DEUTSCHE AGREES TO PAY $55 MILLION TO SETTLE SEC CHARGES IT FILED MISSTATED FINANCIAL REPORTS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

05/26/2015 11:25 AM EDT

The Securities and Exchange Commission today charged Deutsche Bank AG with filing misstated financial reports during the height of the financial crisis that failed to take into account a material risk for potential losses estimated to be in the billions of dollars.

Deutsche Bank agreed to pay a $55 million penalty to settle the charges.

An SEC investigation found that Deutsche Bank overvalued a portfolio of derivatives consisting of “Leveraged Super Senior” (LSS) trades through which the bank purchased protection against credit default losses.  Because the trades were leveraged, the collateral posted for these positions by the sellers was only a fraction (approximately 9 percent) of the $98 billion total in purchased protection.  This leverage created a “gap risk” that the market value of Deutsche Bank’s protection could at some point exceed the available collateral, and the sellers could decide to unwind the trade rather than post additional collateral in that scenario.  Therefore, Deutsche Bank was protected only up to the collateral level and not for the full market value of its credit protection.  Deutsche Bank initially took the gap risk into account in its financial statements by adjusting down the value of the LSS positions.

According to the SEC’s order instituting a settled administrative proceeding, when the credit markets started to deteriorate in 2008, Deutsche Bank steadily altered its methodologies for measuring the gap risk. Each change in methodology reduced the value assigned to the gap risk until Deutsche Bank eventually stopped adjusting for gap risk altogether.  For financial reporting purposes, Deutsche Bank essentially measured its gap risk at $0 and improperly valued its LSS positions as though the market value of its protection was fully collateralized.  According to internal calculations not for the purpose of financial reporting, Deutsche Bank estimated that it was exposed to a gap risk ranging from $1.5 billion to $3.3 billion during that time period.

“At the height of the financial crisis, Deutsche Bank’s financial statements did not reflect the significant risk in these large, complex illiquid positions,” said Andrew J. Ceresney, Director of the SEC’s Division of Enforcement.  “Deutsche Bank failed to make reasonable judgments when valuing its positions and lacked robust internal controls over financial reporting.”

In addition to the $55 million penalty, the SEC’s order requires Deutsche Bank to cease and desist from committing or causing any violations or future violations of Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Securities Exchange Act of 1934 and Rules 12b-20, 13a-1, and 13a-16.  Deutsche Bank neither admits nor denies the SEC’s findings in the order.

The SEC’s investigation was conducted by Amy Friedman, Michael Baker, Eli Bass, and Kapil Agrawal.  The case was supervised by Scott Friestad, Laura Josephs, Ms. Friedman, and Dwayne Brown.  The SEC appreciates the assistance of the German Federal Financial Supervisory Authority and the United Kingdom Financial Conduct Authority.

ADDRESS BY CFTC COMMISSIONER J. CHRISTOPHER GIANCARLO ON END-USERS AND THE FINANCIAL CRISIS

FROM:  U.S. COMMODITY FUTURES TRADING COMMISSION

Keynote Address by CFTC Commissioner J. Christopher Giancarlo

Commodity Markets Council, State of the Industry Conference

Miami, Florida

End-Users Were Not the Source of the Financial Crisis: Stop Treating Them Like They Were

January 26, 2015

INTRODUCTION

Good afternoon. Thank you for your warm welcome. Thank you for inviting me to speak today. I am delighted to be at the CMC conference that brings together so many important participants in the markets regulated by the Commodity Futures Trading Commission (CFTC).

Let me begin by saying that my remarks reflect my own views and do not necessarily constitute the views of the CFTC, my fellow CFTC Commissioners or of the CFTC staff.

It is an honor to be on a program that includes both Chairmen of the House and Senate Agriculture Committees. Having spent time with both men, I can say that we are all very fortunate to have two experienced friends of agriculture chairing the Committees that oversee the CFTC and the markets we regulate.

I appreciate the opportunity to give this keynote address. I want to discuss a few issues that are important to the commodity and energy markets. These markets and your companies help to feed the globe’s population, heat and power millions of homes, and fuel the trains, planes, ships and trucks that deliver the commodities you produce and trade to the far corners of the world.

BACKGROUND AND MARKET EXPERIENCE

I dare say that before the Dodd-Frank Act was signed into law in July of 2010, some of you in the room, particularly in the energy space, did not have many dealings or interactions with the CFTC. There’s no doubt that since then, many of you have become intimately more familiar with the agency.

That was certainly true for me. Before the Dodd-Frank Act, I didn’t pay a lot of attention to the CFTC, but I gained a lot of experience in the global swaps markets. When I first left my law practice in 2000 and entered the swaps industry, I was struck by the fact that swaps brokerage was a regulatorily recognized activity in most overseas trading markets, but NOT in the U.S. I always felt this omission was somewhat detrimental to the ability of the U.S. swaps markets to compete against overseas markets such as London.

In the years before the financial crisis, I came to see that certain reforms would improve the swaps industry. In the mid-2000s, I became a supporter of central counterparty clearing of swaps when I saw how its emergence in the energy swaps markets increased trading and market participation. In 2005, I led an effort to develop a clearing facility for credit default swaps. That initiative ultimately led to the creation of ICE Clear Credit, the world’s leading clearer of credit derivative products.

Six years ago, I saw how the lack of regulatory transparency into swaps counterparty credit risk exacerbated the financial crisis. I remember very well an early morning phone call the second week of September 2008. It was from one of the principle U.S. bank prudential regulators. He was asking about widely gapping credit spreads in bank CDS protection, including Lehman Brothers. The regulator wanted to understand what was going on in trading markets. After a short conversation, I said that I would be glad to explain the current market situation to him face-to-face. He suggested a date in mid-October. I said “sure, but it all may be over by then.” It became clear to me then that regulators needed to have a far more transparent window into swap counterparty credit risk.

So as you can see, by the time Congress began drafting the bills that would become Title VII of the Dodd-Frank Act, I was already a confirmed advocate for its three key pillars of:

Central counterparty clearing;
Swap data reporting; and
Regulated swaps execution.
My support for these reforms is driven by my professional and commercial experience, not academic theory or political ideology. I believe that well-regulated markets are good for American business and job creation. That is why I consider myself pro-reform. That is why I support clearing more swaps through CCPs, reporting swap trades to trade repositories and executing swaps on regulated trading platforms. Unfortunately, many of the rules governing who and how swaps are traded do not conform to marketplace reality.

END-USERS ARE COLLATERAL DAMAGE OF DODD-FRANK REFORMS

Unfortunately, caught up in some of the collateral damage surrounding the Dodd-Frank reforms were the traditional commodity and energy markets and the end-users who depend on them for a variety of uses. Yet, end-users were not the source of the financial crisis. That is why Congress undertook to exempt end-users from the reach of swap trading regulation. It is our job at the CFTC to make sure that our rules do not treat them like they were the cause of the crisis.

