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

The SEC has announced that it has made its first award to a whistleblower under its new Section 21F whistleblower program.  For background or a quick refresher, you can find our prior coverage of the whistleblower program here.

The Dodd-Frank Act created new Section 21F of the Securities Exchange Act of 1934.  Section 21F and accompanying rules establishes a tip program pursuant to which whistleblowers can report securities fraud to the SEC.  As an incentive for reporting, whistleblowers who provide the SEC with information that leads to an enforcement action in which more than $1 million in sanctions is ordered can receive rewards of up to 30% of the amount of sanctions.  The whistleblower program also includes provisions designed to protect the identity of whistleblowers to prevent employment retaliation.  Here are a few highlights from the press release and related coverage:

  • A second individual sought an award in connection with this enforcement action, but the SEC refused to grant any award because the information provided by the second whistleblower didn’t “lead to or significantly contribute to” the enforcement action.
  • The whistleblower program was established in August 2011, and since then the SEC has fielded about 8 tips per day from whistleblowers.
  • Forbes has raised several questions about the viability of the program, including whether the quantity of tips will be too high, or the quality too low, to result in many effective enforcement actions, and whether the anonymity provisions will actually work as intended.
  • On the other hand, the L.A. Times reports that the SEC believes the program is working effectively: “We are getting very, very high-quality information from whistle-blowers,” said Sean McKessy, director of the SEC’s whistle-blower office. “I was girding myself for what we were promised, which was an avalanche of nonsense, and I’ve been very pleased.”

Check Dodd-Frank.com frequently for updates on the implementation of the Dodd-Frank Act and other important securities law developments.

Today, the CFTC announced the launch of a website for swap market participants to register for CFTC Interim Compliant Identifiers (CICIs), which are interim versions of the legal entity identifiers (LEIs) required for all swap data reporting. Since all swaps are required to be reported under Dodd-Frank, all entities engaging in swaps, whether they are the reporting counterparties or not, must obtain LEIs (for now, CICIs). Registration for a CICI requires a 200 USD fee. As described in a prior dodd-frank.com post, the CICIs will be provided by DTCC-SWIFT.

The CFTC is participating in an international process to implement a global LEI system and anticipates that, once the global LEI system is implemented and operational, the CICI will transition into the global LEI system.

The International Swaps and Derivatives Association, Inc. (ISDA) has announced the launch of the August 2012 Dodd-Frank Protocol (DF Protocol). The DF Protocol is designed to allow swap market participants to amend their ISDA Master Agreements (widely used standardized contracts under which derivatives and other products can be traded and netted) to facilitate compliance with the CFTC’s Dodd-Frank regulatory requirements.

Covered Rules

The DF Protocol is intended to address the requirements of the following final CFTC rules (Covered Rules):

• External Business Conduct Standards for Swap Dealers (SDs) and Major Swap Participants (MSPs)
• Large Trader Reporting for Physical Commodity Swaps
• Position Limits for Futures and Swaps
• Real-Time Public Reporting of Swap Transaction Data
• Swap Data Recordkeeping and Reporting Requirements
• SD and MSP Recordkeeping, Reporting and Duties Rules; Futures Commission Merchant (FCM) and Introducing Broker Conflicts of Interest Rules, and Chief Compliance Officer Rules for SDs, MSPs, and FCMs
• Swap Data Recordkeeping and Reporting Requirements: Pre-Enactment and Transition Swaps

Structure of the Protocol

The primary modification of ISDA Master Agreements is accomplished through (i) the “DF Supplement,” which contains 6 schedules setting forth certain standardized representations, acknowledgments, notifications, and agreements relating to the Covered Rules and (ii) a “DF Protocol Questionnaire,” by which a participant provides certain required information to its counterparty, including representations as to its legal status under various Dodd-Frank categorizations (e.g., eligible contract participant, swap dealer, special entity status), and makes various elections with respect to the DF Supplement.

Unlike previous ISDA protocols, where amendments or supplements were effected solely through the delivery of an adherence letter to the relevant protocol, the DF Protocol has additional bilateral delivery requirements in order to effectuate the addition of supplemental terms. Each party that submits an Adherence Letter to ISDA (along with a one-time $500 fee) must also deliver a completed Questionnaire to its adhering counterparty for the addition of supplemental terms to be effective with respect to that counterparty. To facilitate these additional bilateral delivery requirements, ISDA and Markit have developed a technology-based solution (“ISDA Amend”) to automate the information gathering process and provide sharing of submitted data and documents to counterparties based on selected permissions.

