Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

The CFTC rulemaking whirlwind that was 2012 has come and gone, putting the agency’s comprehensive swap regulatory regime mostly in place. While many energy companies and other swaps end users found much to be happy about in the final rules adopted during 2012 (such as high de minimis levels and new exclusions with respect to swap dealer determinations, reporting obligations that in most instances fall on exchanges and swap dealers, and a district court’s rejection of the CFTC’s position limits rule), there are several important steps such companies should be taking during 2013 to ensure compliance with the new regime:

1. Identify your swap transactions and activities

This step is essential to determine what your company’s swap compliance obligations are and to make sure it has appropriate processes and controls in place for compliance. What type of swaps do you engage in? Who trades in them at your company? Who are your swap counterparties and how are they classified under Dodd-Frank? What are your volumes? Are some of your “forward contracts” at risk of actually being considered swaps? What sort of optionality do they contain? Do you engage in book-outs?

2. Confirm that you are not a swap dealer

The regulatory obligations imposed on swap dealers are substantial. Although the general threshold under the de minimis exception is quite high ($8 billion, phasing out to $3 billion, in gross notional amount of swaps over a 12-month period in connection with dealing activity), the threshold with respect to dealing with special entity counterparties (i.e., government bodies, pension plans, endowments) is considerably lower ($25 million in general; $800 million, plus notice requirement, with respect to utility special entities under temporary no-action relief).

3. Establish parameters and controls for your trading desks

Establish parameters and controls to prevent your transactional personnel from engaging in transactions that may subject you to regulatory obligations for which you are not prepared, or that may require pre-approval by a compliance manager or other flagging. What kinds of contracts can they trade in freely? What kind of contracts should they not trade in? What kind of transactions should they flag, before or after execution, for the attention of your compliance team?

4. Properly document your book-out transactions (back to October 12, 2012)

If your transactional personnel book out forward contracts over the phone (or maybe even IM), you should have processes in place to ensure such book-outs are properly documented. Under an interpretation in the CFTC’s final swap definition rule, effective October 12, 2012, oral book-outs must be followed in a commercially reasonable timeframe by a confirmation in written or electronic form. Not doing so creates risk that the transactions may be viewed as swaps, and thus be subject to the reporting and other compliance obligations applicable to swaps.

5. Prepare for swap reporting obligations (April 10, 2013)

All swaps must be reported to a swap data repository under the Dodd-Frank Act. However, end users, if trading with swap dealer counterparties or in on-exchange, cleared swaps, can generally avoid swap reporting obligations. Nonetheless, all end users trading in swaps will need to obtain a legal entity identifier (LEI) for reporting purposes, most by April 10, 2013, and should have processes and controls in place to ensure that they are not required to report swaps or are able to report them correctly and in a timely manner if they are a “reporting counterparty” with respect to any swaps.

6. Prepare for swap recordkeeping obligations (April 10, 2013)

All swap counterparties and swaps are subject to the CFTC’s recordkeeping obligations. Are you prepared to keep “full, complete, and systematic records” with respect to each swap? Such records must be kept for 5 years after the termination of a swap and meet “ready accessibility” requirements.

7. Preserve your ability to trade with swap dealer counterparties (May 1, 2013)

Even though you may not be a swap dealer, you may need to amend your ISDA and other master agreements with swap dealer counterparties to continue trading with such counterparties, in order to satisfy their Dodd-Frank compliance obligations. ISDA has published the August 2012 Dodd-Frank Protocol, which allows counterparties to amend their ISDA (and other) master agreements accordingly and has provided an online “ISDA Amend” process that allows counterparties to amend their master agreements with counterparties through an online exchange. Over 4800 parties have already adhered to the Protocol.

8. Prepare for end-user exception to mandatory clearing (September 9, 2013 for certain swaps)

If you’re planning to continue trading in uncleared swaps, you or your counterparty must satisfy the requirements of the “end user exception” to mandatory clearing, unless the swap is of a type the CFTC has not yet determined is “required to be cleared.” Are your swaps required to be cleared? Is one of the counterparties using the swap to “hedge or mitigate commercial risk,” as required to elect the exception? If an SEC filer, do you have the required board approval in place to trade in uncleared swaps and a process for annual or more frequent committee review based on appropriate triggering events?

