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Volatile Market Spurs SEC’s Focus on Clearing Agency Conflicts

Aug. 15, 2022, 9:00 AM

Stock market volatility and the rise of meme stocks are prompting the SEC to consider tightening oversight of potential conflicts of interest at securities clearing agencies.

The Securities and Exchange Commission’s proposed rules, announced on Aug. 8, aim to enhance governance standards by requiring clearing agencies—intermediary firms that facilitate and settle securities transactions—to identify and snuff out potential conflicts of interest, particularly among their board members and directors.

The SEC’s move, aimed at companies like the National Securities Clearing Corp. and the Depository Trust Co., reflects the regulator’s desire, under Chair Gary Gensler, to work proactively given recent market turbulence, lawyers said.

“This is to avoid a problem in the future, rather than to wait for one to arise,” said Chris Robertson, a partner at Seyfarth Shaw LLP.

The move wasn’t driven by a massive enforcement sweep of the industry identifying deep-rooted problems, said Robertson, a former SEC enforcement senior counsel. “That’s a big part of this, [the SEC] doesn’t want to get caught off guard.”

In its proposal, the SEC pointed to increased market volatility, referencing the meme stock frenzy in January 2021 and financial distress from the Covid-19 pandemic. “These events underscore the importance of a strong regulatory framework to oversee registered clearing agencies that clear or settle securities transactions and provide transparency to the markets,” the SEC said.

The role of clearing agencies in a rocky market has drawn some attention from lawmakers too. A June House Financial Services Committee report said that Robinhood, a retail brokerage that halted trading during the meme stock event, risked defaulting on its daily collateral deposit requirement.

But the company was saved by “a discretionary and unexplained” waiver from a clearing agency, the National Securities Clearing Corp., the report said.

“There are economic realities that require the agency to react,” said Yuliya Guseva, a professor at Rutgers Law School.

Critical Service Providers

“The proposed rule would also require new policies and procedures regarding conflicts of interest, board obligations to oversee relationships with service providers for critical services, and a board obligation to consider stakeholder viewpoints,” the SEC said.

It would also call for the majority of boards to be generally made up of independent directors.

The rules “would help ensure our markets are more resilient, protecting investors and building trust in our markets,” Gensler said.

Gensler particularly noted clearing agencies’ potential conflicts of interest with critical service providers, such as vendors that provide technology or risk management support.

“I think that registered clearinghouses should have policies and procedures describing how the board will monitor such risks from arrangements with critical service providers,” he said.

Compliance Costs

The proposal builds on the SEC’s post-financial crisis changes in 2012 and 2016 to impose general governance requirements for clearinghouses.

Clearinghouses likely have many of these proposed internal controls in place already, lawyers said. But some clearing agencies that fall short if the new requirements pass “would have to comply with more specific rules” and potentially take on additional costs, Guseva said.

The SEC said it wants to minimize burdens by using a phased-in compliance schedule. The requirements, if adopted, wouldn’t start immediately after the rules are finalized.

Lawyers said they expect clearing agencies to push back to some extent during the 60-day comment period.

“We are evaluating the proposed regulation, and we look forward to discussions with the SEC and others on these topics,” the Depository Trust & Clearing Corp., the parent of DTC, said in a statement.

The proposal faced Republican commissioners’ opposition.

Commissioner Mark Uyeda said the provisions are too broad and could disincentivize new market entrants.

The rule “risks diluting the duties of directors to the clearing agency and depriving clearing agencies of the flexibility and expertise needed for effective governance,” said Commissioner Hester Peirce.

“An independent director mandate sounds good because it resembles what we require in many other contexts, but clearing agencies operate best when a visceral awareness of the consequences of failed risk management drives the board’s decision making,” Peirce said.

To contact the reporter on this story: Clara Hudson at chudson@bloombergindustry.com

To contact the editor responsible for this story: Roger Yu at ryu@bloomberglaw.com, Melissa B. Robinson at mrobinson@bloomberglaw.com