Making DF Protocol Arrangements For Your ISDA Master Agreements

Many of the Covered Rules listed above go into effect on or shortly after October 12, 2012. SDs, many with hundreds or thousands of ISDA Master Agreements to bring into compliance within such timeframe, may be challenged to put the DF Protocol into place with each of their counterparties and thus may find it necessary to concentrate on doing so with their largest counterparties first. Smaller counterparties should consider contacting their SD counterparties and putting DF Protocol arrangements in place with them soon so that they don’t find themselves with a usually available trading partner unwilling to enter into a desired swap on short notice because of unaddressed compliance issues. Starting April 10, 2013, even end users trading swaps with other end users will at least have to address which parties will be responsible for reporting the swaps.

ISDA states that while the DF Protocol is designed to provide an efficient manner for a large number of counterparties to amend their bilateral contracts, “it cannot address all situations, products or types of counterparties” and thus recommends that counterparties obtain legal advice as to whether the provisions of the Protocol address their particular situation.

The Commodity Futures Trading Commission, or CFTC, has issued a proposed rule to exempt swaps between certain affiliated entities within a corporate group from the clearing requirement of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  Section 723 of the Dodd-Frank Act added Section 2(h) to the Commodity Exchange Act, or CEA, to establish a clearing requirement for swaps.  As a general matter, the new section makes it unlawful for any person to engage in a swap that the CFTC determines must be cleared, unless the swap is submitted for clearing to a derivatives clearing organization.  The proposed rule, however, asks the public to comment on whether inter-affiliate swaps pose less counterparty risk than swaps transactions with third parties. Accordingly, the CFTC is considering whether alternative methods of counterparty risk mitigation may be appropriate for swaps between majority-owned affiliates of the same corporate group. 

Specifically, the proposed rule would use Section 4(c)(1) of the CEA, which grants the CFTC general exemptive powers.  Pursuant to that authority, the Commission is proposing to exempt certain inter-affiliate swaps from the clearing requirement in CEA section 2(h) subject to the following conditions:

  • The proposed exemption would be limited to swaps between majority-owned affiliates whose financial statements are included in the same consolidated financial statements.
  • The proposed rules would require the following: centralized risk management; swap trading relationship documentation; variation margin payments; and satisfaction of reporting requirements.
  • The proposed rules would permit affiliates of the same corporate group to elect the exemption for their inter-affiliate swaps if one of the following four conditions is satisfied for each affiliate: the affiliate is located in the United States; the affiliate is located in a jurisdiction with a comparable and comprehensive clearing requirement; the affiliate is required to clear all swaps it enters into with non-affiliate counterparties; or the affiliate does not enter into swaps with non-affiliate counterparties.

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

Six federal financial regulatory agencies have issued a proposed rule to establish new appraisal requirements for “higher-risk mortgage loans.”  The proposed rule would implement amendments to the Truth in Lending Act enacted by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.  Under the Dodd-Frank Act, mortgage loans are higher-risk if they are secured by a consumer’s home and have interest rates above a certain threshold.

 The proposed rule is being issued by the Board of Governors of the Federal Reserve System, the Consumer Financial Protection Bureau, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, the National Credit Union Administration, and the Office of the Comptroller of the Currency.

 For higher-risk mortgage loans, the proposed rule would require creditors to use a licensed or certified appraiser who prepares a written report based on a physical inspection of the interior of the property.  The proposed rule also would require creditors to disclose to applicants information about the purpose of the appraisal and provide consumers with a free copy of any appraisal report.

 Creditors would have to obtain an additional appraisal at no cost to the consumer for a home-purchase higher-risk mortgage loan if the seller acquired the property for a lower price during the past six months.  This requirement would address fraudulent property flipping by seeking to ensure that the value of the property being used as collateral for the loan legitimately increased.

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

 

The CFTC’s and SEC’s joint final rule defining the term “swap” was published in the Federal Register today, establishing compliance dates for numerous swap-trading regulations, including the following:

October 12, 2012
– Swap Dealers (SDs) and Major Swap Participant (MSPs): Registration, Internal Business Conduct Standards, Reporting and Recordkeeping Requirements for Interest Rate and Credit Swaps
– Position Limits (Spot Month)
– Large Trader Reporting

January 10, 2013
– SDs and MSPs: Reporting and Recordkeeping Requirements for All Swaps

April 10, 2013
– End Users: Reporting and Recordkeeping Requirements for All Swaps

A recap of important definitional concepts and compliance obligations related to the term “swap,” particularly as concerns energy companies, is available here.