9. Stay tuned for additional CFTC rulemakings, no-action and interpretive letters, and court challenges to CFTC rules

The CFTC has some important unfinished rulemakings to complete in 2013, and additional no-action and interpretive letters by the agency and court challenges to its rules are practically a certainty. Stay tuned during the year for further developments on position limits, capital and margin rules, and other important rulemaking areas.

A new bill has been signed into law which prevents a waiver of attorney-client privilege when a regulated entity submits information to the CFPB.  Unlike most Federal legislation, it’s less than one page long.  We would analyze it further, but a blog post that is longer than the related legislation would be unseemly.

 Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

The CFPB has adopted a rule which states its rules are deemed issued upon the earlier of:

  • when the final rule is posted on the Bureau’s Web site, or
  • when the final rule is published in the Federal Register.

The CFPB regularly posts final rules on its Web site. Typically on the same day, the CFPB will submit the document to the Office of the Federal Register. After a period of time that depends on the length of the document and other factors, the Office of the Federal Register will then make the document available for public inspection and then publish it in the Federal Register. The CFPB does not believe that delaying issuance until the rule is published in the Federal Register is necessary or in the public interest. Accordingly, the rule provides that when a final rule is posted on the CFPB’s Web site before it is published in the Federal Register, the posting on the Web site shall constitute the official issuance of the rule.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

The Dodd-Frank Wall Street Reform and Consumer Protection Act  amended the Electronic Fund Transfer Act, or  EFTA, to restrict interchange fees and to prohibit exclusive networks for debit card transactions. The Federal Trade Commission has the authority to enforce these EFTA amendments and the regulations that the Federal Reserve Board has issued to implement them. The FTC has provided a report to Congress on its law enforcement, outreach, and other activities to implement these new requirements, as well as on the FTC’s other efforts to protect consumers who use payment cards.

 According to the report, some have expressed a concern that smaller community banks and credit unions, although exempted from caps on debit card interchange fees, will nonetheless also see a reduction in interchange revenue.  According to data collected by the Federal Reserve Board and released in May 2012, interchange fees paid to exempt issuers are higher than those paid to non-exempt issuers. A recent report by the General Accountability Office also concluded that “community banks and credit unions have not, on average, experienced a significant decline in their debit interchange fees as a result of the Federal Reserve’s implementation of section 1075 of the Dodd-Frank Act.”

 The Senate Appropriations Committee asked the FTC whether it has identified any evidence that payment card network companies have taken steps to diminish the ability of small banks and credit unions to successfully compete with large financial institutions in the debit card issuance market, and if any such steps have been taken by the card network companies in coordination or collusion with large financial institutions. To date, the FTC staff has not uncovered evidence that this type of conduct is occurring.

 Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

GAO is required to annually study financial services regulations. GAO has issued a report that examines:

  • the regulatory analyses federal agencies performed for rules issued pursuant to the Dodd-Frank Act;
  • how the agencies consulted with each other in implementing the final rules to avoid duplication or conflicts; and
  • what is known about the impact of the Dodd-Frank Act rules.

GAO identified 66 final Dodd-Frank Act rules in effect between July 21, 2011, and July 23, 2012. GAO examined the regulatory analyses for the 54 regulations that were substantive and thus required regulatory analyses.

The GAO report found, among other things:

  • As part of their analyses, the agencies generally considered, but typically did not quantify or monetize, the benefits and costs of the rules reviewed. Most of the federal financial regulators, as independent regulatory agencies, are not subject to executive orders that require comprehensive benefit-cost analysis in accordance with guidance issued by the Office of Management and Budget. Although most financial regulators are not required to follow OMB’s guidance, they told GAO that they attempt to follow it in principle or spirit. GAO’s review of selected rules found that regulators did not consistently follow key elements of the OMB guidance in their regulatory analyses.
  • Federal financial agencies continue to coordinate on rulemakings informally in order to reduce duplication and overlap in regulations and for other purposes, but interagency coordination does not necessarily eliminate the potential for differences in related rules.
  • Some indicators suggest that since 2010 U.S. bank holding companies subject to enhanced prudential regulation under the Dodd-Frank Act (SIFIs) , on average, have decreased their leverage and enhanced their liquidity. Second, empirical results of GAO’s regression analysis suggest that, to date, the act may have had little effect on U.S. bank SIFIs’ funding costs but may have helped improve their safety and soundness.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

