Seeing red over bank affiliates' waivers

Money managers affiliated with banks admitting they violated U.S. securities, banking and other laws could find it hard to get the necessary permission from regulators to continue running the more than $1.3 trillion they oversee.

“I am troubled to see yet another bank plead guilty to criminal charges, only to turn around and ask federal regulators to allow it to continue doing business as if it has done nothing wrong,” U.S. Rep. Maxine Waters, D-Calif., said in an e-mail. Ms. Waters is the ranking member of the House Financial Services Committee and a vocal critic of what she calls the “seemingly reflexive granting of waivers to bad actors.”

After being found guilty of criminal charges, financial firms routinely apply for exemptions from the Department of Labor to be allowed to keep managing retirement assets and file for waivers from the Securities and Exchange Commission to continue raising capital and managing money for investors.

While getting those waivers has been pro forma in the past, the wave of bank criminal cases is changing that.

In addition to guilty pleas for rigging foreign currency exchange rates already reached against Deutsche Bank AG, Credit Suisse Group AG and BNP Paribas, separate settlement agreements are reportedly being negotiated with Citigroup Inc., Barclays PLC, J.P. Morgan Chase & Co. and Royal Bank of Scotland Group. UBS Group AG faces a similar fate.

“Now you've got all these high-profile criminal cases, and these financial institutions could have some real problems,” said Thomas Gorman, a former SEC enforcement official and a partner at international law firm Dorsey & Whitney LLP in Washington. “If you (a bank that also manages money) have problems with the Investment Advisers Act (of 1940, which regulates money managers) ... those are the ones that could really put you out of business.”Pressure is building at the SEC to make waivers harder to get. Two of the most vocal waiver critics are Commissioners Kara Stein and Luis Aguilar.

The latest criticism came after Deutsche Bank was granted a waiver May 1 following a criminal conviction and $2.5 billion fine for manipulating the London interbank offered rate. The bank's money management arm, Deutsche Bank Asset & Wealth Management, managed $496 billion in worldwide institutional assets and $11.56 billion in U.S. institutional tax-exempt assets as of Dec. 31, according to P&I data.

After “nearly a decade of lying, cheating and stealing (that was) pervasive and widespread,” by granting the bank its third waiver in eight years, “the commission continues to erode even this lowest of hurdles (the waiver process) for large companies,” Ms. Stein said in her dissenting opinion. “Deutsche Bank is a recidivist, and its past conduct undermines its current promise of future good conduct.”

Ms. Stein also chastised the Commodity Futures Trading Commission for wording in a related order against Deutsche Bank that prevented triggering any SEC disqualification, a tactic since adopted by other banks in negotiations with the CFTC.

“The more sophisticated investors are clearly focusing on” SEC bad actor rules, said Deborah Prutzman, founder and CEO of New York-based Regulatory Fundamentals Group, a compliance consultant to institutional investors. “A compliance program needs to focus on enforcement issues, not just SEC registration issues. "The bad acts that could lead to disqualification are triggered by failing to satisfy a number of statutes. The first line of protection is a compliance program that covers the kinds of events that could lead to disqualifications.”

The recent scrutiny of the waiver process led Credit Suisse to withdraw in early May its request for an SEC waiver for raising capital, after its banking entity pleaded guilty in May 2014 to helping U.S. citizens avoid taxes overseas.

That followed a contentious public hearing in January at the Department of Labor over Credit Suisse Asset Management's bid for an exemption allowing it to continue providing asset management services to retirement plans. The company, which managed $15.62 billion for U.S. institutional tax-exempt clients as Dec. 31 according to Pensions & Investments data, was granted a temporary exemption with several conditions to avoid disrupting retirement plan participants.

DOL officials, who stress that weaker cases for exemptions are not even considered, say they have been imposing more conditions when granting exemptions — like increased compliance training and auditing — that they say gives them more oversight leverage over the firms. The conditions in the exemption granted in April to BNP Paribas Investment Partners “would provide much or all of the deterrent effect that would have been achieved through outright denial,” the exemption notice said. BNP Paribas Investment Partners managed $3.62 billion for U.S. institutional tax-exempt clients as of Dec. 31.

At the SEC, losing market privileges became a more serious threat after passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Under Dodd-Frank, an automatic “bad actor” disqualification provision was added for private offerings under Rule 506 of Regulation D, which governs securities registration requirements and exemptions.

A convicted firm can petition the SEC for a waiver to remove what would otherwise be a restriction on private offerings or a possible ban from serving as an investment adviser or getting referral fees from fund managers.

Urska Velikonja, a law professor at Emory University, Atlanta, in an upcoming paper for the California Law Review, looked at 201 “bad actor” and “ineligible issuer” waivers granted by the SEC between July 2003 and December 2014, and found that large financial firms received 81.6% of them, while other firms rarely did.

While some of that might be due to more sophisticated oversight in place at larger firms, Ms. Velikonja in her paper criticized the SEC for having unwritten criteria for granting waiver requests and a lack of transparency into the waiver process.

Ms. Waters has drafted legislation to require the SEC to implement a more rigorous and public process for granting waivers. Similar legislation also would help the DOL waiver process, said Bartlett Naylor, a financial policy advocate with advocacy group Public Citizen in Washington. Mr. Naylor questions the “Alice-in-Wonderland logic” of DOL officials who say the waiver process gives them more oversight after standing laws have been broken.

SEC Chairwoman Mary Jo White defended her agency's handling of waivers for large financial institutions. Ms. White declined to comment for this article, but when addressing the Corporate Counsel Institute in Washington in March, she said the public controversy “can take on a political tone that can blur the analysis.”

What is less discussed, she said, “are the many instances where waivers are never requested or (are) withdrawn after discussion with our staff.”

Denying a waiver where circumstances do not warrant it “would not be an appropriate exercise of our authority ... to further punish an entity for its misconduct or history of misconduct, or in an effort to deter it or others from possible future misconduct,” Ms. White said in her March speech. Still, she added, SEC officials now consider more extensive conditions to impose with waivers, and stress the risk of losing one if conditions are not met. It is “a process that we continue to scrutinize and enhance,” said Ms. White.

That is a good sign, said Stephen Hall, a securities specialist with Better Markets, a non-partisan non-profit organization in Washington. “We are hopeful that there will be fundamental change. It should be much more rigorously applied. Don't always deny it, but certainly don't always grant it. (The banks) should at least lose some privileges.”