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

The GAO has issued a report that examines among other things:

  • steps the SEC has taken toward issuing a conflict minerals disclosure rule; and
  • stakeholder-developed initiatives that may help covered companies comply with the anticipated rule.

 The GAO concludes the continued delay in issuing a final rule has contributed to a lingering uncertainty among industry and other stakeholders who expect their actions to be guided by a final rule. Some of these industry and other stakeholders have engaged in the development of various initiatives that they hope may help covered companies comply with the anticipated rule, in part by helping foreign and domestic suppliers of those covered companies trace minerals in their supply chains. Without a final rule, it is unclear to what extent the initiatives currently being developed or implemented by industry and other stakeholders will achieve results consistent with those anticipated under the conflict minerals legislation. Moreover, in part because of the delay in the rule’s issuance, many companies across the tin, tantalum, tungsten, and gold supply chains are reluctant to participate in or support the global and in-region initiatives currently being developed or implemented because they are uncertain whether or not the initiatives will align with the anticipated rule.

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 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:

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

An unofficial version of the rule has been released while publication in the Federal Register remains pending.

Reduced Reporting and Board Approval Requirements

In a win for end users and reporting counterparties, the CFTC reduced the reporting burden associated with electing the exemption for individual swaps from what was required under the proposed rule. Under the final rule, only two pieces of information are strictly required to be reported with each swap:

(1) notice of the election of the exception; and
(2) the identity of the counterparty electing not to clear the swap.

The following information must also be provided, but can be submitted by an annual filing by the electing counterparty rather than provided with each swap:

(1) whether the electing counterparty is a financial entity electing the exception on behalf of an affiliate or as a small financial institution;
(2) whether the swap for which the exception is being elected is used to hedge or mitigate commercial risk;
(3) information regarding how the electing counterparty generally meets its financial obligations associated with entering into non-cleared swaps; and
(4) if the electing counterparty is an “SEC Filer,” whether its board of directors has approved generally the decision to enter into swaps that are exempt from the clearing and trading requirements.

In another win for end users advocated for by dodd-frank.com blogger Steve Quinlivan (see former post), among others, the CFTC clarified that, for SEC Filers, the board approval requirement can be satisfied by general approval with respect to an entity’s swap business, as opposed to requiring swap-by-swap approval as suggested by the proposed rule. On the frequency of board review and/or approval, the CFTC added: “The Commission would expect an SEC Filer’s board to set appropriate policies governing the SEC Filer’s use of swaps subject to the end-user exception and to review those policies at least annually and, as appropriate, more often upon a triggering event (e.g., a new hedging strategy is to be implemented that was not contemplated in the original board approval).”

Hedging or Mitigating Commercial Risk

The CFTC adopted a definition of “hedging or mitigating commercial risk” that is virtually the same as that used in the definition of “major swap participant” recently adopted by the Commission, which encompasses the definition of “bona fide hedging” under the position limits rule (one of several different hedge definitions under the CFTC’s Dodd-Frank regulations), transactions qualifying for hedging treatment under FASB standards, and, more generally, swaps that are “economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise. . . .”

Financial Entity Exceptions

The rule also allows financial entities to take advantage of the exception with respect to certain narrow classes of activities related to financing manufacturing activities and hedging the risks of affiliates, as provided for by the Dodd-Frank Act. Finally, acting upon the Act’s direction to consider an exemption for small banks, savings associations, farm credit system institutions, and credit unions, the CFTC provided a new exemption for such entities having less than $10 billion in total assets.

Clearing Determinations, and Mandatory Clearing, Set for Fall 2012

Chairman Gensler indicated at this week’s rulemaking that the Commissioners expect to consider the first determinations on swaps required to be cleared later this month, suggesting that mandatory clearing could go into effect as early as October 2012.

In a joint rulemaking with the SEC announced here, the CFTC voted today to approve a final rule defining the term “swap,” which will trigger compliance requirements under several major CFTC swap market regulations. As Commissioner Wetjen put it: “The new swap regulatory regime is on the verge of becoming a reality.” Sixty days after the new swap definition rule is published in the Federal Register, swap dealers (SDs) and majors swap participants (MSPs) must comply with registration requirements, internal and external business conduct standards, and certain reporting and recordkeeping requirements, and all market participants will be subject to spot-month position limits with respect to swaps referencing certain energy and agricultural commodities. SDs and MSPs must be reporting all of their swaps after an additional 90 days, and, 90 days after that, all swaps regardless of counterparty-type must be reported. Commissioner O’Malia’s statement predicted that “many companies will find the registration and compliance schedule to be very aggressive and quite challenging.”

