a no-brainer, since pro-industry Chairman Mary Jo White plus the two Republicans could be relied upon to approve them. But Mary Jo White has had to recuse herself for having represented the Charlotte bank. Stein and Aguilar teamed up to demand tougher punishments for this recidivist lawbreaker.

The sanction that Stein and Aguilar want to impose is that of barring Bank of America from fundraising for private concerns. That stings because Merrill, now Bank of America, has long been a leader in the low-risk, lucrative business of raising money for hedge funds and private equity funds. Of course, if you didn’t know better, you’d think this was a grave injustice being visited upon American engines of growth.

Bloomberg ran a story we mentioned on October 27. The news service ran another article, Bank of America Said to Make New Pitch to SEC for Relief, on how Stein and Aguilar were still hanging tough, and the poor mistreated Charlotte bank was suffering. A key section:

In a letter last week, the bank’s top lawyer Gary Lynch made a pitch to the agency’s commissioners to waive additional sanctions set to kick in when the settlement is entered in court, said the people, who asked not to be named because the entreaty was private. Lynch argued in part that the firm is being unfairly treated because other banks had been given waivers in similar cases.

A former SEC enforcement director, Lynch said saddling the bank with a penalty that could include barring it from selling investments in hedge funds would be unprecedented and cause reputational damage, the people said. The case remains in purgatory because SEC Chairman Mary Jo White is recused, while the agency’s Democratic and Republican members are deadlocked.

“They will not be able to engage in some of the investment-banking business that is highly profitable” if they fail to get the waiver, said Marlon Paz, a partner at law firm Locke Lord LLP in Washington. “That would be a show-stopper.”

This argument is simply disingenuous. It assumes that banks, which are so heavily subsidized by the government as to not warrant being treated as private, nevertheless have a right to profit. The notion that “this type of punishment wasn’t made in the past, so we should get it again,” is tantamount to a driver who managed to get away with paying less than the legally prescribed fine for driving 70 miles an hour in a school zone should get away with getting a break on his fine again. If anything, one could argue that a better remedy would be to go back and reopen those earlier settlements, as the Department of Justice is doing in money laundering and foreign exchange trading cases.

Similarly, a bank defender might argue that is it unfair to damage a business unrelated to the conduct at hand. First, these punishments haven’t been a mystery; any miscreant financial firm should have recognized that it could get hit by these additional sanctions. Second, in a recent speech about fixing bank culture, none other than the New York Fed’s William Dudley spoke about the importance of having much broader incentives in firms for employees to watch out for bad conduct in other business units, and that their pay should be at risk. He suggested that bonuses, particularly of senior employees, be significantly retained and treated as a performance bond, and would be the first source of payment for any regulatory fines or court judgments for deceptive behavior.

Why is Kara Stein and Luis Aguilar’s insistence on imposing these sanctions, particularly the one regarding barring Bank of America from raising money for hedge funds and private equity funds, so important? It hits the bank in a revenue stream. Even though this is still a financial penalty rather than fining or prosecuting individuals, it hits the bank in its wallet in a way that has captured senior management’s attention, presumably because it will also dent their bonuses. Recall that investors tend to blow off or even reward bank settlements. JP Morgan’s stock traded up strongly when it announced its $13 billion headline amount mortgage settlement. Its board even awarded Dimon a 74% increase in pay, despite his running the bank with the biggest rap sheet of them all. Clearly, being crooked and getting away with it is highly valued in Corporate America.

By contrast, Bank of America is a leader in the business of stumping for money for alternative investments. This is a pure fee business, and so particularly attractive from a profit perspective. It also has synergies with other businesses, such as Merrill’s prime brokerage business, and its private banking business (these investors love being shown “exclusive” deals like hedge funds, even when pros like CalPERS have concluded they don’t perform well enough to justify the fees). It isn’t simply that Bank of America will lose income from this business however long the firm is kept in the penalty box; its staff in this business will bolt, either to go to other firms or to set up shop themselves.

Keep in mind that the timing of this row could not be worse from Bank of America’s perspective. Bonus time is nigh, which means key employees in this unit are probably being recruited heavily in case the negotiations with the SEC are protracted or work out unfavorably for the Charlotte bank.

As much as it would be preferable to see stronger efforts to hold individuals accountable, Stein and Aguilar have not just Bank of America, but other banks worried about the SEC. That alone is a big step forward for a regulator that has too long been seen as a pushover.

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