WASHINGTON — Senate Agriculture Committee chairman Blanche Lincoln and other Democrats contend it’s necessary to impose a fiduciary duty on dealers that act as swap counterparties to state and local governments because some of them have misled municipalities into entering swaps they didn’t understand.
Asked about the provision in her bill to regulate derivatives, which imposes a fiduciary duty on dealers who pitch, advise, or enter into swaps with localities and pension funds, the Arkansas Democrat said: “Maybe you ought to ask the people of Alabama,” a reference to the muni-related scandals in Jefferson County.
The county, home to Birmingham, has teetered on the edge of bankruptcy for well over a year while officials have tried unsuccessfully to negotiate a restructuring of $3.2 billion of variable- and auction-rate sewer warrants for which interest rates have skyrocketed.
Meanwhile, the Justice Department and the Securities and Exchange Commission have taken enforcement action against former county officials and participants in its bond and swap transactions, charging that former dealers made payments and gifts to county officials in exchange for its business.
Lincoln’s committee is expected to vote on the bill today. Market participants have expressed skepticism about imposing a fiduciary duty on transaction participants whose interests are generally counter to states and localities — by the very nature of their being “counterparties.”
Representatives of Wall Street and other firms have gone further, panning the proposal as legally unworkable.
“A better solution is to mandate that states and localities employ registered and regulated swap advisers who do have a fiduciary obligation towards their state and local clients,” Michael Decker, managing director and co-head of the Securities Industry and Financial Markets Association’s municipal securities division, said earlier this week.
While the Jefferson County crisis could be attributable more to fraud rather than a lack of sophistication, Lincoln said that she believes dealers have a responsibility to ensure their clients understand the financial products they enter into.
“When those clients come to them, they come to them not only with the request of financing, but also an understanding of what we have seen to be a tremendously difficult market,” she said.
At an earlier briefing on the derivatives legislation held by Sen. Maria Cantwell, the Washington Democrat said that she supports the fiduciary duty provision for dealers because of the way that public utility districts were lied to about deferred payment power contracts by Enron Corp. traders in the early 2000s.
“Culturally, we have got to change the way people are operating on Wall Street, believing that they can misinform or have manipulative ways of conveying information,” she said.
Maryland School of Law professor Michael Greenberger, who spoke at the Cantwell briefing, also invoked Jefferson County when asked about the fiduciary duty provision, which he strongly defended. He said he does not believe it is legally unworkable.
Dealers, he said, “are selling a product and telling Birmingham, Ala., we’re going to help you, and they know darn well that, what they say in the industry is, 'we’re going to rip their face off.’ ”
“What they want to do is reinstate the doctrine of caveat emptor,” Greenberger said, referring to dealers who by and large oppose the bill. “We have risen from the level of buyer beware to requiring people who sell cars, dangerous equipment, to tell you of defects. [Similarly], these guys should be telling small cities in this country, schools boards, of defects.”
Meanwhile, Lincoln told reporters yesterday she has assurances from Senate Majority Leader Harry Reid that her bill will somehow be merged with the financial regulatory reform package approved by Senate Banking Committee Democrats last month.
That measure, which is pending before the full Senate, includes a derivatives section that, as with Lincoln’s measure, calls for strong new derivatives regulations.
Senate Banking Committee chairman Christopher Dodd, D-Conn., declined to give his view on Lincoln’s bill but said the two committees are “trying to come to an understanding that we can live with,” according to a Dow Jones report.