Regulators and industry spar over meaning of "swap"
WASHINGTON (Reuters) - As Alabama's Jefferson County teeters closer to bankruptcy, U.S. regulators and the securities industry are locked in a struggle about the oversight and very nature of the derivatives that helped bring the county to this pivotal point.
Jefferson County entered the interest rate swaps hoping to lower the cost of its sewer bonds. Instead, it was so overwhelmed paying the obligations that it may have to file for bankruptcy as early as Friday.
The county's outstanding sewer debt stands at $3.2 billion.
In a swap, two parties exchange interest rate payments, with one paying a fixed rate and the other a floating rate usually linked to an index. If the index drops, the party paying a fixed rate faces a deficit.
The Securities and Exchange Commission has sued Larry Langford, former president of the county's commission and currently the mayor of Birmingham, for alleged fraud connected to the swaps. It also charged Alabama investment bank Blount Parrish, its chairman, William Blount, and lobbyist Albert LaPierre with paying Langford more than $156,000 to involve Blount Parrish in all of the county's swap agreements in 2003 and 2004.
In filing those charges, which the defendants have asked be dismissed, the SEC has taken on the bond sector's lobbying group, the Securities Industry and Financial Markets Association.
"SIFMA baselessly contends the broad statutory definition of a security-based swap agreement should be so narrowly construed as to vitiate the authority Congress gave the Securities and Exchange Commission to protect investors by prosecuting fraud in connection with such agreements," the SEC wrote in a brief filed on Wednesday with the U.S. District Court for the Northern District of Alabama.
The SEC contends the swaps fall within its jurisdiction because they are security-based, meaning they are based on "the price yield, value or volatility of any security or any group or index of securities, or any interest therein."
Under federal law, most swaps are commodities and can be regulated only by the SEC if they are security-based.
The swaps in Jefferson County relied on an index set by SIFMA -- the Municipal Swap Index.
In a brief it filed August 8, SIFMA says its index "is an index of interest rates, not an index of securities." If the county's swaps are not securities-based, they are likely outside of the SEC's jurisdiction.
In its brief, the SEC says "that is nothing more than a tortured linguistic interpretation" because the interest rates that the index uses are taken from municipal bonds "which are undisputedly securities."
A standstill agreement between Jefferson County and its creditors will end Friday evening. While Alabama's governor has been negotiating with Wall Street to resolve the problem, he has also ordered the county's lawyers to draw up bankruptcy papers.
(Reporting by Lisa Lambert, additional reporting by Karey Wutkowski; Editing by Dan Grebler) 