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

The SEC has issued a policy statement describing the order in which it expects new rules regulating the derivatives market would take effect. The statement covers final rules to be adopted by the SEC under the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act.

Title VII of the Dodd-Frank Act establishes a comprehensive framework to regulate over-the-counter derivatives, authorizing the Commodity Futures Trading Commission to regulate “swaps,” and the SEC to regulate “security-based swaps.”

The SEC is requesting public comment on its plan to phase in final rules regulating security-based swaps and security-based swap market participants. The policy statement does not estimate when the rules would be put in place, but describes the sequence in which they would take effect. The phased-in approach is intended to avoid the disruption that could occur if all the new rules took effect simultaneously.

In addition, the policy statement discusses the timing of the expiration of the temporary relief the SEC previously granted to securities-based swaps market participants. The relief exempts these market participants from certain provisions of the Securities Act of 1933, the Securities Exchange Act of 1934, and the Trust Indenture Act of 1939. Much of this relief is due to expire when certain final rules under Title VII become effective.

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

 

According to a recent report published by SNL Financial, community banks across the country are deregistering their stock with the SEC.  These community banks are taking advantage of a provision in the Jumpstart Our Business Startups Act, or JOBS Act, signed into law on April 5.  The JOBS Act increases the threshold for deregistration under the Securities Exchange Act to 1,200 shareholders from the previous threshold of 300 shareholders. Accordingly, community banks and bank holding companies with more than 300 but less than 1,200 shareholders are eligible to deregister with the SEC.

The 61 financial institutions highlighted in the SNL Financial report have filed to deregister their common stock and suspend securities reporting requirements. Essentially all of the deregistering banks are community banks. More than 80% of the banks had assets of less than $500 million and only three had assets in excess of $1 billion.

Elimination of the Securities Exchange Act registration requirement for these community banks and bank holding companies obviously results in a huge reduction in regulatory burdens.  Community banks and bank holding companies with registered stock must file annual reports with the SEC. These banks and holding companies must also file reports with the SEC disclosing significant events affecting their business and reports disclosing certain ownership changes, along with numerous other regulatory and reporting requirements. Deregistration eliminates these obligations. At a time when regulatory burdens are otherwise significantly increasing for community banks, the deregistration option provides much needed regulatory relief.

The process of deregistering a bank or bank holding company’s stock with the SEC is relatively straightforward. The bank or holding company must file SEC Form 15 and certify that it has less than 1,200 shareholders. After filing Form 15, the bank or holding company’s Securities Exchange Act reporting obligations are immediately suspended. Deregistration becomes effective and the process is complete 90 days after filing Form 15.

According to SNL Financial, there are over 300 registered banks and thrifts in the U.S. with fewer than 1,200 shareholders and two-thirds of these institutions have less than $1 billion in assets. Given that deregistration eliminates one of the many regulatory burdens on community banks, we expect this deregistration trend to continue in the community banking industry.

The CFPB has adopted three final rules that deal with its procedures and practices related to enforcing federal consumer financial law.  The three final rules deal with the agency’s investigative and adjudicative processes and its interactions with state law enforcement authorities.  The three final rules are:

  • Rule Relating to Investigations: This rule describes the CFPB’s procedures for investigating whether persons have engaged in conduct that violates federal consumer financial law. This rule sets forth the CFPB’s authority to conduct investigations, including the procedures for issuing civil investigative demands. It also describes the rights of persons from whom the CFPB seeks to compel information in investigations.
  • Rules of Practice for Adjudication Proceedings: Under this rule, the CFPB can conduct administrative adjudications (hearings) to ensure or enforce compliance with federal laws and regulations.
  • State Official Notification Rule: This rule is designed to help the CFPB stay informed about state-level legal developments relating to the Dodd-Frank Act. It describes the process through which state officials update the agency on certain legal actions they bring to enforce compliance with certain provisions of the Dodd-Frank Act and regulations the CFPB may issue. Proper notification will help ensure that the law is being enforced in a consistent manner. 

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 extended the date by which advisers must comply with the ban on third-party solicitation in rule 206(4)-5 under the Investment Advisers Act of 1940, which is known as the “pay to play” rule. The SEC extended the compliance date in order to ensure an orderly transition for advisers and third-party solicitors as well as to provide additional time for them to adjust compliance policies and procedures after the transition.

The compliance date for the ban on third-party solicitation was extended until nine months after the compliance date of a final rule adopted by the Commission by which municipal advisor firms must register under the Securities Exchange Act of 1934. Once that final rule is adopted, the SEC will issue the new compliance date for the ban on third-party solicitation in a notice in the Federal Register.

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

Five federal supervisory agencies have released a Memorandum of Understanding, or MOU, that clarifies how the agencies will coordinate their supervisory activities, consistent with the Dodd-Frank Wall Street Reform and Consumer Protection Act

Section 1025 of the Dodd-Frank Act requires that the Consumer Financial Protection Bureau and the prudential regulators–the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the National Credit Union Administration, and the Office of the Comptroller of the Currency–coordinate important aspects of their supervision of insured depository institutions with more than $10 billion in assets and their affiliates. Such coordination includes scheduling examinations, conducting simultaneous examinations of covered depository institutions unless an institution requests separate examinations, and sharing draft reports of examination for comment.

