SEC Launches Repo 105 Investigation

The Financial Times reports that the SEC has launched a probe into whether other financial firms used repos to engage in what amounted to financial fraud (as in fraudulent financial reporting), although perilous few are using the “F” word.

From the Financial Times:

US regulators on Monday asked more than 20 financial groups whether they engaged in transactions along the lines of “Repo 105” – an accounting device that helped Lehman Brothers conceal its high leverage ratio during the financial crisis.

The corporate finance division of the Securities and Exchange Commission wrote to chief financial officers of “close to two dozen” large foreign and domestic banks and insurers, demanding details of repurchase agreement deals.

The SEC probe includes whether companies booked repos as asset sales for accounting purposes over the past three years, and whether these deals were concentrated with certain counterparties or certain countries. Regulators also asked companies to quantify the amount of repos that were disclosed as asset sales and to explain the “business reasons” for use of these structures.

Yves here. While this is a welcome move, the open question is whether the SEC has sufficient reach to be effective. Repo 105 provides a template for one sort of violation, but how many other balance-sheet flattering games, involving God-knows-what jurisdictions, might have taken place? The SEC regulates broker-dealers, so for commercial banks with broker-dealer operations, its authority extends only to the US broker dealer operations. Even for the former investment banks, the SEC’s authority over the holding companies was tenuous. Per an earlier post:

The SEC did not have statutory authority over Lehman’s holding company. Its authority was “voluntary”, a sort of regulatory default. The lack of statutory authority creates ambiguity as to its basis for action (for instance, it cannot use statutory violations as a basis for action, nor can it threaten to revoke a license, since it does not have licensing authority. The examiner’s report is definitive upon this point (p. 1484):

The Gramm‐Leach‐Bliley Act of 1999 had created a void in the regulation of systemically important large investment bank holding companies. Neither the SEC nor any other agency was given statutory authority to regulate such entities.

In keeping, to induce the US LIBHCs to participate in an toothless regulatory scheme, the SEC weakened net capital requirements, an action that many experts see as having played a direct role in the crisis (as it is allowed investment banks to attain higher levels of leverage). Moreover, note the implicit limits on the SEC’s authority. From Report 466-A, published September 25, 2008:

The CSE program is a voluntary program that was created in 2004 by the Commission pursuant to rule amendments under the Securities Exchange Act of 1934. This program allows the Commission to supervise these broker-dealer holding companies on a consolidated basis. In this capacity, Commission supervision extends beyond the registered broker-dealer to the unregulated affiliates of the broker-dealer to the holding company itself. The CSE program was designed to allow the·Commission to monitor for financial or operational weakness in a CSE holding company or its unregulated affiliates that might place United States regulated broker-dealers and other regulated entities at risk.

Yves here. Did you catch that? While the SEC can supervise the holding company and unregulated entities, its scope of action is limited to preserving the health of regulated entities only.

The CSE program focused on liquidity, NOT solvency.

Back to the current post. So for the former investment banks, the SEC presumably has some history in supervising their “unregulated entities” but it can’t really force them to comply. Now these firms don’t want to appear to be obstructionist, but I would not be surprised to see any queries answered as narrowly as possible.

And how far can the SEC get, say, with a US or foreign bank with US broker dealer operations? It can presumably demand that the US broker dealer explain any suspect looking end of reporting period transactions, but the SEC’s ability to demand documents from the entity on the other side of the trade (even if it is another affiliate) would seem to be limited.

That is a long-winded way of saying that it is not a good sign that the SEC appears to be conducting this investigation without the support of other regulators, both in the US and overseas. Perhaps some will throw their weight behind it, but the lack of coordinated action does not bode well for reform.

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  1. psychohistorian

    I think F is for fig leaf.

    Just obfuscate the truth long enough for the next catastrophe for the sheeple to focus on.

    It is like the whole agnotology idea, Yves. The manufacturing of ignorance is a long used marketing strategy and in this case they are feigning serious investigation so there is cover for the congress critters to say that the system is working.

    Wake me when there is some evolution.

  2. kevinearick

    I stick with Vermont & elevators for the sake of clarity, but it goes on everywhere:

    there’s a turn-key community bank in rural Vermont that was built on selling people dairy farms with delapidated equipment and non-producing cows. it took the down payment, sold slightly less non-producing cows and delapidated equipment to the mortgage holders, in cycles, until they went broke. rinse and repeat.

    there is nothing new about banks or human psychology. in something for nothing economies, the ineffective always crowds out the effective. the only thing that changes is the number of layers involved in the misdirection, plausible deniability under the law, the percentage above the line, and the percentage below the line.

    divide and conquer, bet both sides of the trade, rinse and repeat.

    there is no need for direct communication between like psychologies, nor any great analytic ability in a symbiotic system.

    the service economy is 70% consumption … so we need to boost consumption … with deficit spending … hello. in an economic activity economy, what parades as investment and government is really consumption, which is why the food chain is collapsing.

    gotta honeybee?

  3. MindTheGAAP

    It would be nice to know if the financials-in-drag group such as GE are being probed as well.

  4. Steve Hamlin

    The SEC might not be the primary regulator of the activities of the sub-entities or the holding companies, but they still have significant power over the filed financial statements of the registered public entities.

    Note that the SEC is asking about the accounting treatment of certain transactions on the 10K, for a reconciliation to quarterly filed statements, for an explanation of changes in accounting treatments of those transactions over time, and an explanation of accounting decisions about disclosure in the 10K.

    This is less a ‘regulator’ inquiry with suspect regulatory purview (SEC Division of Trading and Markets) than it is a traditional public financial statement 10K inquiry from the SEC’s Chief Accountant (Division of Corporation Finance).

    This might lead to (in order of severity) clarifications of SEC regs, advisory opinions on the proper treatment and presentation of Repo transactions, restatements of 10Ks, Division of Enforcement involvment, Well’s notices, civil actions, criminal indictments for financial statement fraud. All in the absence of regulatory actions towards the broker-dealers.

  5. Doc Holiday

    I always thought that the FASB worked with SIFMA to front-run accounting regulations, which IRS didn’t understand, but as far as the SEC being involved, I thought they were always out of the loop, so this is retarded that SEC is going to pretend that they have some political coinage to spend …. WTF does the SEC do anyway …. besides help ring the bell for the wall street circus. I guess while I’m at it, as far as DOJ goes, they just follow the bribes and go along with the ride no matter who is driving. As far as DOL and FTC, those wankers are just sucking off the taxpayer teats and staying under the radar … is there any government agency that does anything?

  6. Mr. E

    “The SEC might not be the primary regulator of the activities of the sub-entities or the holding companies, but they still have significant power over the filed financial statements of the registered public entities.”

    I think this is the real power they have. If these companies made material intentional mis-statements in their filings, they could be looking at jail time for top executives.

  7. JB

    Yves, all,

    Please forgive the off-topic query(it would be great if there were a way to contact NC with tips/queries/comments that do not relate to a specific post).

    Is there anything at all in this story about the silver market: ?

    Is there anyone at or related to NC who can help non-experts sort out what is fact and what is fantasy here?


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