Proposed Changes to Rule 1.35

In a number of key areas that I will discuss, reforms born from or inspired by Dodd-Frank are overly burdening end-users. For example, in 2012, the CFTC revised Rule 1.35. The revised rule requires the keeping of all oral and written records that lead to the execution of a transaction in a commodity interest and related cash or forward transaction in a form and manner “identifiable and searchable by transaction.” This recordkeeping must be done (with certain carve outs) by futures commission merchants (FCMs), retail foreign exchange dealers, introducing brokers, and members of designated contract markets and swap execution facilities.

As I have said before, the revised rule proved to be unworkable. Its publication was followed by requests for no-action relief and a public roundtable at which entities covered by the rule voiced their inability to tie all communications leading to the execution of a transaction to a particular transaction or transactions. End-user exchange members pointed out that business that was once conducted by telephone had moved to text messaging, so the carve out in the rule for oral communications gave little relief. They pointed out that it was simply not feasible technologically to keep pre-trade text messages in a form and manner “identifiable and searchable by transaction.”

Last fall, I voted against a proposed CFTC rule fix that did not do enough to ease this unnecessary burden on participants in America’s futures markets. That proposal was a well-intentioned, but insufficient attempt to provide relief from unworkable Rule 1.35 requirements. Rather than facilitating the collection of useful records to use in investigations and enforcement actions, the rule imposes senseless costs that fall especially hard on small intermediaries between American farmers, manufacturers, and U.S. futures markets.

Many of the small and medium-sized FCMs are used by America’s farmers and producers to control the costs of production. Unfortunately, today we have around half the number of FCMs serving our farmers than we had a few years ago. FCMs, particularly smaller ones, are being squeezed by the current environment of low interest rates and increased regulatory burdens. They are barely breaking even.

We should not be further squeezing American Agriculture and manufacturing with increased costs of complying with rules such as 1.35, if we can avoid it. The stated purpose of the Dodd-Frank Act was to reform “Wall Street.” Instead, we are burdening “Main Street” by adding new compliance costs onto our farmers, grain elevators, and small FCMs. Those costs will surely work their way into the everyday costs of groceries and winter heating fuel for American families, dragging down the U.S. economy.

End-Users Captured As “Financial Entities”

Another example is the Dodd-Frank definition of “financial entity.” It concerns the inadvertent capture of many energy firms as “financial entities.” As we have seen, imposing banking law concepts onto market participants that are not banks and that did not contribute to the financial crisis is not only confusing, but adds more risk to the system. It has the practical effect of preventing these firms from taking advantage of the end-user exemption for clearing or from mitigating certain types of commercial risk. Again, let’s not punish market participants who played no role in the financial crisis.

Swap Dealer De Minimis Level

Requiring that the Commission take a vote before a major shift in its regulations takes effect seems like a basic tenet of proper administrative law. However, in the CFTC’s final rule defining who would be captured as a “swap dealer,” the Commission abdicated this responsibility. Instead, the rule allows the “de minimis” threshold of $8 billion dollars of swap business per year to automatically lower to $3 billion in only a few short years without any affirmative vote of the Commission. This automatic lowering may occur regardless of the conclusions of a formal study of the matter required by the Commission – even if the study concludes that lowering the threshold is a bad thing to do! This is simply ridiculous.

A few months ago at a CFTC public hearing, I said as much for the official record. Later, I was characterized as “slamming” the particular rule. If calling a bad rule a bad rule is “slamming,” then I guess I did so. But it is merited.

Unquestionably, an arbitrary 60% decline in the swap dealer registration threshold from $8 billion to $3 billion creates significant uncertainty for non-financial companies that engage in relatively small levels of swap dealing to manage business risk for themselves and their customers. It will have the effect of causing many non-financial companies to curtail or terminate risk hedging activities with their customers, limiting risk management options for end-users, and ultimately consolidating marketplace risk in only a few large swap dealers. Such risk consolidation runs counter to the goals of Dodd-Frank to reduce systemic risk in the marketplace. The CFTC must not arbitrarily change the swap dealer registration de minimis level without a formal rulemaking process.

Contracts with Volumetric Optionality

Another topic of concern is risk management contracts that allow for an adjustment of the quantity of a delivered commodity. These types of contracts, known as “Forward Contracts with Embedded Volumetric Optionality,” or EVO Forwards, are important to America’s economy. They provide farmers, manufacturers and energy companies with an efficient means of acquiring the commodities they need to conduct their daily business – at the right time and in the right amounts. This includes providing affordable sources of energy to millions of American households. EVO Forwards do not pose a threat to the stability of financial markets. They should not be regulated in the same manner as financial derivatives.

Forwards are expressly excluded from the definition of a “swap” under the Commodity Exchange Act. The CFTC’s original guidance on how to determine when an EVO Forward should also be considered a forward, and thus excluded, using a “Seven-Factor Test” has been burdensome, unnecessary and duplicative. The Commission captured a large swath of transactions that were not and should not be regulated as “swaps,” including EVO Forwards.

Fortunately, the Commission recently proposed through regular order an amended interpretation of the Seven-Factor Test. That proposal is a good start for providing some sensible relief from the problems arising from the test. We are sorting through the many comments we received. I believe the best approach would be a new and more practical product definition. Short of that, my staff and I will listen carefully to industry’s recommendations for a better interpretation.

If not corrected, the regulation of these transactions will actually have the effect of increasing companies’ costs of doing business. It will force some businesses to curtail market activity and thereby consolidate risk in the marketplace rather than transfer and disperse it. That will ultimately raise costs for consumers. Such costly and unnecessary regulation thwarts the intent of Congress under the Dodd-Frank Act. We need your help to get this rule right.

Position Limits

Let me now turn to everyone’s favorite CFTC rule proposal: position limits that was proposed for the second time in November of 2013.

Shortly after I arrived at the Commission this summer, the CFTC staff hosted a public roundtable to hear concerns from market participants on the position limits rule proposal. In preparing for the roundtable I reviewed the underlying legal authority in Congress’ mandate that the CFTC prevent “excessive speculation.” After listening to almost a full day of testimony, I began to form the view that the CFTC was responding to Congress’ mandate to restrict “excessive speculation” the same way that the Transportation Safety Administration (TSA) goes about the task of catching airplane hijackers. That is, the CFTC intended to subject every single market participant to new federal position limits unless they affirmatively qualified for one of several detailed exemptions. The rule would operate the same way the TSA operated when it made every single passenger, including six-year-old boys and 82-year-old grandmothers, take off their shoes and belts and go through metal detectors before boarding a plane.