The MOU is intended to establish arrangements for coordination and cooperation between the CFPB and the prudential regulators, minimize unnecessary regulatory burden, avoid unnecessary duplication of effort, and decrease the risk of conflicting supervisory directives.

Under the MOU, the agencies will coordinate examinations and other supervisory activities and share certain material supervisory information concerning:

  • Compliance with federal consumer financial laws and certain other federal laws that regulate consumer financial products and services;
  • Consumer compliance risk management programs;
  • Activities such as underwriting, sales, marketing, servicing, collections, if they are related to consumer financial products or services; and
  • Other related matters that the agencies may mutually agree upon.

These coordination undertakings should lead to greater uniformity and efficiencies in supervision and help to minimize regulatory burden on covered depository institutions.

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

 

Hedge funds and private equity advisers with more than $150 million in assets under management that have registered with the SEC as investment advisers will have to begin filing Form PF with the SEC as required by the Dodd-Frank Act.  Form PF will be filed electronically through the PFRD system, which is a subsystem of the IARD system. Both systems are managed by FINRA.  The PFRD system is now available on a limited basis for user testing purposes. The system will become available for production on or about June 1, 2012. 

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 taken the first step toward adopting consumer protections for the prepaid card market. The CFPB’s Advance Notice of Proposed Rulemaking seeks input on how to ensure that consumers’ funds on prepaid cards are safe and that card terms and fees are transparent.

The Bureau’s rulemaking will focus on “General Purpose Reloadable” prepaid cards which allow consumers to load the cards with money upfront and use them as if they were checking account debit cards. 

The prepaid market is still largely unregulated at the federal level. The CFPB plans to evaluate several topics:

  • Fees and Terms Disclosure: The CFPB plans to evaluate the best way to balance the need for disclosure with the fact that many cards are purchased at retail locations and space for disclosures is limited. The CFPB believes consumers should also know whether or not their funds are protected by FDIC insurance. The CFPB plans to evaluate how prepaid card issuers should disclose the insurance status of cardholders’ funds.
  • Unauthorized Transactions: Federal regulations require that credit and debit card issuers limit consumers’ liability when their cards are used without their authorization. These regulations do not extend to prepaid cards. Many prepaid card issuers voluntarily offer this protection, but it is not standard across the industry. The CFPB will evaluate the costs and benefits of card issuers providing limited liability protection from unauthorized transactions.
  • Product Features: Most prepaid cards do not offer any credit features. In general, cardholders may not be able to withdraw or spend more than the funds loaded on their cards. However, some prepaid cards allow their cardholders to overdraw their accounts, and some offer small-dollar loans or a line of credit. Similarly, very few prepaid cards have a savings account. Even though such savings accounts typically have high interest rates, consumers do not seem to take advantage of the opportunity to save. Another feature is that of credit repair, which claims to offer consumers the opportunity to improve or build credit. The CFPB is looking for public input on the costs, benefits, and consumer protection issues related to those product features.

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

The JOBS Act directs the SEC to eliminate the prohibition on general solicitations for securities offerings under Rule 506. Once the prohibition is eliminated, many advisers to hedge funds and private equity groups may engage in some sort of advertising when placing fund securities.

General Rules

Advertising by registered investment advisers is subject to Section 206 of the Investment Advisers Act.  Under paragraph (4) of Section 206, the SEC has authority to adopt rules defining acts, practices, and courses of business that are fraudulent, deceptive, or manipulative. Pursuant to this authority, the SEC adopted Rule 206(4)-1, which defines the use of certain specific types of advertisements by advisers as fraudulent, deceptive, or manipulative.  Although the rule does not specifically prohibit an adviser from using actual results, or prescribe the manner of advertising these results, paragraph (5) of the rule makes it a fraudulent, deceptive, or manipulative act for any investment adviser to distribute, directly or indirectly, any advertisement that contains any untrue statement of a material fact or that is otherwise false or misleading.

The SEC takes the position that, as a general matter, whether any advertisement is false or misleading will depend on the particular facts and circumstances surrounding its use including:

  • the form as well as the content of the advertisement,
  • the implications or inferences arising out of the advertisement in its total context, and
  • the sophistication of the prospective client.

In the Clover Capital Management, Inc. no action letter, the SEC staff outlined certain advertising practices the staff believes are inappropriate. The list is not intended to address all advertising practices prohibited by Rule 206(4)-1(a)(5) and does not create a “safe harbor” that may be relied upon by an adviser as an exclusive list of the factors that must be considered in determining the type of disclosure necessary when advertising actual results.

Some of the practices the staff deems inappropriate include:

  • Using actual results that do not reflect the deduction of advisory fees, brokerage or other commissions, and any other expenses that a client would have paid or actually paid;
  • Suggesting or making claims about the potential for profit without also disclosing the possibility of loss;
  • Compares actual results to an index without disclosing all material facts relevant to the comparison;
  • Failing to disclose any material conditions, objectives, or investment strategies used to obtain the results portrayed (e.g., the model portfolio contains equity stocks that are managed with a view towards capital appreciation);
  • Failing to disclose prominently, if applicable, that the results portrayed relate only to a select group of the adviser’s clients, the basis on which the selection was made, and the effect of this practice on the results portrayed, if material.

