|
|
Some of might
remember a blog entry I made about inconsistencies in The SEC’s Annual Reports.
(emphasis mine) [my
comment]
Look
at the unconsolidated balance sheet of broker-dealers from the SEC’s 1983 Annual Report.
Notice the numbers for Receivable from Other Broker-Dealers and
Payable to Other Broker-Dealers. These numbers are opposite
sides of the same transactions between broker dealers. Securities borrowed
from one broker are owed to another. As expected, in 1981 and 1982, the
numbers for Receivables and Payables between broker dealers are fairly close
to each other
Now look at the unconsolidated balance sheet of broker-dealers from the SEC's 2003 Annual Report (the
last one available). The numbers for Receivable from Other
Broker-Dealers and Payable to Other Broker-Dealers are
completely disconnected. For example, in 2002 Broker-Dealers claim other
broker-dealers owe them either 939 billion or 387 worth billion of
borrowed securities. These are the same securities!
[I originally thought the discrepancies might be explained by how the
numbers were reported (accounting gimmicks). The reality is worse]
Well, I found the
answer to explain these inconsistencies: bank securities activities
(including security lending) are not subject to broker-dealer
regulation. This means that when banks lend securities to other
broker-dealers in exchange for cash, only one side of the exchange gets
reported to the SEC. In essence, since the 1980s, banks have been operating
as unregulated, “invisible” broker-dealers.
As David S. Ruder remarked in 1988, the barriers to securities activities by
banks was significantly eroded by new interpretations of Glass-Steagall
during the 1980s.
Remarks
of David S. Ruder
Chairman
States Securities and Exchange Commission
Before the American Bar Association
Section of Corporation, Banking and Business Law
Annual Spring Meeting
Philadelphia, Pennsylvania
March 25, 1988
…
III. Glass—Steagall Reforms
…
Originally the Glas-Steagall Act, enacted in 1933, strictly limited the
extent to which banks could engage in securities broker-dealer, underwriting,
or investment advisory activities. However, during the 1980s the
barriers to securities activities by banks have been significantly eroded as
a result of new interpretations of Glass-Steagall by banking
regulators and by courts. Glass-Steagall — once thought
to be an impenetrable barrier to such activities — is today a
barrier full of gaping holes.
Because banks’ securities activities are not subject to
broker-dealer regulation, the expansion of these activities has
concerned the Commission for some time. As a result, in 1985 the Commission
adopted Rule 3b-9, which was intended to fulfill the Commission’s goal
of achieving adequate and consistent regulation of securities activities of
banks. The rule required any bank engaged in the business of effecting
brokerage transactions, or dealing in or underwriting non-exempted securities
to either register as a broker-dealer or enter into a contractual or other
relationship under which a registered broker-dealer would in fact be the
provider of such services. Following the Commission’s adoption of Rule
3b-9, over 170 banks and bank holding companies established registered
broker-dealer subsidiaries.
…
Additionally, I urged that, if banks are permitted to underwrite and
distribute investment company securities, the Investment Company Act and the
Investment Advisers Act must be amended. Because the two Acts were drafted in
the context of the separation between banking and securities manated by
GlassSteagall, they do not adequately address the investor protection
concerns that will arise if banks are permitted to engage generally in the
investment company business. These concerns arise from bank custody
of assets of affiliated investment companies, transactions between
affiliates, investment company borrowing from affiliated banks, bank advising
of investment companies, the independence of directors, and the use of a
bank’s name by an affiliated investment company.
On December 9, 1987, I testified before the House Banking committee
emphasizing again that the Commission would be unable to support repeal or
modification of the Glass-Steagall Act unless the Commission’s investor
protection concerns were met.
Subsequently, at Senator Procnire’s request, the Commission staff met
with the Federal bank regulators to draft legislative language
addressing the Commission’s investor protection concerns.
Compromise language resulting from those meetings was included in the version
of S. 1886, the Glass-Steagall reform bill sponsored by Senators Proire and
Garn, that was approved on March 2nd by the Senate Banking Committee by a
vote of 18 to 2. In order to achieve an agreement, the Commission had to
make some significant concessions [to Federal bank regulators].
Nevertheless, the compromise, taken as a whole, provides adequate
investor protection, and provides significantly better protection for
investors than that likely to exist if banks’ securities activities
increase through regulatory interpretation and court decisions.