It struck me that there had to be a better way. There had to be a way to limit excessive speculation that was not so burdensome on America’s energy producers and hedgers, along with its farmers, ranchers and manufacturers.

The Dodd-Frank Act instructed the CFTC on how to define what constitutes a bona fide hedging transaction so those trades would not count towards position limits. The statutory definition states that the reduction of risk inherent to a commercial enterprise is a factor in determining what qualifies as a bona fide hedging transaction.

Instead, the currently proposed CFTC rule contains a number of provisions that will weigh heavily on hedgers, including:

(1) articulating 14 categories of transactions it deems bona fide hedges and requiring staff “guidance” before any other type of transaction qualifies;
(2) for the first time and without adequate explanation, the proposal requires not only a qualitative correlation but also a quantitative correlation of 80% or better between the futures price and the spot price of two commodities before a cross-commodity hedge is considered bona fide; and
(3) the proposal reverses course and eliminates the long-standing, flexible process for obtaining a so-called un-enumerated hedge exemption.

I am very concerned that the effect of the CFTC’s bona fide hedging framework is to impose a federal regulatory edict in place of business judgment in the course of risk hedging activity by America’s commercial enterprises. The CFTC must allow greater flexibility. It must encourage – not discourage – commercial enterprises to adapt to developments and advances in hedging practices.

The CFTC is a markets regulator, not a prudential regulator. The CFTC has neither the authority nor the competence to substitute its regulatory dictates for the commercial judgment of America’s business owners and executives when it comes to basic risk management.

The LAST thing our economy needs is the federal government dictating the conduct of everyday business risk management.

I believe the Commission should carefully consider many of the well-informed comments and suggestions on position limits raised by market participants. These include:

updating and modernizing deliverable supply estimates;
carving out ERISA plans;
modifying or eliminating the limitations on cross-commodity hedging;
restoring bona fide hedging status to anticipatory merchandising hedges; and
creating an aggregation policy that focuses on effective control over trading decisions, rather than primarily on ownership.
The CFTC should work closely with market participants to make sure the enhanced federal rules strike the right balance between regulation and well-functioning markets.

It is worth noting that there is a complete paucity of real Commission generated research or data to justify a sweeping new position limits regime. While we are all familiar with the various academic studies that make conclusions on both sides of the speculation issue, the only CFTC analysis cited in the position limits proposal was generated three decades ago related to the Hunt Brothers. Surely we can do better than that.

Let me be very clear. As a Commissioner, I believe the lack of CFTC analysis of the impact of “excessive speculation” is of fundamental significance to any decision to adopt a final position limits regulation.

Surely the Commission should look at the recent market events surrounding the decline in the price of crude oil over the past six months and determine why gasoline is averaging around two dollars a gallon these days. Even the President commented in the State of the Union address that we now produce more oil at home than we buy from the rest of the world—something that hasn’t happened in almost twenty years.1 Further, the President’s own Energy Information Administration (EIA) has stated repeatedly that the price of oil is directly related to global supply and demand and a recent revolution in American production.2 I cannot understand why this isn’t relevant to consider in any final version of a position limits regime put forward by the Commission.

ENERGY AND ENVIRONMENTAL MARKETS ADVISORY COMMITTEE

As a final note, I want to put in a plug for the CFTC’s Energy and Environmental Markets Advisory Committee (EEMAC) that I have been fortunate enough to be asked to sponsor. The EEMAC Committee hasn’t met since 2009, which, ironically, is actually a violation of the Dodd-Frank Act, which requires that EEMAC meet at least twice a year. Since its last meeting, we have had a sea-change in the CFTC’s impact on U.S. energy markets, all while the markets themselves are undergoing the largest technological and structural change in a generation. I am very optimistic the EEMAC will provide an open forum to discuss many of the issues I have mentioned today. I hope the EEMAC will be a catalyst to drive necessary improvements in CFTC rules and regulations. I welcome your participation and support and would like to thank the Commission for approving the membership just this morning.

In closing, I want to tell you how pleased I am to be a Commissioner of the CFTC. It is the highest honor to be nominated by the President and confirmed by the U.S. Senate to serve my country. After 30 years in the private sector advising clients, building businesses and operating trading venues, I have the opportunity to put my swaps knowledge and experience to good use.

I pledge to you today my full engagement on the many complex issues facing U.S. risk hedging markets. I intend to be:

A diligent student of market evolution and structure;
A champion for market efficiency and liquidity;
A protector of end-users’ rightful exemption from overly burdensome rules; and
A proponent for the proper use of U.S. commodity and energy markets in durable service to the American public.
Thank you very much for your time. I look forward to your questions.

1 See President Barack Obama, State of the Union Address, Jan. 28, 2014, available at http://www.whitehouse.gov/the-press-office/2014/01/28/president-barack-obamas-state-union-address

2 See Administrator Adam Sieminski, Energy Information Agency, U.S. Department of Energy, Statement Before the U.S. Senate Committee on Energy and Natural Resources, July 16, 2013, available at http://www.energy.senate.gov/public/index.cfm/files/serve?File_id=bb2fa999-fe76-4c27-9853-fc21b7b3601e; See also Sieminski, EIA, Statement Before the U.S. House of Representatives Committee on Energy and Commerce, Dec. 11, 2014, available at http://energy.gov/sites/prod/files/2015/01/f19/12-11-14_Adam_Sieminski%20FT%20HEC.pdf.

Last Updated: January 26, 2015

CFTC CHAIRMAN MASSAD'S TESITMONY BEFORE U.S. SENATE COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

FROM:  COMMODITY FUTURES TRADING COMMISSION

Testimony of Chairman Timothy Massad before the U.S. Senate Committee on Banking, Housing, and Urban Affairs, Washington, DC

September 9, 2014

Thank you Chairman Johnson, Ranking Member Crapo and members of the Committee. I am pleased to testify before you today on behalf of the Commission. This is my first official hearing as Chairman of the CFTC. It is truly an honor to serve as Chairman at this important time.

I met and spoke with several members of this Committee during the confirmation process, and I appreciated hearing your thoughts and suggestions during that time. I look forward to this Committee’s input going forward.

During the last five years, we have made substantial progress in recovering from the worst financial crisis since the Great Depression. The Dodd-Frank Act was a comprehensive response, and much has been accomplished in implementing it. The CFTC has largely completed the rulemaking stage of Dodd-Frank implementation. However, much work remains to finish the job Congress has given us.

I look forward to working together with you, as well as my colleagues at the CFTC and others around the globe to ensure that our futures, swaps and options markets remain the most efficient and competitive in the world, and to protect the integrity of the markets.

