Problem: LEGAL/ETHICAL CHALLENGE

Secret Banking Elite Rules Trading in Derivatives

Until recently, nine people had a standing meeting in Manhattan one Wednesday each month. This was a highly secretive group of powerful people across Wall Street, known by critics as the "derivatives dealers club." The membership and discussions were strictly confidential. The focus: Protect the interests of the largest firms on Wall Street that serve as dealers in the highly lucrative derivatives market. Derivatives (swaps and options) are financial products used like insurance to hedge financial risk. Because derivatives do not trade on formal exchanges, like stocks on the New York Stock Exchange (NYSE), and are largely unregulated by agencies such as the Securities and Exchange Commission (SEC), their creation and trading are largely self-managed by the firms themselves. This secretive group helped oversee and control this multitrillion-dollar market. The dealers' club attempted to block the efforts of other banks to enter the market and compete with select few member firms. It also blocked many efforts by regulators and others to get full and free disclosure of dealer prices and fees. The situation is similar to a real estate agent selling a house and the buyer only knowing what he or she paid, the seller only knowing what he or she received, and the agent pocketing the rest in fees. These fees would not be known to either the buyer or the seller.

This lack of disclosure has implications far beyond the biggest banks. Pension funds, states, cities, airlines, food companies, and some small businesses use derivatives to offset and manage risk. These parties argue that without transparency they cannot determine if they receive a fair price. What is known, however, is that Wall Street's largest firms collect billions of dollars in undisclosed fees each year from trading these derivatives-fees that certainly would be smaller if there was more transparency and competition. These concerns have spurred investigation of anticompetitive practices by the Department of Justice and threats by some legislators. The firms, however, have powerful allies-the many politicians in Washington to whom they've made substantial campaign contributions. Derivatives dealers' defense is that derivative prices are complex. Unlike shares of Netflix stock, which are all equivalent-one share has the same price as all the rest- terms of oil derivatives can vary greatly. The complexity therefore requires customization, and greater transparency is impractical if not impossible. What Is Your Position on Derivatives Trading?

1. Regulators should assert influence over the derivatives market, like they do with stocks, and require derivatives to be traded on an open exchange where buyers and sellers disclose prices and fees.

2. Nothing should be done to change how derivatives are bought and sold. If buyers and sellers don't like the lack of dealer transparency, then they can choose not to trade derivatives.

3. The derivatives market should be modified only slightly to allow other players (e.g., banks) to provide derivatives. If they then choose to disclose prices and fees, that is their choice, just as it is the choice of others to buy derivatives.

4. Invent other alternatives and explain.