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

The CFTC has approved its final rules regarding business conduct standards for swap dealers (“SDs”) and major swap participants (“MSPs”), which governs their dealings with counterparties generally and imposes additional requirements to their dealings with Special Entities (which include governmental entities, certain employee benefit plans under ERISA, and endowments). The rules prohibit certain abusive practices, require disclosures of material information to counterparties, and require SDs and MSPs to undertake certain due diligence relating to their dealings with counterparties.

Prohibition of Abusive Practices; Confidentiality

Prohibitions include those against fraudulent, deceptive, and manipulative acts or practices. An affirmative defense is available to non-scienter fraud violations based on good faith compliance with policies and procedures. Counterparty information must be treated with confidentiality.

Duties to All Counterparties

Verification of Counterparty Information – SDs and MSPs must verify that a counterparty is an eligible contract participant and whether a counterparty is a Special Entity; specified counterparty representations may be relied on as a safe harbor.

Disclosure of material information – SDs and MSPs must disclose material information in a manner sufficient to allow their counterparties counterparty to assess material risks and characteristics of transactions and SD/MSP incentives and conflicts of interest.

Daily Mark – SDs and MSPs must provide counterparties the daily mid-market mark for their uncleared swaps.

Clearing Disclosures – SDs and MSPs must notify counterparties of their rights (1) to clear swaps that are not required to be cleared and (2) to select derivatives clearing organizations.

Communications and Fair Dealing – SDs and MSPs must communicate with counterparties in a fair and balanced manner based on principles of fair dealing and good faith.

Scenario Analysis (applies to SDs only) – SD counterparties may elect to receive scenario analyses from SDs for swaps that are not made available for trading on swap execution facilities or designated contract markets.

Duties to Special Entities

Advising Special Entities (SDs only) – A SD that “acts as an advisor to a Special Entity” has a duty to act in the “best interests” of the Special Entity. A SD “acts as an advisor to a Special Entity” when it recommends a swap or swap trading strategy tailored to the needs or characteristics of the Special Entity. Safe harbors are available with respect to ERISA plans that represent that they have ERISA fiduciaries and under other specified circumstances based on representations by SDs and their Special Entity counterparties.
Special Entity Representatives – A SD or MSP must have a reasonable basis to believe that a Special Entity (other than an ERISA plan) has a “representative” that meets the following criteria:

• is sufficiently knowledgeable to evaluate the transaction and risks;
• is not subject to statutory disqualification;
• is independent of the SD or MSP;
• acts in the best interests of the Special Entity;
• makes appropriate and timely disclosures to the Special Entity;
• evaluates, consistent with any guidelines provided by the Special Entity, fair pricing and appropriateness of the swap; and
• in the case of a governmental Special Entity, is subject to restrictions on certain political contributions to public officials of the governmental Special Entity

Political Contributions by SDs

SDs must refrain from entering swaps with a governmental Special Entity for two years after making certain political contributions to officials of the governmental Special Entity.

Means of Compliance with Business Conduct Standards

As appropriate, SDs and MSPs can:

• reasonably rely on representations of counterparties to meet due diligence obligations
• make disclosures by any reliable means agreed to by the counterparty
• make disclosures of material information to counterparties in a standard format
• include representations and disclosures in counterparty relationship documentation, and deem them renewed with each subsequent swap.

The CFTC has approved final regulations establishing a registration process for swap dealers (“SDs”) and major swap participants (“MSPs”), although the rule defining the terms “swap dealer” and “major swap participant” has yet to be finalized. As such, the registration requirement will not go into effect until the definition becomes effective.

Registration is done by filing a Form 7-R and, for each of the SD’s or MSP’s principals, a form 8-R and fingerprint card. In addition, the SD or MSP must demonstrate compliance with the Section 4s implementing regulations that impose, among other things, capital and margin requirements, reporting and recordkeeping requirements, daily trading records requirements, business conduct standards, documentation standards, trading duties, designation of a chief compliance officer, and, with respect to uncleared swaps, segregation of customer funds.

The Commission is delegating the registration functions to the National Futures Association. Unlike associated persons of other registrants, such as futures commission merchants, commodity pool operators, and commodity trading advisors, persons associated with swap entities are not required to register. However, subject to certain limited exceptions, a SD or MSP may not permit any person associated with it who is subject to a statutory disqualification under section 8a(2) or 8a(3) of the Commodity Exchange Act to be involved in effecting swaps on its behalf.

The Consumer Financial Protection Bureau, or CFPB, announced a key initial step in implementing its Nonbank Supervision program — the publication of the Mortgage Origination Examination Procedures. These procedures are a field guide for CFPB examiners looking at mortgage originators in both the bank and nonbank sectors of the industry.

