SEC bars brokers from betting against the assets they sell to investors

In a move aimed at preventing conflicts of interest and protecting investors, the U.S. Securities and Exchange Commission (SEC) on Monday adopted a rule barring traders in asset-backed securities (ABS) from betting against the same assets they sell to investors.

The SEC’s action is mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was enacted in response to the 2008 financial crisis. The law was designed to prevent the kind of reckless behavior that contributed to the crisis, including conflicts of interest and misleading sales practices.

The new rule prohibits “securitization participants” from engaging in transactions that involve shorting or buying credit-default swaps against those same securities. Securitization participants are parties involved in the creation and sale of ABS, such as underwriters, placement agents, and sponsors.

The rule is among the last major provisions of the Dodd-Frank Act to be implemented. It faced a long and winding road to completion, with an earlier version of the rule being proposed in 2011 but never finalized.

SEC Chair Gary Gensler said in a statement that the rule applies to a market “that was at the center of the 2008 financial crisis.” He said that the rule will help to protect investors and promote a more level playing field in the ABS market.

In a nod to industry concerns, the SEC made some modifications to the rule before adopting it. These modifications include exemptions for hedging risk and market-making activities, as well as exemptions for affiliates who do not act in concert with traders and for investors with “long” positions.

Republican SEC Commissioner Hester Peirce, a frequent critic of the agency’s rulemaking agenda who previously served as the director of the Financial Markets Working Group at George Mason University’s Mercatus Center, voted against the rule.

She said that the rule was “overly complex” and that it would “have a significant impact on market liquidity.”

The SEC said that it will require compliance with the rule for ABS with closing dates falling 18 months after the rule appears in the Federal Register.