The Significance of Derivatives Market Oversight

Very few Americans participate directly in the derivatives markets. Yet these markets profoundly affect the prices we all pay for food, energy, and most other goods and services we buy each day. They enable farmers to lock in a price for their crops, utility companies or airlines to hedge the costs of fuel, and auto companies or soda bottlers to know what aluminum will cost. They enable exporters to manage fluctuations in foreign currencies, and businesses of all types to lock in their borrowing costs. In the simplest terms, derivatives enable market participants to manage risk.

In normal times, these markets create substantial, but largely unseen, benefits for American families. During the financial crisis, however, they created just the opposite. It was during the financial crisis that many Americans first heard the word derivatives. That was because over-the-counter swaps – a large, unregulated part of these otherwise strong markets – accelerated and intensified the crisis like gasoline poured on a fire. The government was then required to take actions that today still stagger the imagination: for example, largely because of excessive swap risk, the government committed $182 billion to prevent the collapse of a single company – AIG – because its failure at that time, in those circumstances, could have caused our economy to fall into another Great Depression.

It is hard for most Americans to fathom how this could have happened. While derivatives were just one of many things that caused or contributed to the crisis, the structure of some of these products created significant risk in an economic downturn. In addition, the extensive, bilateral transactions between our largest banks and other institutions meant that trouble at one institution could cascade quickly through the financial system like a waterfall. And, the opaque nature of this market meant that regulators did not know what was going on or who was at risk.

Responding to the Crisis – Enactment and Implementation of the Dodd-Frank Act

The lessons of this tragedy were not lost on the leaders of the United States and the G-20 nations. They committed to bring the over-the-counter swaps market out of the shadows. They agreed to do four basic things: require regulatory oversight of the major market players; require clearing of standardized transactions through regulated clearinghouses known as central counterparties or CCPs; require more transparent trading of standardized transactions; and require regular reporting so that we have an accurate picture of what is going on in this market.

In the United States, these commitments were set forth in Title VII of the Dodd-Frank Act. Responsibility for implementing these commitments was given primarily to the CFTC. I would like to review where we stand in implementing the regulatory framework passed by Congress to bring the over-the-counter swaps market out of the shadows.

Oversight

The first of the major directives Congress gave to the CFTC was to create a framework for the registration and regulation of swap dealers and major swap participants. The agency has done so. As of August 2014, there are 104 swap dealers and two major swap participants provisionally registered with the CFTC.

We have adopted rules requiring strong risk management. We will also be making periodic examinations to assess risk and compliance. The new framework requires registered swap dealers and major swap participants to comply with various business conduct requirements. These include strong standards for documentation and confirmation of transactions, as well as dispute resolution processes. They include requirements to reduce risk of multiple transactions through what is known as portfolio reconciliation and portfolio compression. In addition, swap dealers are required to make sure their counterparties are eligible to enter into swaps, and to make appropriate disclosures to those counterparties of risks and conflicts of interest.

As directed by Congress, we have worked with the SEC, other US regulators, and our international counterparts to establish this framework. We will continue to work with them to achieve as much consistency as possible. We will also look to make sure these rules work to achieve their objectives, and fine-tune them as needed where they do not.

Clearing

A second commitment of Dodd-Frank was to require clearing of standardized transactions at central counterparties. The use of CCPs in financial markets is commonplace and has been around for over one hundred years. The idea is simple: if many participants are trading standardized products on a regular basis, the tangled, hidden web created by thousands of private two-way trades can be replaced with a more transparent and orderly structure, like the spokes of a wheel, with the CCP at the center interacting with other market participants. The CCP monitors the overall risk and positions of each participant.

Clearing does not eliminate the risk that a counterparty to a trade will default, but it provides us various means to mitigate that risk. As the value of positions change, margin can be collected efficiently to ensure counterparties are able to fulfill their obligations to each other. And if a counterparty does default, there are tools available to transfer or unwind positions and protect other market participants. To work well, active, ongoing oversight is critical. We must be vigilant to ensure that CCPs are operated safely and deliver the benefits they are designed to provide.

The CFTC was the first of the G-20 nations’ regulators to implement clearing mandates. We have required clearing for interest rate swaps (IRS) denominated in US dollars, Euros, Pounds and Yen, as well as credit default swaps (CDS) on certain North American and European indices. Based on CFTC analysis of data reported to swap data repositories, as of August 2014, measured by notional value, 60% of all outstanding transactions were cleared. This is compared to estimates by the International Swaps and Derivatives Association (ISDA) of only 16% in December 2007. With regard to index CDS, most new transactions are being cleared – 85% of notional value during the month of August.

Our rules for clearing swaps were patterned after the successful regulatory framework we have had in place for many years in the futures market. We do not require that clearing take place in the United States, even if the swap is in U.S. dollars and between U.S. persons. But we do require that clearing occurs through registered CCPs that meet certain standards – a comprehensive set of core principles that ensures each clearinghouse is appropriately managing the risk of its members, and monitoring its members for compliance with important rules.

Fourteen CCPs are registered with the CFTC as derivatives clearing organizations (DCOs) either for swaps, futures, or both. Five of those are organized outside of the United States, including three in Europe which have been registered since 2001 (LCH.Clearnet Ltd.); 2010 (ICE Clear Europe Ltd); and 2013 (LCH.Clearnet SA). In some cases, a majority of the trades cleared on these European-based DCOs are for U.S. persons.

At the same time, the CFTC has specifically exempted most commercial end-users from the clearing mandate. We have been sensitive to Congress’s directive that these entities, which were not responsible for the crisis and rely on derivatives primarily to hedge commercial risks, should not bear undue burdens in accessing these markets to hedge their risk.

Of course, central clearing by itself is not a panacea. CCPs do not eliminate the risks inherent in the swaps market. We must therefore be vigilant. We must do all we can to ensure that CCPs have financial resources, risk management systems, settlement procedures, and all the necessary standards and safeguards consistent with the core principles to operate in a fair, transparent and efficient manner. We must also make sure that CCP contingency planning is sufficient.

Trading

The third area for reform under Dodd-Frank was to require more transparent trading of standardized products. In the Dodd-Frank Act, Congress provided that certain swaps must be traded on a swap execution facility (SEF) or other regulated exchange. The Dodd Frank Act defined a SEF as “a trading system or platform in which multiple participants have the ability to execute or trade swaps by accepting bids and offers made by multiple participants.” The trading requirement was designed to facilitate a more open, transparent and competitive marketplace, benefiting commercial end-users seeking to lock in a price or hedge risk.

The CFTC finalized its rules for SEFs in June 2013. Twenty-two SEFs have temporarily registered with the CFTC, and two applications are pending. These SEFs are diverse, but each will be required to operate in accordance with the same core principles. These core principles provide a framework that includes obligations to establish and enforce rules, as well as policies and procedures that enable transparent and efficient trading. SEFs must make trading information publicly available, put into place system safeguards, and maintain financial, operational and managerial resources to discharge their responsibilities.