Previous blog posts discussed the final rule’s interpretations regarding certain kinds of consumer and commercial contracts that fall outside the definition of “swap” and the exclusion of “forward contracts” from the definition pursuant to the Dodd-Frank Act.

According to CFTC statements made today, the CFTC’s final “swap” definition rule follows the basic framework set out in the proposed rule with respect to the statutory exclusion of forward physical contracts, i.e., “any sale of a nonfinancial commodity or security for deferred shipment or delivery, so long as the transaction is intended to be physically settled,” from the definition of the term “swap.” Although the text of the rule has not been released, Commissioner statements and a fact sheet released today indicate that the forward contract exclusion will be interpreted in a manner consistent with the CFTC’s historical interpretation of the existing forward exclusion with respect to futures contracts.

Book-Out Transactions

In particular, the principles underlying the CFTC’s “Brent Interpretation” with respect to “book-out” transactions will apply to the forward exclusion from the definition of “swaps.” Accordingly, a financially-settled book-out of a transaction contractually required to be physically settled should qualify for the exclusion if the counterparties are commercial market participants who regularly make or take delivery of the referenced commodity in the ordinary course of business and the book-out was effectuated through a subsequent, separately negotiated agreement. The Commission also clarifies that oral book-outs are permissible if they are followed by a written or electronic confirmation.

Forward Contracts With Embedded Volumetric Optionality

Forward contracts with embedded optionality posed a unique issue to the Commission in that “options” are explicitly identified as “swaps” by the Dodd-Frank Act, yet industry participants identified that a vast swath of industry contracts that call for deferred delivery of physical commodities contain embedded optionality yet were not intended to be regulated as swaps under the Act. The Commission recognized industry concerns by expanding its interpretation of the exclusion with respect to such contracts. Whereas the proposed rule allowed optionality only with respect to the price term, the final rule recognizes that forward contracts with embedded optionality with respect to volume or quantity can also qualify for the exclusion. Commission statements indicate that such contracts must satisfy a seven-factor test, including a requirement that the volumetric optionality be due to physical factors or regulatory requirements beyond the control of the parties, to qualify for the exclusion. According to Commission O’Malia, a contract should satisfy the test if its predominate feature is actual delivery. Commissioner Wetjen worried that the seven-factor test may “needlessly complicate” commercial practices.

Additional Guidance

The Commission provided additional guidance that:

– Environmental commodities, such as offsets, allowances, and Renewable Energy Credits (RECs) are nonfinancial commodities eligible for the exclusion;
– Energy management agreements do not alter the nature of the transactions conducted under them for purposes of the exclusion;
– Certain types of arrangements as described in the release, such as fuel delivery agreements and physical exchange transactions, are not swaps;
– Certain physical commercial arrangements that are similar to leases are not options and may qualify for the forward exclusion under the facts and circumstances; and
– Certain contract provisions do not disqualify transactions for the forward exclusion (e.g., liquidated damages, renewal/evergreen provisions).

The CFTC is issuing an interpretation that certain consumer and commercial transactions that have not previously been considered “swaps” do not fall within the statutory definitions of those terms.

Consumer Transactions

Transactions entered into by consumers (natural persons) as principals (or by their agents) primarily for personal, family or household purposes that would not be considered swaps under the interpretation include:

  • Agreements, contracts, or transactions to acquire or lease real or personal property, to obtain a mortgage, to provide personal services, or to sell or assign rights owned by such consumer (such as intellectual property rights);
  • Agreements, contracts, or transactions to purchase products or services for personal, family or household purposes at a fixed price or a capped or collared price, at a future date or over a certain time period (such as agreements to purchase for personal use or consumption nonfinancial energy commodities, including agreements to purchase home heating fuel or agreements involving residential fuel storage, in either case, where the consumer takes delivery of and uses the fuel, and the counterparty is a merchant that delivers in the service area where the consumer resides);
  • Agreements, contracts, or transactions that provide for an interest rate cap or lock on a consumer loan or mortgage, where the benefit of the rate cap or lock is realized only if the loan or mortgage is made to the consumer;
  • Consumer loans or mortgages with variable rates of interest or embedded interest rate options, including such loans with provisions for the rates to change upon certain events related to the consumer, such as a higher rate of interest following a default;
  • Service agreements, contracts, or transactions that are consumer product warranties, extended service plans, or buyer protection plans, such as those purchased with major appliances and electronics;
  • Consumer options to acquire, lease, or sell real or personal property, such as options to lease apartments or purchase rugs and paintings, and purchases made through consumer layaway plans;
  • Consumer agreements, contracts, or transactions where, by law or regulation, the consumer may cancel the transaction without legal cause; and
  • Consumer guarantees of credit card debt, automobile loans, and mortgages of a friend or relative.