Cherry Picking

Sometimes fund advisers want to highlight a past specific portfolio company or trading strategy that was highly profitable.  The SEC often looks askance at this sort of advertising. 

According to the SEC, when it adopted rule 206(4)-1 under the Advisers Act, it stated that advertisements containing past specific recommendations were inherently misleading because “by their very nature they emphasize the comments and the activities favorable to the investment adviser and ignore those which were unfavorable.”  The primary concern underlying the prohibition against advertisements containing past specific recommendations is that an adviser could “cherry pick” its profitable recommendations and omit the unprofitable ones.  Under those circumstances, an advertisement could fraudulently or deceptively imply that the recommendations listed, and their profitability, are representative of the experience of the adviser’s clients, according to the SEC.

The SEC set forth some of its thoughts in this area in the The TCW Group, Inc. no action letter.  There the SEC granted no-action relief to with respect to advertising that presented no fewer than five holdings that contributed most positively to a representative account’s performance and an equal number of holdings that contributed most negatively to the representative account’s performance.  So apparently the idea is you have to present the best and the worst.

Performance of Prior Funds

Fund founders sometime wish to present their experience at a prior employer. The SEC staff has taken the position that it may be misleading for an adviser to advertise the performance results of accounts managed at an employee’s prior place of employment when the employee had been one of several persons responsible for selecting the securities for those accounts.

In the Horizon Asset Management, LLC no action letter, the SEC outlined factors when an investment adviser may use an advertisement that includes prior performance results of accounts managed by a predecessor entity:

  • the person or persons who manage accounts at the adviser were also those primarily responsible for achieving the prior performance results,
  • the accounts managed at the predecessor entity are so similar to the accounts currently under management that the performance results would provide relevant information to prospective clients,
  • all accounts that were managed in a substantially similar manner are advertised unless the exclusion of any such account would not result in materially higher performance,
  • the advertisement is consistent with staff interpretations with respect to the advertisement of performance results, and
  • the advertisement includes all relevant disclosures, including that the performance results were from accounts managed at another entity.

Reports to Investors

Private equity sponsors and hedge funds also report regularly to their clients.  In those circumstances, the Investment Counsel Association of America, Inc. no action letter suggests such reports are not advertisements.  In that no-action letter the SEC staff stated that a written communication by an investment adviser to its existing clients generally would not be an advertisement within the meaning of rule 206(4)-1(b) merely because it discusses the adviser’s past specific recommendations concerning securities that are or were recently held by each of those clients. In general, the staff continued, written communications by advisers to their existing clients about the performance of the securities in their accounts are not offers of investment advisory services but are part of the adviser’s advisory services. If, however, the context in which the past specific recommendations are presented by the investment adviser to an existing client suggests that a purpose of the communication is to offer advisory services, the SEC staff stated it  would conclude that the communication was an advertisement.

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

During its audit of the CFPB’s fiscal year 2011 financial statements, the GAO identified seven internal control issues that could adversely affect CFPB’s ability to meet its internal control objectives. GAO does not consider these issues to represent material weaknesses or significant deficiencies in relation to the CFPB’s financial statements. Nonetheless, it believes they warrant management’s attention and action. These issues concern necessary controls to ensure:

  • complete and finalized documentation of CFPB’s accounting processes and procedures, in relation to CFPB’s financial statements. Nonetheless, we believe they warrant management’s attention and action. These issues concern necessary controls to ensure
  • an effective internal control assessment process supporting management’s internal control assertion,
  • security over CFPB’s data and information systems,
  • accurate calculation and timely recording of CFPB undelivered orders balances,
  • accurate calculation and timely disbursement of CFPB payroll transactions,
  • proper prior approval of CFPB travel transactions, and
  • timely recording of CFPB prepaid expenses as assets.

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 proposed to modify the aggregation provisions of the position limits rule that it issued in late 2011 (summary, final rule). The rule currently requires aggregation of positions across all entities in which a person owns a 10 percent or greater ownership or equity interest. In the announcement accompanying its proposed rulemaking, the Commission states that the modifications would allow any person with a greater than 10 percent ownership or equity interest in an entity to disaggregate the owned entity’s positions, provided there are protections and firewalls in place to ensure trading decisions are made independently of one another.

According to the announcement, under the proposed rule:
1. Any person with an ownership or equity interest in an entity (financial or non-financial) of between 10 percent and 50 percent may disaggregate the owned entity’s positions upon demonstrating independence of trading
2. In order to be permitted to disaggregate:
– Trading must be conducted in separate locations;
– Risk management systems must not allow the sharing of trades or trading strategy;
– Different traders must be doing the trading;
– Information about individual trades or trading strategies may not be shared between entities.
3. Aggregation would always be required if one entity owns greater than 50 percent of another entity.

An unofficial draft release of the proposed rulemaking is available here.