Trading on SEFs began in October of last year. Beginning February 2014, specified interest rate swaps and credit default swaps must be traded on a SEF or other regulated exchange. Notional value executed on SEFs has generally been in excess of $1.5 trillion weekly.

It is important to remember that trading of swaps on SEFs is still in its infancy. SEFs are still developing best practices under the new regulatory regime. The new technologies that SEF trading requires are likewise being refined. Additionally, other jurisdictions have not yet implemented trading mandates, which has slowed the development of cross-border platforms. There will be issues as SEF trading continues to mature. We will need to work through these to achieve fully the goals of efficiency and transparency SEFs are meant to provide.

Data Reporting

The fourth Dodd-Frank reform commitment was to require ongoing reporting of swap activity. Having rules that require oversight, clearing, and transparent trading is not enough. We must have an accurate, ongoing picture of what is going on in the marketplace to achieve greater transparency and to address potential systemic risk.

Title VII of the Dodd-Frank Act assigns the responsibility for collecting and maintaining swap data to swap data repositories (SDRs), a new type of entity necessitated by these reforms. All swaps, whether cleared or uncleared, must be reported to SDRs. There are currently four SDRs that are provisionally registered with the CFTC.

The collection and public dissemination of swap data by SDRs helps regulators and the public. It provides regulators with information that can facilitate informed oversight and surveillance of the market and implementation of our statutory responsibilities. Dissemination, especially in real-time, also provides the public with information that can contribute to price discovery and market efficiency.

While we have accomplished a lot, much work remains. The task of collecting and analyzing data concerning this marketplace requires intensely collaborative and technical work by industry and the agency’s staff. Going forward, it must continue to be one of our chief priorities.

There are three general areas of activity. We must have data reporting rules and standards that are specific and clear, and that are harmonized as much as possible across jurisdictions. The CFTC is leading the international effort in this area. It is an enormous task that will take time. We must also make sure the SDRs collect, maintain, and publicly disseminate data in the manner that supports effective market oversight and transparency. Finally, market participants must live up to their reporting obligations. Ultimately, they bear the responsibility to make sure that the data is accurate and reported promptly.

Our Agenda Going Forward

The progress I have outlined reflects the fact that the CFTC has finished almost all of the rules required by Congress in the Dodd-Frank Act to regulate the over-the-counter swaps market. This was a difficult task, and required tremendous effort and commitment. My predecessor, Gary Gensler, deserves substantial credit for leading the agency in implementing these reforms so quickly. All of the Commissioners contributed valuable insight and deserve our thanks. But no group deserves more credit than the hardworking professional staff of the agency. It was an extraordinary effort. I want to publicly acknowledge and thank them for their contributions.

The next phase requires no less effort. I want to highlight several areas going forward that are critical to realizing the benefits Congress had in mind when it adopted this new framework and to minimizing any unintended consequences.

Finishing and Fine-tuning Dodd-Frank Regulations

First, as markets develop and we gain experience with the new Dodd-Frank regulations, I anticipate we will, from time to time, make some adjustments and changes. This is to be expected in the case of a reform effort as significant as this one. These are markets that grew to be global in nature without any regulation, and the effort to bring them out of the shadows is a substantial change. It is particularly difficult to anticipate with certainty how market participants will respond and how markets will evolve. At this juncture, I do not believe wholesale changes are needed, but some clarifications and improvements are likely to be considered.

In fine-tuning existing rules, and in finishing the remaining rules that Congress has required us to implement, we must make sure that commercial businesses like farmers, ranchers, manufacturers, and other companies can continue to use these markets effectively. Congress rightly recognized that these entities stand in a different position compared to financial firms. We must make sure the new rules do not cause inappropriate burdens or unintended consequences for them. We hope to act on a new proposed rule for margin for uncleared swaps in the near future. On position limits, we have asked for and received substantial public comment, including through roundtables and face-to-face meetings. This input has been very helpful enabling us to calibrate the rules to achieve the goals of reducing risk and improving the market without imposing unnecessary burdens or causing unintended consequences.

Cross-Border Regulation of the Swaps Market

A second key area is working with our international counterparts to build a strong global regulatory framework. To succeed in accomplishing the goals set out in the G-20 commitments and embodied in the Dodd-Frank Act, global regulators must work together to harmonize their rules and supervision to the greatest extent possible. Fundamentally, this is because the markets that the CFTC is charged to regulate are truly global. What happens in New York, Chicago, or Kansas City is inextricably interconnected with events in London, Hong Kong and Tokyo. The lessons of the financial crisis remind us how easy it is for risks embedded in overseas derivatives transactions to flow back into the United States. And Congress directed us to address the fact that activities abroad can result in importation of risk into the United States.

This is a challenging task. Although the G-20 nations have agreed on basic principles for regulating over-the-counter derivatives, there can be many differences in the details. While many sectors of the financial industry are global in nature, applicable laws and rules typically are not. For example, no one would expect that the laws which govern the selling of securities, or the securing of bank loans, should be exactly the same in all the G-20 nations. While our goal should be harmonization, we must remember that regulation occurs through individual jurisdictions, each informed by its own legal traditions and regulatory philosophies.

Our challenge is to achieve as consistent a framework as possible while not lowering our standards simply to reach agreement, thus triggering a “race to the bottom.” We must also minimize opportunities for regulatory arbitrage, where business moves to locales where the rules are weaker or not yet in place.

The CFTC’s adoption of regulations for systemically important CCPs is a useful model for success. Our rules were designed to meet the international standards for the risk management of systemically important CCPs, as evidenced by the Principles for Financial Market Infrastructures (PFMIs) published by the Bank of International Settlement’s Committee on Payment and Settlement Systems and the Technical Committee of the International Organization of Securities Commissions, to which the Commission was a key contributor.

Since the day I joined the CFTC, I have been focused on cross-border issues. In my first month in office I went to Europe twice to meet with my fellow regulators, and I have been engaged in ongoing dialogue with them.

Robust Compliance and Enforcement

A third major area is having robust compliance and enforcement activities. It is not enough to have rules on the books. We must be sure that market participants comply with the rules and fulfill their obligations. That is why, for example, several weeks ago we fined a large swap dealer for failing to abide by our data reporting rules.

A strong compliance and enforcement function is vital to maintaining public confidence in our markets. This is critical to the participation of the many Americans who depend on the futures and swaps markets – whether they are farmers, oil producers or exporters. And even though most Americans do not participate directly in the futures and swaps markets, our enforcement efforts can help rebuild and maintain public confidence and trust in our financial markets.