…
Now you may wonder why in the world the Commission supports repeal of
Glass-Steagall. Well, for starters, we believe that repeal of
Glass-Steagall will increase competition in the financial services industry
and will make U.S. financial services providers more competitive in world
markets. Moreover, investors will be better protected with the S. 1886
compromise legislation than by continuation of the de facto
circumvention and creative regulatory interpretation that has eroded
Glass-Steagall. To my mind, it has not been a healthy
development for the Commission to lose control over the banking segment of
the securities industry -- not healthy, that is, if you want
securities regulation to do the job intended by Congress.
Below, the SEC
explains how Banks and FDIC-Insured Savings
Associations can avoid registerering as broker-dealers.
Staff
Compliance Guide to Banks on Dealer Statutory Exceptions and Rules
…
Special Rules for Banks and FDIC-Insured Savings Associations
If a bank — or an FDIC-insured savings association or savings bank
(which we will refer to as "savings banks") — is engaging in
dealer activity, it does not necessarily have to register as a dealer
with the Commission [and doesn’t show up in SEC statistics]. Rather,
Section 3(a)(5) of the Exchange Act and certain Commission rules provide
transaction-specific exceptions and exemptions from the definition of
"dealer" for banks and savings banks. These exceptions and
exemptions are outlined below.
…
Exemptions from the Definition of "Dealer"
In addition to the four exceptions from the definition of "dealer"
outlined above, banks and savings banks should also consider two exemptions
adopted by the Commission by rule. These exemptions pertain to riskless
principal transactions and securities lending transactions.
…
2. Securities lending transactions. [17 CFR 240.3a5-3.] This
exemption, under Rule 3a5-3, permits banks to engage in, or effect,
securities lending transactions with certain counterparties. A
"securities lending transaction" is a transaction in which the
owner of a security lends the security temporarily to another party under a
written securities lending agreement. Through this agreement, the lender
retains the economic interests of an owner of the securities. Subject to any
terms agreed upon by the parties, including an agreement to loan the
securities for a fixed term, the lender also has the right to terminate the
transaction and to recall the loaned securities.
…
A final note about safekeeping and custody activities: Banks also
have a conditional exception under Section 3(a)(4)(B)(viii) from the Exchange
Act definition of "broker" for safekeeping and custody activities.
Under that exception, banks may engage in securities lending services for
custody customers without meeting the requirements of this exemption. For
example, the safekeeping and custody exception permits a bank to engage
in securities lending transactions for custody customers that are not
"qualified investors." Of course, because
the custody exception is only an exception from the definition of
"broker," it does not cover "dealer" transactions.
lawprofessors
reports that bank securities activities has been
within the regulatory purview of the Federal Banking Agencies, not the SEC.
October
02, 2006
SEC Extends Exemption for Banks
On Sept. 29, 2006, the SEC gave banks another extension until January 15,
2007. Before the Gramm-Leach-Bliley Act of 1999 ("GLBA"), banks
had a blanket exemption from the requirements of the Securities Exchange Act
of 1934 governing "brokers" and "dealers". Bank
securities activities were within the regulatory purview of the Federal
Banking Agencies, not the SEC. Under GLBA, banks must either engage
in securities activities through a registered broker-dealer or they must make
sure their activities fit within a functional exception to the new securities
laws definitions of "broker" and "dealer". SEC is now the
primary functional regulator for securities activities, even for banks. The
SEC is still evaluating comments on its proposed Regulation B and has
extended the pre-GLBA exemption until January 15, 2007.
Graphs showing
bank securities lending activity
To put this in perspective, the ultimate cost of the S&L crisis is
estimated to have totaled around only $160.1 billion, about $124.6
billion of which was directly paid for by the US government. By 1994, banks
had used securities lending to raise over $200 billion in cash.
Without this security
Some charts of the S&L crisis
Example of bank securities-lending activity
The Star Tribune reports about Wells Fargo's securities-lending program.
Bank
blamed for big losses to charities
Local
foundations are fighting Wells Fargo in court, saying it lied about safety of
investments made before market plunge.
By CHRIS SERRES, Star Tribune
Last update: December 9, 2009 - 8:14 AM
David Joles, Star Tribune
Monica Nilsson is street outreach director for St. Stephen's Human Services
and chairwoman of the Minnesota Homeless Coalition. Like many people who work
for nonprofits, Nilsson has seen her job affected by funding cuts by the
Minneapolis Foundation -- the state's second largest community foundation and
one of the largest donors to hundreds of small charitable groups across the
Twin Cities. It has made her job more difficult. Here, Nilsson pauses with
Frank Killsright, an Army Vietnam vet who was a member of the 82nd Airborne
175th Ranger Regiment Special Forces, who is homeless and lives under a
bridge in Minneapolis after the two visited Killsrights living quarters.