The first set of the CFPB’s proposed rules would provide consumers with information about their mortgages. The proposed rules would do this with:

  • Clear Monthly Mortgage Statements: Servicers would be required to provide regular statements which would include: a breakdown of payments by principal, interest, fees, and escrow; the amount of and due date of the next payment; recent transaction activity; and warnings about fees.
  • Warning Before Interest Rate Adjusts: Servicers would have to provide earlier disclosures before the interest rate adjusts for most adjustable-rate mortgages. This disclosure would include information about alternatives and counseling resources if the new payment is unaffordable. Existing disclosures for interest rate adjustments that cause a change in mortgage payments would be amended to include improved information and arrive earlier so that borrowers can anticipate consequences of payment changes.
  • Options for Avoiding Costly “Force-Placed” Insurance: Servicers have the responsibility to ensure that borrowers maintain property insurance. If the borrower does not maintain this insurance, however, the servicer has the right to purchase insurance to protect the lender’s interest in the property. This is called “force-placed” insurance and the CFPB believes it is typically more expensive than insurance the borrower could privately purchase. The CFPB is proposing a rule that would provide more transparency in this process, including requiring servicers to give advance notice and pricing information before charging consumers for this insurance. The servicer would also be required to terminate the insurance within 15 days if it receives evidence that the borrower has the necessary insurance and the insurer would refund the force-placed insurance premiums.
  • Early Information and Options for Avoiding Foreclosure: Servicers would be required to make good faith efforts to contact delinquent borrowers and inform them of their options to avoid foreclosure.

The second set of proposed rules would impose requirements for handling consumer accounts, correcting errors, and evaluating borrowers for options to avoid foreclosure. These  rules would include:

  •  Payments Promptly Credited: Servicers generally would have to credit a consumer’s account as of the date a payment is received.
  • Maintain Accurate and Accessible Documents and Information: Servicers would be required to establish reasonable policies and procedures to provide accurate and current information to borrowers and minimize errors. They would have to submit accurate legal documents that comply with applicable law, help borrowers on options to avoid foreclosure, and provide oversight of their contractors and foreclosure attorneys.
  • Errors Corrected Quickly: If a consumer notifies the servicer that he or she thinks there has been an error, the servicer would be required to acknowledge receiving the notification, conduct a reasonable investigation, and, in a timely manner, inform the consumer about the resolution.
  • Direct and Ongoing Access to Servicer Personnel To Assist Delinquent Borrowers: Servicers would be required to provide delinquent borrowers with direct, easy, ongoing access to employees who are dedicated and empowered to help delinquent borrowers.
  • Evaluate Borrowers For Options To Avoid Foreclosure: Servicers that offer options to borrowers to avoid foreclosure, such as loan modifications or other payment plans, would be required to promptly review applications for those options. Servicers would be prohibited from proceeding with a foreclosure sale until the review of the borrower’s application is complete. Servicers would also be required to let borrowers know when applications are incomplete and to allow borrowers to appeal certain servicer decisions.

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 published information which outlines the process for evaluating tips submitted by whistleblowers.  Among other things, the SEC states: When your TCR (the form required to submit tips) is submitted to the SEC, our attorneys, accountants, and analysts will review the data you submit to determine how best to proceed. If it is a matter the Enforcement Division is working on already, the TCR gets forwarded to the staff handling that matter. Often a TCR gets sent to the experts in another Division at the SEC for their evaluation. Even if your tip does not cause us to open an investigation right away, the information you provide is retained and may be reviewed again in the future if more facts come to light and a picture becomes clearer. In any event, please know that each tip received is evaluated very soon after being received by the SEC and it is looked at by at least two SEC attorneys. If we need additional information to evaluate your tip, or to assist us in any resulting investigation, we will contact you, or your attorney.

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

A bill that has passed both houses of Congress and is now waiting for the President’s signature imposes new reporting requirements on companies required to file quarterly and annual reports under Section 13(a) of the Securities Exchange Act of 1934.  The Iran Threat Reduction and Syria Human Rights Act of 2012 (the “Act”) requires new disclosure in the event that a company knowingly:

  • Engaged in certain conduct described in the Iran Sanctions Act of 1996 or certain conduct described in the Comprehensive Iran Sanctions, Accountability, and Divestment Act of 2010;
  • Engaged in transactions or dealings with “blocked” persons pursuant to Executive Order No. 13224 (relating to blocking property and prohibiting transactions with persons who commit, threaten to commit, or support terrorism);
  • Engaged in transactions or dealings with “blocked” persons pursuant to Executive Order No. 13382 (relating to blocking of property of weapons of mass destruction proliferators and their supporters); or
  • Engaged in transactions or dealings with any person identified with the government of Iran pursuant to 31 C.F.R. 560.304.