We must aggressively pursue wrongdoers, big or small, and vigorously fulfill our responsibility to enforce the regulations governing these markets. Our pursuit of those who have manipulated benchmarks like LIBOR, a key global benchmark underlying a wide variety of financial products and transactions, is a prime example of this principle in practice. So is our successful litigation against Parnon Energy and Arcadia, two energy companies that systematically manipulated crude oil markets to realize illicit profits.

Dodd-Frank provided the Commission with a number of new statutory tools to ensure the integrity of our markets, and we have moved aggressively to incorporate these tools into our enforcement efforts. Our new anti-manipulation authority gives us enhanced ability to go after fraud-based manipulation of our markets. We have put that authority to good use in a host of cases and investigations, including actions against Hunter Wise and a number of smaller firms for perpetrating precious metals scams. Congress also gave us new authority to attack specific practices that unscrupulous market participants use to distort the markets, such as "spoofing," where a party enters a bid or offer with the intent to move the market price, but not to consummate a transaction. We used this new anti-spoofing provision to successfully prosecute Panther Energy for its spoofing practices in our energy markets.

Going forward, protecting market integrity will continue to be one of our key priorities. Market participants should understand that we will use all the tools at our disposal to do so.

Information Technology and Data Management

It is also vital that the CFTC have up to date information technology systems. Handling massive amounts of swaps data and effective market oversight both depend on the agency having up-to-date technology resources, and the staff – including analysts and economists, as well as IT and data management professionals – to make use of them. The financial markets today are driven by sophisticated use of technology, and the CFTC cannot effectively oversee these markets unless it can keep up.

Cyber-security is a related area where we must remain vigilant. As required by Congress, we have implemented new requirements related to exchanges’ cyber-security and system safeguard programs. The CFTC conducts periodic examinations that include review of cyber-security programs put in place by key market participants, and there is much more we would like to do in this area. Going forward, the Commission’s examination expertise will need to be expanded to keep up with emerging risks in information security, especially in the area of cyber-security.

Resources and Budget

All of these tasks represent the significant increases in responsibility that came with Dodd Frank. They require resources. But the CFTC does not have the resources to fulfill these tasks as well as all the responsibilities it had – and still has – prior to the passage of Dodd Frank. The CFTC is lucky to have a dedicated and resourceful professional staff. Although I have been at the agency a relatively short time, I am already impressed by how much this small group is able to accomplish. Still, as good as they are, the reality of our current budget is evident.

I recognize that there are many important priorities that Congress must consider in the budgeting process. I appreciate the importance of being as efficient as possible. I have also encouraged our staff to be creative in thinking about how we can best use our limited resources to accomplish our responsibilities. We will keep the Teddy Roosevelt adage in mind, that we will do what we can, with what we have, where we are.

But I hope to work with members of Congress to address our budget constraints. Our current financial resources limit our ability to fulfill our responsibilities in a way that most Americans would expect. The simple fact is that Congress’s mandate to oversee the swaps market in addition to the futures and options markets requires significant resources beyond those the agency has previously been allocated. Without additional resources, our markets cannot be as well supervised; participants cannot be as well protected; market transparency and efficiency cannot be as fully achieved.

Specifically, in the absence of additional resources, the CFTC will be limited in its ability to:

Perform adequate examinations of market intermediaries, including systemically important DCOs and the approximately 100 swap dealers that have registered with the Commission under the new regulatory framework required by Dodd-Frank.

Use swaps data to address risk in a marketplace that that has become largely automated, and to develop a meaningful regulatory program that is required to promote price transparency and market integrity.

Conduct effective daily surveillance to identify the buildup of risks in the financial system, including for example, review of CFTC registrant activity reports submitted by Commodity Pool Operators and banking entities, as well as to monitor compliance with rules regarding prohibitions and restrictions on proprietary trading.

Investigate and prosecute major cases involving threats to market integrity and customer harm and strengthen enforcement activities targeted at disruptive trading practices and other misconduct of registered entities such as precious metals schemes and other forms of market manipulation.
Conclusion

A few core principles must motivate our work in implementing Dodd-Frank. The first is that we must never forget the cost to American families of the financial crisis, and we must do all we can to address the causes of that crisis in a responsible way. The second is that the United States has the best financial markets in the world. They are the strongest, most dynamic, most innovative, most competitive and transparent. They have been a significant engine of our economic growth and prosperity. Our work should strengthen our markets and enhance those qualities. We must be careful not to create unnecessary burdens on the dynamic and innovative capacity of our markets. I believe the CFTC's work can accomplish these objectives. We have made important progress but there is still much to do. I look forward to working with the members of this Committee and my fellow regulators on these challenges.

Thank you again for inviting me today. I look forward to your questions.

Last Updated: September 9, 2014

FIFTH THIRD BANK AND FORMER CFO CHARGED BY SEC WITH IMPROPER ACCOUNTING OF COMMERCIAL REAL ESTATE LOANS

FROM:  U.S. SECURITIES AND EXCHANGE COMMISSION 

The Securities and Exchange Commission today charged the holding company of Cincinnati-based Fifth Third Bank and its former chief financial officer with improper accounting of commercial real estate loans in the midst of the financial crisis.

Fifth Third agreed to pay $6.5 million to settle the SEC’s charges, and Daniel Poston agreed to pay a $100,000 penalty and be suspended from practicing as an accountant on behalf of any publicly traded company or other entity regulated by the SEC.

According to the SEC’s order instituting settled administrative proceedings, Fifth Third experienced a substantial increase in “non-performing assets” as the real estate market declined in 2007 and 2008 and borrowers failed to repay their loans as originally required.  Fifth Third decided in the third quarter of 2008 to sell large pools of these troubled loans.  Once Fifth Third formed the intent to sell the loans, U.S. accounting rules required the company to classify them as “held for sale” and value them at fair value.  Proper accounting would have increased Fifth Third’s pretax loss for the quarter by 132 percent.  Instead, Fifth Third continued to classify the loans as “held for investment,” which incorrectly suggested that the company had not made the decision to sell the loans.

“Improper accounting by Fifth Third and Poston misled investors during a time of significant upheaval and financial distress for the company,” said George S. Canellos, co-director of the SEC’s Division of Enforcement.  “It is important for investors to know the financial consequences of decisions made by management, so accounting rules that depend on management’s intent must be scrupulously observed.”

According to the SEC’s order, Poston was familiar with the company’s loan sale efforts, which included entering into agreements with brokers during the third quarter of 2008 to market and sell loans.  Despite understanding the relevant accounting rules, Poston failed to direct Fifth Third to classify and value the loans as required.  Poston also made inaccurate statements to Fifth Third’s auditors about the company’s loan classifications, and certified the company’s inaccurate results for the third quarter of 2008.

“By failing to classify large pools of loans as required, Fifth Third and Poston kept investors from knowing the full truth behind its commercial real estate loan portfolio,” said Stephen L. Cohen, an associate director in the SEC’s Division of Enforcement.