Nilsson is working to get Killsright into permanent housing as well as get
him Veteran's benefits. Killsright, who is Sioux and Cheyanne, served in
Vietnam from 1970 to 1975 and suffers from war-related PTSD.
Graphic: How Wells Fargo's securities lending program worked
For years, some large charitable foundations in the Twin Cities tried
to earn a little extra cash by hiring Wells Fargo & Co. to lend the
securities they owned to Wall Street.
Now, those foundations are engaged in a high-stakes lawsuit that accuses
Wells Fargo of costing them -- and the charities they support -- tens of
millions of dollars by violating the conservative investment principles that
the bank's top executives preached publicly.
The Minneapolis Foundation, Minnesota Medical Foundation, the Robins Kaplan
Miller & Ciresi Foundation for Children and the Minnesota Workers'
Compensation Reinsurance Association together accuse Wells Fargo of lying
about the safety of the investments they made with it in the months before
the market's plunge. Instead of safe, plain-vanilla investments, their
money was tied up in securities that became so toxic they couldn't be sold
except at fire-sale prices, according to the suit filed in state District
Court in St. Paul.
The losses likely will reverberate through the Twin Cities for years to come.
Many non-profit groups have already seen their funding cut this year.
For smaller charities, the cutbacks can be deadly, as a single grant from the
Minneapolis Foundation -- the state's second-largest community foundation
ranked by grants paid -- can make or break their chances of attracting
additional money.
"Every dollar lost is a dollar that's not available for the
community," said Mike Ciresi, partner in the Robins Kaplan Miller &
Ciresi law firm and one of the attorneys in the case.
Wells Fargo said in a statement that it "categorically denies" the
allegations made in the lawsuit, and that "as with all investments, the
investors bear the risk" of losses.
"We continue to vigorously defend against the allegations," the bank
said. "We continue to assist clients in working through the
extraordinary market events of the past several years." Citing the
litigation, the bank declined to comment further.
'On life support'
The full extent of the losses won't become clear until the nonprofits finally
untangle themselves from Wells Fargo's securities-lending program.
The nonprofits declined to comment or to make executives available, citing
the litigation, and referred calls to attorneys at the Ciresi firm.
But judging from the amount of capital they previously committed to
securities lending, the losses are significant.
The latest annual financial statements from the Minneapolis Foundation
shows that, for the year ended March 31, 2008, it had $95 million worth of
securities loaned to brokers. By March 31 of this year, that figure stood at
$30 million, though much of the reduction was due to simply shifting assets
away from securities lending.
For the Minnesota Medical Foundation, securities on loan declined from $42
million to $17 million in the year ended June 30.
The asset declines will have a direct impact on how much the foundations give
away, since their annual payout rates are calculated as a percentage of
assets. And the losses from securities lending come on top of the plunge in
value that foundations have seen in their stock investments since last year.
The Minneapolis Foundation's investments, outside of securities lending,
declined 29 percent in the year ended March 31.
Some nonprofits that have relied on the Minneapolis Foundation recently
received notices informing them that their funding will be cut or eliminated
for 2010. The foundation has narrowed the scope of its community grant-making
to organizations and activities that can demonstrate that their programs
benefit Minneapolis residents. It previously supported causes throughout the
Twin Cities.
The Minnesota Coalition for the Homeless, a statewide group that represents
150 homeless organizations, last month was turned down for a grant, after
receiving money from the Minneapolis Foundation for eight consecutive years.
Monica Nilsson, president of the coalition, said the decision means fewer
people will be advocating for the homeless, at a time when more families are
being forced onto the street or to homeless shelters.
Also turned down was Fund for an Open Society in Minneapolis, which sought
$75,000 to advocate for racial equity in public schools and housing.
"We're on life support," said Catie Royce, executive director for
Fund for an Open Society.
"The people most hurt by something like this are the ones who can least
afford to bear it in this economy," said Steve Paprocki, an adjunct
professor of philanthropy at Hamline University and managing partner of
Access Philanthropy, a firm that researches nonprofits. "It's a huge
black eye for everyone involved."
