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

The International Swaps and Derivatives Association, Inc., or ISDA, and the Securities Industry and Financial Markets Association, or SIFMA, have filed a legal challenge to the CFTC’s final rules that limit the positions that investors may own in certain commodities. The Associations believe that the position limits rule may adversely impact commodities markets and market participants, including end-users, by reducing liquidity and increasing price volatility. In addition, the Associations contend that the CFTC’s decision-making process in enacting the rule was procedurally flawed.

Prior to this litigation, SEC Rule 14a-11 allowed a shareholder (or group of shareholders) to include a shareholder nominee, in certain limited circumstances, in a public company’s proxy statement. The Business Roundtable and the US Chamber of Commerce challenged the rule before the Court of Appeals for the District of Columbia.  The Court issued a decision which vacated Rule 14a-11.  The proxy access decision is directly relevant to the position limits litigation.

It is interesting to compare the SEC and CFTC litigation.  The  SEC proxy access litigation was started with a three page straight forward petition for review.  The basis for vacating Rule 14a-11 at this stage was it is arbitrary and capricious.  In contrast, the ISDA and SIFMA complaint is 33 pages long with six causes of action.  It looks as if the plaintiffs are upping the ante.

In the CFTC litigation, the plaintiffs have included six causes of action.  Two relate to violations of the Commodity Exchange Act, and one is a general claim for injunctive relief.  Three claims relate to the Administrative Procedures Act, as did the proxy access litigation.  The claims are

  • A count for arbitrary and capricious administrative action;
  • A count related to the adoption of the specific positions in violation of the Administrative Procedures Act; and
  • A count related to failure to provide interested persons a meaningful opportunity to participate in proposed rule making.

Eugene Scalia plays a key role in both litigations for the plaintiffs.  He is the son of Supreme Court Justice Antonin Scalia.

The crux of the CFTC litigation is whether the position limits rule was required by the Dodd-Frank Act, or was optional.  The CFTC apparently believes the position limits are required by the Dodd-Frank Act, according to the litigation.  A minority of the commissioners believe that CFTC should first make a determination that position limits are necessary and effective in relation to the identifiable burden of excessive speculation.

One of the beauties of the SEC is the commissioners know when to keep their mouth shut.  That it not the same with the CFTC.  As an example, the second paragraph of the complaint noted a statement by a commissioner that “no one has presented this agency with any reliable economic analysis to support the contention that excessive speculation is affecting the market we regulate or that position limits will prevent excessive speculation.”   Other portions of the complaint state that the CFTC found it impracticable to develop any calculation of the costs, the CFTC has limited data regarding the swaps in question and engaged in only a brief analysis under the Administrative Procedures Act.

Some of the other allegations of the complaint include:

  • The CFTC grossly misinterpreted its statutory authority.
  • The CFTC ignored data that position limits were unnecessary and would be ineffective and harmful to the US economy.
  • There is no rational connection between the facts found and the decisions made.

Obviously the plaintiffs are sailing toward a replay of the SEC proxy access litigation. In the proxy access litigation, the court found the SEC:

  • Inconsistently and opportunistically framed the costs and benefits of the rule;
  • Failed adequately to quantify certain costs or to explain why those costs could not be quantified;
  • Neglected to support its predictive judgments;
  • Contradicted itself; and
  • Failed to respond to substantial problems raised by commenters.

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

The CFTC has issued an interpretation that relates to anti-fraud authority provided in the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The interpretation is the CFTC’s view of the meaning of the term “actual delivery,” and guidance on how the CFTC will determine if the actual delivery exception applies to a transaction.

Section 742(a) of the Dodd-Frank Act amended the Commodity Exchange Act to add a new section, 2(c)(2)(D), entitled “Retail Commodity Transactions.” Section 2(c)(2)(D) broadly applies to any agreement, contract, or transaction in any commodity that is entered into with, or offered to, a non-eligible contract participant or non-eligible commercial entity on a leveraged, margined, or financed basis. The Section requires such agreements, contracts, and transactions to be conducted on a regulated exchange and subjects them to the CFTC’s anti-fraud authority. However, the Section does not apply if “actual delivery” of the commodity is made within 28 days. The CFTC issued the interpretation to explain its view of “actual delivery” and provide several examples of when “actual delivery” does and does not occur.

The CFTC anticipates it will use the interpretation to prosecute ponzi schemes and other frauds that are perpetrated in the retail commodities markets, such as scams by people acting as legitimate providers of investments in precious metals like gold and silver.

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

NASDAQ has filed a rule change that is immediately effective with the SEC regarding a product called NOTO.  NOTO is a market data product offered by the NASDAQ that is designed to provide proprietary electronic trade data to subscribers. NOTO provides information about the activity of a particular option series during a particular trading session.