According to the CFPB, these product-specific procedures are an extension of the CFPB’s general Supervisory and Examination Manual. The Mortgage Origination Examination Procedures outline the CFPB’s supervisory approach to ensure mortgage originators — lenders and brokers — comply with federal consumer financial laws. In particular, the Mortgage Origination Examination Procedures describe the types of information that the agency’s examiners will gather to evaluate mortgage originators’ policies and procedures, assess whether originators are in compliance with applicable laws, and identify risks to consumers throughout the mortgage origination process. The examination manual tracks key mortgage originator activities, from initial advertisements and marketing practices to closing practices.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

Michael McRaith, Director, Federal Insurance Office, or FIO, gave his thoughts on the role of the FIO at the Property/Casualty Insurance Joint Industry Forum On January 10. 2010.  Highlights of Mr. McRaith’s speech are extracted below.

According to Mr. McRaith, “a key responsibility of the FIO is to “monitor all aspects of the insurance industry.” Of course, different people have offered different views about what monitoring will look like and what constitutes an “aspect” of the insurance industry. 

Circumstances will largely influence our focus at times, but it definitely does not mean that FIO will sit idly by while the world spins. 

FIO is poised to be flexible enough to not only be responsive to current events affecting the insurance industry, but also to take the lead in facilitating dialogue and direction regarding the insurance sector both nationally and internationally.

FIO will be increasingly well-suited to be engaged and assertive, when necessary, to offer views, leadership, and guidance on insurance in the United States. We intend to become a source of expertise within the federal government, expertise that understands all aspects of the marketplace, regulation, and international matters. 

Of course, much of our effort will involve data analysis.  I understand some in the industry question the need for FIO’s authority to ask for and receive information.  Some have reported, in fact, that something of a cottage industry has developed around concerns that FIO will duplicate the data and document requests that insurers receive from state regulators.

These concerns are not well-founded.

The law is clear that FIO must first seek any information it needs from a public source or from another regulator, including the states. Only if the information is unavailable from either of those sources does FIO then directly ask an insurer for information.

In that same vein, FIO’s subpoena authority is an important component of our mission.  Remember that authority will be exercised only if (1) the information is not publicly available, and (2) the information is not available to FIO from a regulator. 

Subpoena authority is an authority to use as a last resort for critical information that the office may need, and is intended to be used only in the absence of another viable source to obtain that information.

We are aware of the reasons that the statute explicitly defines when information can be requested directly from an insurer, and I respect those reasons.”

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The Commodity Futures Trading Commission, or CFTC, has proposed rules implementing the so-called “Volcker Rule” requirements of Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Section 619 of the Dodd-Frank Act, among other things, generally prohibits two activities of banking entities.

  • It prohibits federally insured depository institutions, bank holding companies, and their subsidiaries or affiliates (banking entities) from engaging in short-term proprietary trading of any security, derivative, and certain other financial instruments for a banking entity’s own account, subject to certain exemptions.
  • It prohibits owning, sponsoring, or having certain relationships with a hedge fund or private equity fund, subject to certain exemptions.

Section 619 also prohibits banking entities from entering into any transaction or engaging in any activity that would:

  • Involve or result in a material conflict of interest,
  • Result in a material exposure to high-risk assets or high-risk trading strategies,
  • Pose a threat to the safety and soundness of the banking entity, or
  • Pose a threat to the financial stability of the United States.

According to the CFTC, its proposal to implement Section 619 is substantively similar to the joint rule proposal issued by the Board of Governors of the Federal Reserve System; OCC, the FDIC and the SEC in October of 2011.

According to CFTC Commissioner Scott O’Malia, quoting Sheila Bair, the former Chairman of the FDIC, and a former Acting Chairman and Commissioner of the CFTC, the proposed rules are aptly described as a “300-page Rube Goldberg contraption of a regulation.”

Commissioner O’Malia believes the proposal is overly complex. Firms must first assess whether they are a regulated banking entity, whether or not they are dealing in covered financial positions, evaluate whether their activities are legitimate market-making, underwriting, or hedging (which is different than hedging under the Commodity Exchange Act) and finally determine whether or not the asset is an acceptable interest. Once these parameters are defined, the regulated entity must establish a compliance program, which depending on their book of business, will be tiered accordingly.

Commissioner O’Malia stated that upon reviewing the proposal’s discussion of the compliance metrics, he couldn’t help but notice the number of questions inquiring whether or not these were the correct metrics. He said if he didn’t  know better, he would say even the CFTC has reservations about these metrics.

Commissioner O’Malia also noted that after publishing 300 pages of preamble and rule text, one would expect the CFTC to have a very clear regulatory mandate and enforcement responsibility, but that isn’t the case. Broadly speaking, Commissioner O’Malia stated it is unclear what role the CFTC has in enforcing the gamut of rules that will ultimately comprise the Volcker Rule.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The SEC has issued a small entity compliance guide entitled “Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF.”  The guide may be of some use to advisers to smaller hedge funds and private equity groups in determining whether and how often they need to file Form PF which was adopted as a result of the Dodd-Frank Act.  Form PF must be filed by SEC-registered investment advisers with at least $150 million in private fund assets under management.  The guide does not however address any complexities associated with a Form PF filing if one needs to be made.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The Consumer Financial Protection Bureau, or CFPB, has launched its federal nonbank supervision program, one of the central new responsibilities the agency acquired with a director. This will be an extension of the CFPB’s bank supervision program that began last July and will ensure that banks and nonbanks follow federal consumer financial laws.