A $4 trillion business
Thousands of documents and dozens of motions have been filed by both sides
since the suit was filed last year. The documents are held in 28 bulging
folders stacked high inside a judge's chambers on the 15th floor of the
Ramsey County court building in St. Paul.
Many of the details related to Wells Fargo' securities-lending program are
sealed, though more information likely will emerge as the suit grinds on. The
case is so complicated that a state court judge appointed a special master to
oversee the discovery process.
"In my 40 years of practicing commercial trial law," wrote the
special master in a report to the court, "I cannot recall a case in
which discovery has been more contentious." [discovery
is the pre-trial phase in a lawsuit in which each party can request documents
and other evidence from other parties and can compel the production of
evidence]
The case is being closely watched by attorneys across the country, including
those whose clients have lost money in securities-lending programs. It is
viewed as the first securities lending case involving a large bank likely to
head to trial, now slated for April. Some similar disputes were settled out
of court, with the banks agreeing to make good some of the losses.
Securities lending was long considered a risk-free way to squeeze slightly
better returns from large investment portfolios. Earlier this decade, as the
demand for loaned securities mushroomed along with the stock market, assets
in securities-lending programs reached nearly $4 trillion. But the
strategy backfired after some of the firms that manage the programs began to
invest in riskier securities backed by loans tied to the housing market.
Lending began in the 1980s
Wells Fargo began promoting securities lending to larger institutional
investors, such as foundations and insurance companies, in the early
1980s, when it was still Norwest Corp. in Minnesota.
Under its program, Wells Fargo would lend out the securities held by
institutional clients for temporary periods to broker-dealers who like to
borrow securities for short-selling. (Short-sellers try to profit by selling
borrowed shares in the anticipation that the stock will fall, hoping to buy them
back later at a lower price and pocket the difference.) Wells Fargo
would ask for cash collateral for the loaned securities, then invest
that cash to generate a small return, splitting those returns with its
institutional clients.
According to the lawsuit, securities-lending agreements signed between Wells
Fargo and the nonprofits limited the bank to investing their collateral in
"short-term money market instruments," which can be bought and sold
easily. The agreements further said that the "prime considerations"
of the investments "shall be safety of principal and liquidity,"
the suit says.
But in recent years, the bank invested in securities, some backed by subprime
mortgages, with maturities "that reach out nearly 40 years," according
to the suit. These securities lost much of their value and became harder to
sell when housing prices began to fall in 2007. Wells Fargo also parked
client money in so-called structured investment vehicles, or SIVs -- pools of
money also invested in subprime-tainted securities, according to the lawsuit.
The nonprofits say they first learned something was amiss in November 2007
when Wells Fargo informed clients that one of its SIVs -- called Cheyne
Financial -- was in receivership. Wells Fargo also said it would no longer
value the cash collateral within its securities program "at par,"
meaning that investors might not get all their principal back.
Alarmed by the losses, the Minneapolis Foundation and other plaintiffs
said they tried to withdraw from the program, but Wells Fargo
"unlawfully barred the doors," by requiring them to repay any
lost cash collateral.
The nonprofits argue that the bank should foot the bill. They accuse it of
fraud, breach of fiduciary duty and civil theft, among other things. They
demand that Wells Fargo compensate them for their losses and return the
securities still tied up in the program.
The nonprofits allege that at one point Wells Fargo even
"misappropriated the proceeds" from an unrelated bond fund
held by the Robins Kaplan Miller & Ciresi Foundation For Children to
compensate for the losses of securities-lending collateral, according to
court documents.
"The highest levels of Wells Fargo management knew, or should have
known, that Wells Fargo was systematically investing the cash collateral in a
risky and unlawful manner," the lawsuit says.
…
Wells Fargo was not the only bank to run into trouble with a securities
lending program. Insurance giant AIG and Northern Trust, among others, were
sued on similar grounds over client losses. Though investing in
mortgage-related securities "appears reckless now," many of these
securities were considered safe just a few years ago, said Andrew Gogerty, a
fund analyst at Morningstar.
Conclusion:
1) Federal bank regulators led the push to repeal glass steal, and the reason
is obvious. Without the cash banks generated through securities lending, the
cost of the S&L crisis would have been at least double what it was.
2) Broker dealers are completely insolvent, as they are owed 1 trillion
dollars from insolvent banks.
Eric de Carbonnel
Market Skeptics
Support Market Skeptics with a donation :
please click
here
|
|