Fifth Third and Poston consented to the entry of the order finding that they violated or caused violations of Sections 17(a)(2) and (3) of the Securities Act of 1933 as well as the reporting, books and records, and internal controls provisions of the federal securities laws.  Without admitting or denying the findings, they agreed to cease and desist from committing or causing any violations and any future violations of these provisions.  Poston is suspended from appearing or practicing before the SEC as an accountant pursuant to Rule 102(e) of the Commission’s Rules of Practice with the right to apply for reinstatement after one year.

The SEC’s investigation was conducted by Beth Groves, Paul Harley, Jonathan Jacobs, and Jim Blenko.  The SEC appreciates the assistance of the Office of the Special Inspector General for the Troubled Asset Relief Program (SIGTARP).

SEC SETTLES FINANCIAL CRISIS FRAUD CHARGES WITH COO OF UCBH HOLDINGS, INC.

FROM:  SECURITIES EXCHANGE COMMISSION 
SEC Settles Claims Against Ebrahim Shabudin Arising from Understated Bank Losses During Financial Crisis

On August 8, 2013, the United States District Court for the Northern District of California approved a settlement of the Securities and Exchange Commission’s claims against Ebrahim Shabudin, the former Chief Operating Officer of UCBH Holdings, Inc.  The case against Mr. Shabudin and two other defendants involves fraudulent financial reporting for UCBH Holdings, Inc., the publicly-traded holding company for San Francisco-based United Commercial Bank.  The Commission alleges Mr. Shabudin and other defendants concealed losses on loans and other assets from the bank’s auditors and delayed the proper reporting of those losses.  The Commission’s complaint alleges Mr. Shabudin committed securities fraud by making false and misleading statements in connection with the 2008 annual report and misleading the bank’s independent auditors, among other allegations.

Without admitting or denying the allegations, Mr. Shabudin agreed to pay a civil money penalty of $175,000, with the penalty partially reduced by the amount paid as a civil penalty in a related administrative action brought against him by the Federal Deposit Insurance Corporation.

Mr. Shabudin also consented to the entry of a final judgment that permanently enjoins him from violating Sections 10(b) and 13(b)(5) of the Securities Exchange Act of 1934 and Rules 10b-5, 13b2-1 and 13b2-2 thereunder, and Sections 17(a)(1) and 17(a)(3) of the Securities Act of 1933, and from aiding and abetting violations of Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-11 thereunder.  The judgment also bars Mr. Shabudin from acting as an officer or director of a public company under the Exchange Act.

SEC CHARGES TWO AUDITORS FOR FAILURE AUDIT OF A NEBRASKA BANK

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION

SEC Charges Two KPMG Auditors for Failed Audit of Nebraska Bank Hiding Loan Losses During Financial Crisis

Washington, D.C., Jan. 9, 2013 — The Securities and Exchange Commission today charged two auditors at KPMG for their roles in a failed audit of a Nebraska-based bank that hid millions of dollars in loan losses from investors during the financial crisis and eventually was forced to file for bankruptcy.

The SEC previously charged three former TierOne Bank executives responsible for the scheme. Two executives agreed to settle the SEC’s charges, and the case continues against the other.

The new charges in the SEC’s case are against KPMG partner John J. Aesoph and senior manager Darren M. Bennett. The SEC’s investigation found that they failed to appropriately scrutinize management’s estimates of TierOne’s allowance for loan and lease losses (known as ALLL). Due to the financial crisis and problems in the real estate market, this was one of the highest risk areas of the audit, yet Aesoph and Bennett failed to obtain sufficient evidence supporting management’s estimates of fair value of the collateral underlying the bank’s troubled loans. Instead, they relied on stale information and management’s representations, and they failed to heed numerous red flags when issuing unqualified opinions on TierOne’s 2008 financial statements and the bank’s internal controls over its financial reporting.

"Aesoph and Bennett merely rubber-stamped TierOne’s collateral value estimates and ignored the red flags surrounding the bank’s troubled real estate loans," said Robert Khuzami, Director of the SEC’s Division of Enforcement. "Auditors must adhere to professional auditing standards and exercise due diligence rather than merely relying on management’s representations."

According to the SEC’s order instituting administrative proceedings against Aesoph, who lives in Omaha, and Bennett, who lives in Elkhorn, Neb., the auditors failed to comply with professional auditing standards in their substantive audit procedures over the bank’s valuation of loan losses resulting from impaired loans. They relied principally on stale appraisals and management’s uncorroborated representations of current value despite evidence that management’s estimates were biased and inconsistent with independent market data. Aesoph and Bennett failed to exercise the appropriate professional skepticism and obtain sufficient evidence that management’s collateral value and loan loss estimates were reasonable.

According to the SEC’s order, the internal controls identified and tested by the auditing engagement team did not effectively test management’s use of stale and inadequate appraisals to value the collateral underlying the bank’s troubled loan portfolio. For example, the auditors identified TierOne’s Asset Classification Committee as a key ALLL control. But there was no reference in the audit work papers to whether or how the committee assessed the value of the collateral underlying individual loans evaluated for impairment, and the committee did not generate or review written documentation to support management’s assumptions. Given the complete lack of documentation, Aesoph and Bennett had insufficient evidence from which to conclude that the bank’s internal controls for valuation of collateral were effective.

The SEC’s order alleges that Aesoph and Bennett engaged in improper professional conduct as defined in Section 4C of the Securities Exchange Act of 1934 and Rule 102(e)(1)(ii) of the Commission’s Rules of Practice. A hearing will be scheduled before an administrative law judge to determine whether the allegations contained in the order are true and what, if any, remedial sanctions are appropriate pursuant to Rule 102(e). The administrative law judge will issue an initial decision no later than 300 days from the date of service of the order.

The SEC’s investigation of the auditors was led by Mary Brady and Michael D’Angelo of the Denver Regional Office. Barbara Wells and Nicholas Heinke will lead the Enforcement Division’s litigation in the administrative proceeding.

THREE EXECUTIVES CHARGED BY SEC WITH OVERSTATING ASSETS DURING FINANCIAL CRISIS

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C., Nov. 28, 2012 — The Securities and Exchange Commission today charged three top executives at a New York-based publicly-traded fund being regulated as a business development company (BDC) with overstating the fund’s assets during the financial crisis. The fund’s asset portfolio consisted primarily of corporate debt securities and investments in collateralized loan obligations (CLOs).