Commercial Transactions

The types of commercial transactions that involve customary business arrangements (whether or not involving a for-profit entity) that would not be considered swaps or security-based swaps under the interpretation include:

  • Employment contracts and retirement benefit arrangements;
  • Sales, servicing, or distribution arrangements;
  • Agreements, contracts, or transactions for the purpose of effecting a business combination transaction;
  • The purchase, sale, lease, or transfer of real property, intellectual property, equipment, or inventory;
  • Warehouse lending arrangements in connection with building an inventory of assets in anticipation of a securitization of such assets (such as in a securitization of mortgages, student loans, or receivables);
  • Mortgage or mortgage purchase commitments, or sales of installment loan agreements or contracts or receivables;
  • Fixed or variable interest rate commercial loans or mortgages entered into by banks and non-banks, including the following:
    • Fixed or variable interest rate commercial loans or mortgages entered into by the Farm Credit System institutions and Federal Home Loan Banks;
    • Fixed or variable interest rate commercial loans or mortgages with embedded interest rate locks, caps, or floors, provided that such embedded interest rate locks, caps, or floors are included for the sole purpose of providing a lock, cap, or floor on the interest rate on such loan or mortgage and do not include additional provisions that would provide exposure to enhanced or inverse performance, or other risks unrelated to the interest rate risk being addressed;
    • Fixed or variable interest rate commercial loans or mortgages with embedded interest rate options, including such loans or mortgages that contain provisions causing the interest rate to change upon certain events related to the borrower, such as a higher rate of interest following a default, provided that such embedded interest rate options do not include additional provisions that would provide exposure to enhanced or inverse performance, or other risks unrelated to the primary reason the embedded interest rate option is included; and
  • Commercial agreements, contracts, and transactions (including, but not limited to, leases, service contracts, and employment agreements) containing escalation clauses linked to an underlying commodity such as an interest rate or consumer price index.

The interpretation includes factors that the CFTC will consider in determining whether other consumer and commercial transactions that are not specifically listed should be considered swaps.

Loan Participations

Loan participations are not swaps or security-based swaps if the purchaser is acquiring a current or future direct or indirect ownership interest in the related loan or commitment and if certain other conditions are met.

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

Concerned about the decline in the number of public offerings, the JOBS Act requires the SEC to amend Regulation A (or to adopt a new regulation) to raise the threshold for use of that registration exemption from $5 million to $50 million, and requires the GAO to study the impact of state securities laws on Regulation A offerings.

The GAO has issued a report that  report examines:

  • trends in Regulation A filings,
  • how states register Regulation A filings, and,
  • factors affecting the number of Regulation A filings and how the number of filings may change in the future.

The GAO provided a draft of the report to the SEC and the NASAA for their review and comment. Both provided technical comments, which the GAO incorporated as appropriate. In its letter, the NASAA concurred with the GAO’s findings that multiple factors have affected use of Regulation A, and suggested that the primary reason for its limited use is the “mini-public offering” process that businesses must complete. Stakeholders with whom the GAO did not consistently cite any single factor as the primary reason for the limited use of Regulation A. As noted in the report, the NASAA stated that it will be working to develop model state registration requirements for the larger Regulation A offerings allowed under the JOBS Act, and NASAA suggested that further changes to federal securities laws, particularly Regulation A, should be withheld until states implement a new system to address the JOBS Act’s changes. In considering any changes, the NASAA stressed the importance of balancing the needs of investors with the need to raise capital.

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

Last week, the Minnesota Department of Commerce announced that it was instituting an examination program for investment advisers.  In doing so, Minnesota removes itself from a tiny group of states – the others are New York and Wyoming – that have no investment adviser examinations.