The disclosure of any of these prohibited activities in the applicable 10-Q or 10-K must consist of  “a detailed description of such activity” including the nature and extent of the activity, the gross revenues and net profits attributable to the activity, and whether the issuer or an affiliate of the issuer intends to continue the activity.

Besides including this additional disclosure in the 10-Q or 10-K, the issuer must also separately report to the SEC that it has filed a 10-Q or 10-K containing disclosure required by the Act.  This separate report to the SEC must also contain the same disclosure required in the 10-Q or 10-K.

The reports to the SEC will be posted for the public on the SEC’s website, and will be forwarded to the President and select Congressional committees.  Upon receipt of a report from the SEC, the President will initiate an investigation into whether sanctions against the issuer are appropriate (note also that the scope of activities that can give rise to sanctions under the Iran Sanctions Act of 1996 are expanded and broadened by the Act).  The investigation must be concluded with a final decision on sanctions not later than 180 days after the investigation is initiated.

The CFTC has approved its final rule on the so-called “end-user exception” to the Dodd-Frank Act’s mandatory clearing requirement applicable to swaps required to be cleared (roughly, standardized swaps). Under the exception, as provided by the Act, a swap counterparty may elect not to clear a swap if the counterparty:

  • Is not a “financial entity” (e.g., swap dealer, major swap participant, commodity pool, investment fund, bank, or pension plan);
  • Is using the swap to “hedge or mitigate commercial risk,” as further defined; and
  • Provides certain information along with the swap to a swap data repository or the CFTC.

If the party electing to not clear the swap is a public company (defined as having securities registered under Section 12 of the Exchange Act or being required to file reports under Section 15(d) of the Exchange Act), the public company must provide the following additional information:

  • The relevant SEC Central Key Index number; and
  • Whether an appropriate committee of the public company has reviewed and approved the decision to enter into swaps that are exempt from the requirements of Sections  2(h)(1) (referring to clearing requirements) and 2(h)(8) (referring to designated contract markets, referred to as a DCM, and swap execution facilities, referred to as an SEF) of the Commodity Exchange Act.

The rule also goes on to provide that an entity that qualified for an exemption from the clearing requirement may report the information annually in anticipation of electing the exception for one or more swaps.  Such reporting is effective for 365 days following the date of the reporting.  The electing entity must amend the information as necessary to reflect any material changes to the information reported.

In addition, the adopting release states:

  • The public company board or committee must not only approve the decision to enter into an uncleared swap but also not to execute the trade on a DCM or SEF;
  • The CFTC expects the public company board or committee to review the policy at least annually and more often on appropriate triggering events, such as a new hedging strategy that was not contemplated in the original board approval; and
  •  The CFTC considers a committee to be appropriate if it is specifically authorized to review and approve the public company’s decision to enter into an uncleared swaps.

What should the board or committee consider?  It seems to us that one key component is what benefit is forgone by not using a clearing organization.  Essentially, the clearing organization generally acts as a middleman between the parties to a transaction, and assumes the risk should there be a default.  When structured and operated appropriately, clearing organizations can provide benefits such as improving the management of counterparty risk and reducing outstanding exposures through multilateral netting of trades.

 If the benefit of a cleared swap is to eliminate counterparty risks, then one of the key elements of a decision not use a cleared swap is the financial strength of the counterparty to the uncleared swap.  Boards and committees will want to establish appropriate metrics for approved counterparties or limit transactions to a list of specifically named counterparties where the financial strength of the counterparty has been evaluated.

What type of resolutions should be adopted?  This may be a start:

            WHEREAS, Rule 39.6 of the Commodity Futures Trading Commission (the “CFTC”) provides that an end-user may elect not to clear a swap in certain circumstances;

            WHEREAS, since the Company has a class of securities registered under Section 12 of the Exchange Act [or reference Section 15(d) where appropriate], Rule 39.6 requires the Company to provide a swap data repository, or in certain circumstances, the CFTC, information regarding whether an appropriate committee of the Company’s Board of Directors has reviewed and approved the decision to enter into swaps that are exempt from the requirements of Sections 2(h)(1) and 2(h)(8) of the Commodity Exchange Act;

            WHEREAS, the Board of Directors has carefully considered the advantages and disadvantages of entering into uncleared swaps as opposed to cleared swaps, including the strength of the counterparties the Company transacts with and the Company’s risk management objectives, and other matters the Board of Directors deems relevant;

             NOW THEREFORE BE IT RESOLVED, that the Company is authorized to enter into swaps that are exempt from the requirements of Sections 2(h)(1) and 2(h)(8) of the Commodity Exchange Act.

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