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Regulation by Delegation: The SEC’s Proposed Swap Dealer Registration Process

October 28, 2011

Photo by StripeyAnne. Some rights reserved.

The SEC has published for comment proposed rules that lay out the process by which security-based swap dealers and security-based swap participants (“SBS Entities”) must register with the Commission. At first glance, the proposal appears straightforward, creating a registration framework similar to that used by broker-dealers. Indeed, the proposal allows broker-dealers, as well as those entities registered with the CFTC, to file abbreviated forms. But look closer, and the proposal looks less like a new regulation and more like a delegation of authority.

Paragraph (b) of proposed Rule 15Fb2-1 would require each SBS Entity to provide the SEC with a certification on Form SBSE-C. On it, a “senior officer” would certify that, after due inquiry, he or she has reasonably determined that the SBS Entity has the operational, financial, and compliance capabilities to act as an SBS Entity. That senior officer must also certify that he or she has documented the process by which that determination was made. 

The proposing release notes that the certification “is meant to address many of the same considerations that arise during the in-depth review by the Commission and its staff, or, in some cases, [self-regulatory organizations], prior to granting registration to certain applicants.”  And Commissioner Elisse B. Walter is even more explicit. She notes: “given the Commission’s current resources and the low probability that we will be given sufficient resources to fulfill our historical and new mandates, I do not believe that we can perform all the functions I would like to see us perform when an entity applies for registration.”

When you look very close, the proposal looks less like a delegation of authority and more like the abrogation of responsibility.

But perhaps therein lays the genius of the proposal. Put the responsibility back where it belongs.

Or not.

Although the proposal seeks comment on whether it should define “operational,” “financial,” and “capability,” it fails to do so with respect to “senior officer.” The proposing release simply says “that the senior officer is obligated under the rule to conduct some inquiry to form his or her reasonable determination.” (Emphasis ours.)

Unlike the Sarbanes-Oxley Act, which specifically requires CEO and CFO certification of an issuer’s financials, the proposed swap dealer registration rules simply require the designation of a senior officer. Not necessarily someone with real authority, or the real ability to require safeguards. Just a body at whom fingers can be pointed, like a regulatory sin eater.

And the SEC even envisions more. Question 35 asks whether third party services should be required to examine or confirm the certification’s conclusions. In other words, the Commission would entertain the creation of a private industry, dependent upon SBS Entities for work and compensation, whose sole purpose is to confirm a SBS Entity’s financial and operational capacity. Can anyone say “Nationally Recognized Statistical Rating Organization”?

Despite the credit raters conflicts of interest fiasco, the Dodd-Frank Act’s specific call to remove credit ratings from regulatory requirements, and the responsibility many place on credit raters for the sub-prime mortgage mess, the SEC has actually asked whether a similar framework should be created for the type of financial instrument Warren Buffett once called “financial weapons of mass destruction.”

Regulation by annihilation may be more like it.

Comments should be submitted on or before December 19, 2011.

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