Bruce Karpati, Chief, SEC Enforcement Division’s Asset Management Unit, recently described enforcement priorities with respect to hedge funds.  He noted the Asset Management Unit, comprised of 75 staff across 11 offices, focuses its investigations on investment advisers, investment companies, hedge funds, mutual funds and private equity funds.

Mr. Karpati believes understanding the varying business motivations behind investment advisers’ actions and decisions helps us identify problematic issues and trends within the asset management industry.  For example:

  • Because hedge fund managers are compensated by both management fees and performance fees, the manager has incentives to over-prioritize compensation.  For example, the temptation to overvalue assets to boost compensation has emerged repeatedly in enforcement cases.
  • The hedge fund business model and industry growth put a great deal of pressure on the manager to demonstrate and market consistently positive performance.
  •  Because some hedge fund managers may control every aspect of their business, severe conflicts of interest can arise.

Mr. Karpati stated “The incentives and opportunities provided by the hedge fund operating model may be in tension with a manager’s role as a fiduciary.  As you know, the Investment Advisers Act of 1940 imposes on investment advisers a broad fiduciary duty to act in the best interest of their clients. This means that investment advisers have “an affirmative duty of ‘utmost good faith, and full and fair disclosure of all material facts,’ as well as an affirmative obligation ‘to employ reasonable care to avoid misleading’… clients.”  As a fiduciary, a hedge fund manager must guard against conscious and unconscious incentives that might cause him or her to provide less than disinterested advice since an investment adviser may be faulted even when he or she does not intend to injure a client or even if a client does not suffer a monetary loss.  The fiduciary duty is the lens through which the AMU looks at many of the issues it investigates, and the anti-fraud provisions of the Investment Advisers Act (including Sections 206(1) and (2) and Rule 206(4)-8)) enable the AMU to pursue breaches of fiduciary duty and other forms of misconduct.”

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

The SEC has released the study on credit ratings required by Section 939F of the Dodd-Frank Act.  Section 939F provides that, after submission of the report to Congress containing the

findings of the study, the SEC shall, by rule, as the SEC determines is necessary or appropriate in the public interest or for the protection of investors, establish a system for the assignment of NRSROs to determine the initial credit ratings of structured finance products, in a manner that prevents the issuer, sponsor, or underwriter of the structured finance product from selecting the NRSRO that will determine the initial credit ratings and monitor such credit ratings.  In issuing any rule pursuant to section 939F, the SEC is directed to give thorough consideration to the provisions of section 15E(w) of the Exchange Act, as that provision would have been added by section 939D of H.R. 4173 (111th Congress), as passed by the Senate on May 20, 2010 (the “Section 15E(w) Provisions”), and shall implement the system described in section 939D of H.R. 4173 (the “Section 15E(w) System”) unless the SEC determines that an alternative system would better serve the public interest and the protection of investors.

The study cites several concerns with a Section 15E(w) System including:

  • It may not substantially mitigate the issuer-pay conflict because issuers couldcontinue to engage in “rating shopping” as they would be permitted to hire NRSROs to provide credit ratings to supplement the initial credit rating published by the assigned Qualified NRSRO.
  • The risk that some NRSROs may choose not to apply to become Qualified NRSROs and thereby not participate in the Section 15E(w) System.
  • Even if most NRSROs were to participate in the Section 15E(w) System, there is a risk that it would not change the current dynamics of the market for rating structured finance products.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

Nasdaq recently amended its rule proposal related to compensation committees required by the Dodd-Frank Act.  While the substance of the proposal did not change too much, the transition requirements did, and became more workable.

