| NEW YORK, April 17
NEW YORK, April 17 Wall Street banks have
mounted a massive legal defense of their physical commodities
activities, in a last-ditch effort to convince regulators that
chartering oil tankers and owning power plants pose no risk to
the financial system.
In a 54-page memo drafted by four leading law U.S. law firms
and commissioned by six major financial industry groups, they
argue that existing statutes, case law and risk-management
procedures protect regulated banks - and therefore the taxpayer
- from any catastrophe that might unfold in the course of
trading physical commodities.
"The legal framework governing such activities permits a
(bank) to conduct them without presenting an undue risk" to its
safety and soundness, the memo states, citing sources ranging
from environmental statutes to Supreme Court decisions to
guidance from the Federal Reserve's own bank examination manual.
It was attached to an even lengthier letter submitted at the
end of a three-month period for the Fed to take public comments
on potential new regulations that would limit banks' ability to
trade and invest in physical commodities. It is not clear how
quickly the Fed may move to craft formal rules, which would also
face a period of public scrutiny.
In announcing in January its plans to reexamine existing
rules and requirements for such trading, the Fed cited disasters
including BP's oil spill in the Gulf of Mexico in 2010
and the derailment and explosion of an oil train in Canada last
year as cause for concern over the impact of a commodity
The memo focused on two issues in detail: whether banks face
liability for damages under three federal environmental
statutes, or for incidents involving their portfolio companies,
or merchant banking investments, which are typically held at
The memo argues that environmental statutes generally assign
liability to owners and operators of the facilities from which
an environmentally sensitive substance is leaked or spilled, and
that mere ownership of the commodity does not create liability.
Courts have historically agreed, unless the commodity owner
controls the circumstances of its transport or storage.
Most banks are already barred from directly owning commodity
infrastructure. Morgan Stanley, which along with Goldman
Sachs, is theoretically allowed to do so, has already
agreed to sell its physical oil trading operations.
Similarly, financial holding companies are unlikely to be
found liable for the actions of their portfolio companies, which
are held as arm's length investments and must be disposed of
within 10 years, under a doctrine known as "corporate
For a court to "pierce the corporate veil" and find a parent
company liable, it must show that the parent company exercised
an extraordinary degree of control over the subsidiary and that
domination led to injury, something that is already prohibited
within existing banking guidelines.
"The conclusion is that the law is generally settled in this
area, and that banks are complying with all of the requirements
necessary to ensure that the corporate veil is not pierced,"
said Carter McDowell, the associate general counsel of
Securities Industry and Financial Markets Association (SIFMA),
which submitted the letter alongside other groups.
The Fed extended an initial March 15 deadline to April 16 to
give the four law firms time to compose the memo, said McDowell.
"This is as close as we could get to a legal opinion," he
said, noting that it reflects the unanimous interpretation of
all four law firms and their senior management.
The letter is the latest effort by banks including Goldman
Sachs and Bank of America to defend their physical
trading operations. After several years of slim margins, strong
first-quarter earnings by several banks suggest revenues may be
improving as some banks quit the business.
The Fed's own authorization letters and examination manual
describes steps a financial holding company must take to legally
distance itself from its operating subsidiaries, the memo points
out, thus further limiting any possibility of its facing
liability for damages.
The memo was accompanied by a six-page document detailing
best practices for limiting environmental liability and ensuring
It advises banks to "avoid operating vessels, railcars,
pipelines or other transportation or storage facilities used to
transport physical commodities," and to make sure that portfolio
companies maintain a separate "office space, address ... and
similar aspects of an independent existence."
Since the first bank was granted a license to trade physical
commodities in 2003, a dozen have become substantial
participants in the markets for some of the most commonly traded
commodities, including oil and electricity.
They joined Morgan Stanley and Goldman Sachs, which had been
active in commodities since the 1980s.
In the past year, major banks including JPMorgan Chase and
Co and Deutsche Bank have scaled back their
commodities exposure, citing both intensifying regulation and
lower profits. Total commodity trading revenue at banks has
fallen to a third of its $14 billion peak in 2008.
(Reporting by Anna Louie Sussman; Editing by Steve Orlofsky)