Puts and Calls: Conferees face tough job in reconciling House and Senate financial reform bills

Tom Karol Occasional Political Commentator
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Senate conferees named: The Senate on Tuesday named 12 conferees to reconcile legislative differences between the upper and lower chambers’ financial reform bills. House Financial Services Committee Chairman Barney Frank, Massachusetts Democrat, will serve as chairman of the conference negotiations, which Democrats aim to complete before the July 4 recess. House members are expected to be named next week. The seven Senate Democrats are Banking Committee Chairman Chris Dodd of Connecticut; Agriculture Committee Chairwoman Blanche Lincoln of Arkansas and Sens. Tim Johnson of South Dakota, Jack Reed of Rhode Island, Charles Schumer of New York, Patrick Leahy of Vermont and Tom Harkin of Iowa. The Republicans are Sens. Richard Shelby of Alabama, Bob Corker of Tennessee, Mike Crapo of Idaho, Judd Gregg of New Hampshire and Saxby Chambliss of Georgia.

Chairman Frank and Goldman Sachs agree: A Goldman Sachs client report dated Monday states that the firm does not expect the derivatives proposal from Lincoln will make it in the final bill. On Tuesday, Frank told a group that Senate language that would require commercial banks to wall off their swaps-trading operations “goes too far.” Franks said Lincoln’s concerns were addressed by other provisions in the Senate bill that restrict banks’ proprietary trading. Fed Chairman Ben Bernanke and FDIC Chairman Sheila Bair also oppose the Lincoln swaps-desk language.

Does reform have to hurt? The financial reform bill has been touted as having the potential to dramatically affect the financial services industry, with some analysts estimating it could cut profits of major financial institutions by 20 percent. Such costs are mostly predicated on changes to derivatives trading, which by some estimates accounts for up to half of trading desk revenue at large firms. Now it appears that the most feared derivatives provisions may not come to pass. Even with those regulations, the Goldman report states: “Our normalized EPS estimates adjusted for potential regulatory impact implies that large banks can still generate a return on tangible common equity of 21 percent which is equivalent to a ROE of 13 percent. This compares to an average ROE for the banking industry of 15 percent during the 15 years preceding the crisis (1992-2006).” Are the banks so clever that they have already accommodated the impact of reform, or has the reform been structured so well that the ensuing protections do not impact banks’ bottom lines?

Fiduciary duty: Another key provisions for conferees to address concerns the duties of financial services professionals. The House version calls for SEC rules holding broker-dealers and insurance agents to a fiduciary duty, rather than the suitability standards that applies now. The Senate version calls for an SEC study of the issue. Fiduciary duty requires acting in the best interest of the client and avoiding self-dealing, where suitability is a lower standard that the person has reasonable basis for advice and knowing the customer’s needs, goals and ability to bear risk.

The SEC commissioned a study of this issue in 2008, which concluded that investors don’t understand the distinction even when it is explained to them and believe that financial professionals are acting in their best interest.

As noted in an earlier post, this issue of duty is central to the disagreement, misunderstanding and distrust over just what Goldman and other financial services firms do and how they do it. Goldman’s seemingly inexplicable defense in the Abacus matter is surprisingly simple — they owed no duty to buyers or sellers to provide additional information. Congress and others cannot fathom that such a duty would not exist. As the financial reform bill ambles towards enactment, perhaps this confusion will be resolved.

The Senate understands suitability and fiduciary duty: Monday night, the Senate agreed to two motions to instruct conferees, one to exempt car dealers from financial regulations and another to limit proprietary trading restrictions. Motions to instruct conferees have no binding effect, but require a vote. These same subjects were to be addressed on the Senate floor last week, in the form of outstanding post-cloture amendments. An auto dealer post-cloture amendment was tied to a proprietary trading post-cloture amendment, and both had to be addressed on the Senate floor if either was to be considered. Many senators supposedly wanted to help the car dealers, but not if it meant imposing proprietary trading restrictions. So neither post-cloture amendment came to a vote, and neither was included in the Senate bill. The non-binding motions to instruct conferees, however, allow senators to claim that they voted on the subject, particularly to support those voting auto dealers and bank haters back home. These senators clearly understand that both votes had a reasonable basis, but neither was necessarily in best interests of constituents and without conflicts of interest.