The significance of this is that IAs with between $25 million and $100 million in assets under management, and who are located in states that lacked examination programs, are required to register with the SEC, instead of the state.

The examination process, as announced by the Department, will consist of a review of the following:

  • The adequacy of compliance procedures.
  • The actual adherence to compliance procedures.
  • The accuracy of disclosures to clients.
  • The security of client assets.
  • The financial stability of the adviser.
  • The adviser’s adherence to standards of fiduciary duty.

For now, the Department is only engaged in a pilot program, with five firms to be examined.  Then, in the Fall, the Department will host a conference to discuss process and results.  Firms examined will have to pay a fee, but the amount has not yet been set.

The Dodd-Frank Wall Street Reform and Consumer Protection Act requires that bank holding companies with total consolidated assets of $50 billion or more and nonbank financial companies designated by the Financial Stability Oversight Council for supervision by the Federal Reserve submit resolution plans annually to the FDIC and the Federal Reserve. Each plan must describe the company’s strategy for rapid and orderly resolution under the Bankruptcy Code in the event of material financial distress or failure of the company. The FDIC and Federal Reserve must review each resolution plan and jointly may determine that a resolution plan is not credible or would not facilitate an orderly resolution of the company in bankruptcy.

 

Companies subject to the rule are required to file their initial resolution plans in three groups and on a staggered schedule. Firms in the first group, which includes U.S. bank holding companies with $250 billion or more in total nonbank assets and foreign-based bank holding companies with $250 billion or more in total U.S. nonbank assets, must submit their initial resolution plans on or before July 2, 2012. 

 

By regulation, the plans must be divided into a public section and a confidential section. The public section of the plans are meant to contain detailed information to allow the public to understand the business of the covered company. Information in the public portion includes details such as a description of the company’s core business lines and financial information regarding assets, liabilities, capital, and major funding sources.

 

The public portion of plans submitted on July 2, 2012, can be viewed here.

 

For instance, the public portion of Goldman Sach’s plan states as follows:  “Based on the specific assumptions provided by our Supervisors, for this baseline scenario, we believe that our Resolution Plan, in conjunction with the Firm’s well-established risk management practices, conservative liquidity management practices and rigorous approach to determining the fair value of our assets, provides a process to enable a GS Group resolution. This conclusion is also based upon:

  • Our strong financial position at December 31, 2011 with a Tier I capital ratio of 13.8% and significant excess liquidity of $171.6 billion
  • Our assessment of the type of bankruptcy proceedings that would be commenced
  • The alternative resolution strategies we have identified, including the sale of businesses and assets of our Material Entities individually or as a package or by the liquidation of the assets of GS Group”

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

The SEC recently posted a Sunshine Act notice to its web site which states a meeting will be held on August 22, 2012 on the following topics:

  • Consider whether to adopt rules regarding disclosure and reporting obligations with respect to the use of conflict minerals to implement the requirements of Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
  • Consider whether to adopt rules regarding disclosure and reporting obligations with respect to payments to governments made by resource extraction issuers to implement the requirements of Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
  • Consider rules to eliminate the prohibition against general solicitation and general advertising in securities offerings conducted pursuant to Rule 506 of Regulation D under the Securities Act and Rule 144A under the Securities Act, as mandated by Section 201(a) of the Jumpstart Our Business Startups Act.

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

The Consumer Financial Protection Bureau, or CFPB, has adopted a rule to codify protections for privileged information submitted to the CFPB by the financial institutions it regulates.

In January 2012, the CFPB advised the institutions that it supervises that the submission of privileged information to the CFPB does not waive any applicable privilege with respect to third parties. The CFPB believes the new rule provides supervised entities further assurances that providing privileged information to the CFPB will not adversely affect the confidentiality of such information. According to the CFPB, the new rule also makes clear that the CFPB’s transfer of privileged information to another Federal or State agency does not result in a waiver of any applicable privilege.

The CFPB believes the Dodd-Frank Wall Street Reform and Consumer Protection Act provided the CFPB with the authority to issue rules necessary or appropriate to enable the Bureau to fulfill its obligations to protect consumers of financial products and services. The CFPB also believes the Dodd-Frank Act also specifically provided the CFPB with authority to issue rules regarding the confidential treatment of information obtained by the CFPB.

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