Nasdaq proposes that Rule 5605(d)(3), relating to compensation committee responsibilities and authority, shall be effective on July 1, 2013. Specifically, this proposed rule states that a compensation committee must have the specific responsibilities and authority necessary to comply with Rule 10C-1(b)(2), (3) and (4)(i)- (vi) under the Exchange Act relating to the retention, compensation, oversight and funding of compensation consultants, legal counsel and other compensation advisers, as well as the requirement to consider the six independence factors enumerated in Rule 10C-1(b)(4) before selecting, or receiving advice from, such advisers.

To the extent a company does not have a compensation committee in the period before the final implementation deadline applicable to it as outlined in the paragraph below, the provisions of the rule shall apply to the independent directors who determine, or recommend to the board for determination, the compensation of the chief executive officer and all other executive officers of the company.

Nasdaq believes companies should consider under state corporate law whether to grant the specific responsibilities and authority referenced in Rule 5605(d)(3) through a charter, resolution or other board action; however, Nasdaq proposes to require only that a compensation committee, or independent directors acting in lieu of a compensation committee, have the responsibilities and authority referenced in Rule 5605(d)(3) by July 1, 2013. Companies must have a written compensation committee charter that includes, among others, the responsibilities and authority referenced in Rule 5605(d)(3) by the implementation deadline discussed below.

In order to allow companies to make necessary adjustments to their boards and committees in the course of their regular annual meeting schedules, Nasdaq proposes that companies comply with the remaining provisions of the amended listing rules, as set forth in proposed Nasdaq Listing Rule 5605(d) and IM-5605-6, by the earlier of: (1) their first annual meeting after January 15, 2014; or (2) October 31, 2014.

A company must certify to Nasdaq, no later than 30 days after the final implementation deadline applicable to it, that it has complied with the amended listing rules relating to compensation committees. Nasdaq will provide companies with a form for this certification.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

The SEC has approved new rules requiring broker-dealers to conduct searches for holders of securities with whom they have lost contact. 

A similar rule already applied to recordkeeping transfer agents, who are the intermediaries between the clearing house and the broker-dealer.  The Dodd-Frank Wall Street Reform and Consumer Protection Act tasked the SEC with extending the application of this rule to broker dealers so that broker-dealers have the same obligation.

The new rules also require broker-dealers and other securities market participants to provide notifications to persons who have not processed checks that they have received in connection with their securities holdings. 

Specifically, the new rules:

  • Require broker-dealers to conduct certain searches for lost holders of securities that transfer agents currently are required to conduct.
  • Require “paying agents” – including certain issuers, broker-dealers, transfer agents, and other entities – to notify certain persons – termed “missing securityholders” in the statute and “unresponsive payees” in the adopted rules – in writing that the paying agent has sent the person a check that has not yet been negotiated.
  • Excludes paying agents from their notification requirement when the value of the not yet negotiated check is less than $25.
  • Add a provision clarifying that the notification requirement for paying agents shall have no effect on a state’s ability to collect funds that it deems abandoned under so-called state escheatment laws.
  • Add a conforming technical rule to help ensure that broker-dealers have notice of their new obligations regarding lost holders of securities and unresponsive payees.

The new rules are available in draft form while pending review at the Office of Management and Budget (OMB) of the major rule analysis under the Small Business Regulatory Enforcement Fairness Act.  After the OMB review is complete, the Commission will issue the rule release in final form and send it to the Federal Register for publication.

Check dodd-frank.com frequently for updated information on the JOBS Act, the Dodd-Frank Act and other important securities law matters.

The CFTC has issued an interim final rule regarding certain business conduct and documentation requirements for swap dealers and major swap participants. The compliance date for the business conduct standards and certain documentation requirements has been extended to May 1, 2013. The compliance date for the other documentation requirements has been extended to July 1, 2013. As a result, swap dealers will now have until May 1, 2013 (as opposed to the previously looming December 31, 2012 date) to amend their master agreements and other swap documentation with counterparties, as through the ISDA Dodd-Frank Protocol. Counterparties to swap dealers thus have a few additional months in which to adhere to the Protocol or put other documentation in place to preserve their ability to trade with such dealers.