An SEC investigation found that KCAP Financial Inc. did not account for certain market-based activity in determining the fair value of its debt securities and certain CLOs. KCAP also failed to disclose that the fund had valued its two largest CLO investments at cost. KCAP’s chief executive officer Dayl W. Pearson and chief investment officer R. Jonathan Corless had primary responsibility for calculating the fair value of KCAP’s debt securities, while KCAP’s former chief financial officer Michael I. Wirth had primary responsibility for calculating the fair value of KCAP’s CLOs. Wirth, a certified public accountant, prepared the disclosures about KCAP’s methodologies to fair value its CLOs, and Pearson reviewed those disclosures.

The three executives agreed to pay financial penalties to settle the SEC’s charges.

"When market conditions change, funds and other entities must properly take into account those changed conditions in fair valuing their assets, said Antonia Chion, Associate Director in the SEC’s Division of Enforcement. "This is particularly important for BDCs like KCAP, whose entire business consists of the assets that it holds for investment."

This is the SEC’s first enforcement action against a public company that failed to properly fair value its assets according to the applicable financial accounting standard — FAS 157 — which became effective for KCAP in the first quarter of 2008.

According to the SEC’s order instituting administrative proceedings against the fund and the three executives, KCAP did not record and report the fair value of its assets in accordance with Generally Accepted Accounting Principles (GAAP) and in particular FAS 157, which requires assets to be fair valued based on an "exit price" that reflects the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date.

The SEC’s order found that Pearson and Corless concluded that any trades of debt securities held by KCAP in the fourth quarter of 2008 reflected distressed transactions, and therefore KCAP determined the fair value of its debt securities based solely on an enterprise value methodology. However, this methodology did not calculate or inform KCAP investors of the FAS 157 "exit price" for that security. Wirth calculated the fair value of KCAP’s two largest CLO investments to be their cost, and did not take into account the market conditions during that period.

According to the SEC’s order, in May 2010, KCAP restated the fair values for certain debt securities and CLOs whose net asset values had been overstated by approximately 27 percent as of Dec. 31, 2008. Moreover, KCAP’s internal controls over financial reporting did not adequately take into account certain market inputs and other data.

"KCAP should have accounted for market conditions in the fourth quarter of 2008 in determining the fair values of its assets," said Julie M. Riewe, Deputy Chief of the SEC Enforcement Division’s Asset Management Unit. "FAS 157 is critically important in fair valuing illiquid securities, and funds must consider market information in making FAS 157 fair value determinations and comply with their disclosed valuation methodologies."

KCAP’s overvaluation and internal controls failures violated the reporting, books and records, and internal controls provisions of the federal securities laws, namely Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act, and Rules 12b-20, 13a-1, 13a-11, and 13a-13 thereunder. Pearson, Corless, and Wirth caused KCAP’s violations and directly violated Exchange Act Rule 13b2-1 by causing KCAP’s books and records to be falsified. Pearson and Wirth also directly violated Exchange Act Rule 13a-14 by falsely certifying the adequacy of KCAP’s internal controls.

Pearson and Wirth each agreed to pay $50,000 penalties and Corless agreed to pay a $25,000 penalty to settle the SEC’s charges. KCAP and the three executives, without admitting or denying the findings, consented to the SEC’s order requiring them to cease and desist from committing or causing any violations or any future violations of these federal securities laws.

The SEC’s investigation was conducted by Adam Aderton of the Asset Management Unit, Noel Gittens, and Richard Haynes, and was supervised by Assistant Director Ricky Sachar

SEC SAYS FORMER BANK EXECUTIVES COOKED THE BOOKS DURING FINANCIAL CRISIS

The following excerpt is from the SEC website: “Washington, D.C., Oct. 11, 2011 – The Securities and Exchange Commission today charged former bank executives with misleading investors about mounting loan losses at San Francisco-based United Commercial Bank during the height of the financial crisis in 2008 and 2009. The SEC alleges that the bank’s former chief executive officer Thomas Wu, chief operating officer Ebrahim Shabudin, and senior officer Thomas Yu concealed losses on loans and other assets from the bank’s auditors, causing the bank’s public holding company UCBH Holdings Inc. (UCBH) to understate 2008 operating losses by at least $65 million (approximately 50 percent). A few months later, continued declines in the value of the bank’s loans led the bank to fail, and the California Department of Financial Institutions closed the bank and appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. United Commercial Bank was one of the 10 largest bank failures of the recent financial crisis, causing a loss of $2.5 billion to the FDIC’s insurance fund. “Today’s charges reflect an all too familiar pattern – corporate executives once seen as rising stars embrace deception to avoid losses and conceal negative news, with investors and the FDIC insurance fund left to pick up the pieces,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “But accountability for these executives begins today.” Marc Fagel, Director of the SEC’s San Francisco Regional Office, added, “This investigation shows how federal regulators can work together to ferret out fraud by the guardians of financial institutions entrusted to deal honestly with public investors.” According to the SEC’s complaint filed in federal court in San Francisco, UCBH and its subsidiary United Commercial Bank grew rapidly, doubling in size after an initial public offering in 1998. It was the first U.S. bank to acquire a bank in the People’s Republic of China, and Wu was considered a rising star in the banking industry. By 2009, however, Wu found himself at the helm of a bank on the brink of failure. The SEC alleges that Wu, Shabudin, and Yu deliberately delayed the proper recording of loan losses, and each committed securities fraud by making false and misleading statements to investors and UCBH’s independent auditors. During December 2008 and the first three months of 2009 as the company prepared its 2008 financial statements, Wu, Shabudin, and Yu were aware of significant losses on several large loans. Among other things, these executives allegedly learned about dramatically reduced property appraisals and worthless collateral securing the loans, yet they repeatedly hid this information from UCBH’s auditors and investors. The SEC’s complaint also alleges that the bank’s former chief financial officer Craig On acted negligently by misleading the company’s outside auditors and aiding the filing of false financial statements. On agreed to settle the SEC charges without admitting or denying the allegations. He will be permanently enjoined from violating certain antifraud, reporting, record-keeping, and internal controls provisions of the federal securities laws and will pay a $150,000 penalty. On also consented to an administrative order suspending him from appearing or practicing before the SEC as an accountant, with a right to apply for reinstatement after five years. The litigation against the other defendants is ongoing. Lloyd Farnham, Michael Fortunato, Jason Habermeyer, and Cary Robnett of the SEC’s San Francisco Regional Office conducted the SEC’s investigation. The SEC’s litigation will be handled by Lloyd Farnham and Robert Mitchell. The U.S. Attorney for the Northern District of California today announced parallel criminal charges against former employees of the bank, and the FDIC announced enforcement actions against 13 individuals for violations of federal banking regulations. The SEC acknowledges the assistance of the FDIC, U.S. Attorney’s Office for the Northern District of California, Federal Bureau of Investigation, Office of the Special Inspector General for the Troubled Asset Relief Program (SIGTARP), FDIC’s Office of Inspector General, and Office of Inspector General for the Board of Governors of the Federal Reserve System.”