A “nonbank” – or non-depository business – is a company that offers or provides consumer financial products or services but does not have a bank, thrift, or credit union charter. Nonbanks include companies such as mortgage lenders, mortgage servicers, payday lenders, consumer reporting agencies, debt collectors, and money services companies.

Prior to passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the law that created the CFPB, there was no federal program to supervise nonbanks. Other federal regulators examined banks, credit unions, and thrifts to make sure they were complying with the law, but generally the primary tool used to address issues with nonbanks was “after-the-fact” law enforcement.

Under the law, the CFPB now has the authority to oversee nonbanks, regardless of size, in certain specific markets: mortgage companies (originators, brokers, and servicers including loan modification or foreclosure relief services); payday lenders; and private education lenders.

For other markets, the CFPB can also supervise the larger players, or “larger participants.” Last summer, the CFPB sought public comment to develop an initial rule, identifying six possible markets for consideration—debt collection, consumer reporting, prepaid cards, debt relief services, consumer credit and related activities, and money transmitting, check cashing and related activities. The CFPB intends to propose its initial rule on this issue in the near future.

According to the CFPB. It also has authority to supervise any nonbank that it determines is posing a risk to consumers.

Like the bank supervision program, the CFPB’s nonbank supervision program is designed to ensure that nonbanks comply with federal consumer financial laws and it is designed to assess risk to consumers arising from these businesses. The nonbank supervision program will include conducting individual examinations and may also include requiring reports from businesses to determine what businesses need greater focus. How often and to what degree the examinations are performed will depend on CFPB’s analysis of risks posed to consumers based on factors such as the nonbank’s volume of business, types of products or services, and the extent of state oversight.

The CFPB’s approach to nonbank examination will be the same as its approach to bank examination. The CFPB Examination Manual, released in October, is the field guide that examiners will use for both.

The nonbank business generally will be told of an upcoming examination and will receive status updates throughout the process. If a company is in violation of federal consumer financial laws, the CFPB will seek corrective actions, including strengthening the company’s programs and processes to ensure that violations do not recur and, where appropriate, that remedies are instituted. When necessary, examiners will coordinate and work closely with CFPB’s enforcement staff to bring appropriate legal actions to address harm to consumers.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

Textron and Wells Fargo have filed for SEC no action letters asking the SEC staff to take a no-action position  to permit omission of shareholder proposals requesting the companies to place a future proposal in proxy statements where a company would be required to include shareholder nominees in the company’s proxy statement.

Textron

Textron argues the following grounds for exclusion:

  • It is not one shareholder proposal, but multiple proposals.
  • The proposal is impermissibly vague so as to be inherently misleading.
  • The proposal is beyond the Company’s power to implement.
  • The proposal deals with matters related to the Company’s ordinary business.

Wells Fargo

Wells Fargo seeks to omit a portion of the proposal because the proposal references an external web site where more information can be found.  However, no information related to the proposal appears at the web site.  Therefore Wells Fargo argues the proposal is false and misleading and the portion referencing the web site should be deleted (but not the rest of the proposal).  The SEC decision here will therefore be of little predictive value to companies seeking to exclude proxy access proposals on the merits.

Outcome?

The Textron arguments are long and technical.  Other issuers who have received similar proposals have not sought exclusion.  That could be for several reasons.  Perhaps they have concluded the Textron arguments are not persuasive.  Or perhaps they have concluded that there may be more investor relations damage to seek omission than what it is worth.  Or they are waiting for someone like Textron to be the brave company to go fist, and if Textron is successful, others are sure to follow.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The CFPB has issued a bulletin regarding the collection of information through the supervisory process and the confidentiality protection its process provides to supervised institutions.  For instance, the bulletin states that providing information to the CFPB pursuant to a supervisory request would not waive any privilege that may attach to the information.  The CFPB states if a supervised institution were ever faced with a claim of waiver, the CFPB would take all reasonable and appropriate actions to rebut such a claim.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.

The SEC recently commenced an enforcement action against a registered investment adviser who allegedly “offered more than $500 billion in fictitious securities through various social media websites. For example, he used LinkedIn discussions to promote fictitious “bank guarantees” and “medium-term notes.””

Obviously a situation to be dealt with harshly.  We should appreciate the SEC’s vigilance in identifying and pursuing this individual.

But in addition to pursuing this individual, the SEC has issued this seven page “National Examination Risk Alert” which outlines numerous controls and procedures an investment adviser which uses social media should consider implementing.  Let’s face it, fraudsters will only ignore the document, and it will impose substantial costs on honest advisers.  It looks to us that compliance with these procedures will be on the top of the list for investment advisers undergoing routine examinations.  As a result, we recommend advisers to private equity groups and hedge funds that are newly required to register under the Dodd-Frank Act make sure that compliance procedures under development cover this topic.

Check dodd-frank.com frequently for updates on the Dodd-Frank Act and other important securities law matters.