In the filing, NASDAQ asserts that for the most part the SEC is out of the business in reviewing many NASDAQ fees.  Section 916 of the Dodd-Frank Act amended paragraph (A) of Section 19(b)(3) of the Dodd-Frank Act by inserting the phrase ‘‘on any person, whether or not the person is a member of the self regulatory organization’’ after ‘‘due, fee or other charge imposed by the self regulatory organization.’’ As a result, according to NASDAQ, all self regulatory organizations, or SRO, rule proposals establishing or changing dues, fees, or other charges are immediately effective upon filing regardless of whether such dues, fees, or other charges are imposed on members of the SRO, non-members, or both.

Section 916 of the Dodd-Frank Act further amended paragraph (C) of Section 19(b)(3) of the Exchange Act to read, in pertinent part, to provide a mechanic for the SEC to challenge the fee if it appears to the SEC that such action is necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Exchange Act.

NASDAQ believes that these amendments to Section 19 of the Exchange Act reflect Congress’s intent to allow the SEC to rely upon the forces of competition to ensure that fees for market data are reasonable and equitably allocated. Although Section 19(b) had formerly authorized immediate effectiveness for a ‘‘due, fee or other charge imposed by the self regulatory organization,’’ the SEC adopted a policy and subsequently a rule stipulating that fees for data and other products available to persons that are not members of the self regulatory organization must be approved by the SEC after first being published for comment.  NASDAQ believes that the amendment to Section 19 reflects Congress’s conclusion that the evolution of self-regulatory organization governance and competitive market structure have rendered the SEC’s prior policy on nonmember fees obsolete.

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, issued a report on its first three months of collecting credit card complaint data while also asking the public for feedback on a proposed policy for releasing consumer complaint data in the future.

The CFPB’s Consumer Response office began with an exclusive focus on credit card inquiries and complaints when it launched on July 21, 2011. Inquiries and complaints come into the Bureau in a variety of ways including by mail, fax, telephone, the Bureau website, the online chat function on the website, and referral from other agencies. The CFPB’s U.S.-based call centers handle calls with little or no wait times, provide services for the hearing- and speech-impaired, and have the ability to assist the public in 191 languages.

Though the Consumer Response inquiry and complaint system is still in its early stages, it has received more than 5,000 credit card complaints. Of these complaints, companies reported resolving more than 3,100, with consumers disputing the adequacy of the responses in only 400 cases, or less than 13 percent of the time. The report provides a complete breakdown of complaints by type, as well as by their progress through the complaint handling system.

The report makes three observations about the first three months of credit card complaints:

  • Consumer Confusion: Many complaints show consumers struggling to understand the terms of credit cards and associated products like debt protection services. These complaints show a mismatch between consumer expectations and the way the product functions.
  • Third-Party Fraud: The complaints show some alleged fraudulent credit card charges made by third parties. The CFPB has helped to obtain redress for defrauded consumers in these instances. In some cases, the Bureau has consulted with the appropriate criminal authorities.
  • Factual Disputes: There are a large volume of complaints presenting factual disputes between consumer and issuer. The Bureau has generally found that issuers have been willing to resolve these complaints.

The CFPB is using the information learned in the first few months of credit card complaints to help identify problems in the market. After careful analysis, the Bureau will determine how best to address these issues through a variety of means ranging from consumer education and engagement to new regulatory policies.

The insight gained from the CFPB’s Consumer Response complaint process will also help improve the system as the Bureau expands to new categories of financial products. The Bureau expects to be ready to handle complaints for all financial products and services by the end of 2012. On or about Dec. 1, the Bureau will begin taking complaints and inquiries related to home mortgages.

In conjunction with the report, the CFPB is asking the public to comment on its proposed policy for disclosing certain credit card complaint data. The CFPB is required by statute to provide Congress with semi-annual reports about the complaints that it has handled. The proposed policy would make available to the public a searchable database containing various data fields for each complaint. Individuals and organizations, such as regulated entities and consumer advocacy groups, would be able to analyze this data for patterns and trends.

The CFPB is studying the extent to which it can efficiently and effectively filter confidential personal information from the complaint data. As stated in the proposed policy, the CFPB will exclude from the database any data fields that may contain confidential personal information. The CFPB is inviting comment on the proposed policy through January 30, 2012.

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

The Office of the Comptroller of the Currency, or OCC, proposed a rule to remove references to credit ratings from various OCC regulations and related guidance to assist national banks and federal savings associations in meeting due diligence requirements in assessing credit risk for portfolio investments.

Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires federal agencies to review regulations that require the use of an assessment of creditworthiness of a security or money market instrument and any references to, or requirements, in those regulations regarding credit ratings.  Section 939A then requires the federal agencies to modify the regulations identified during the review to substitute any references to, or requirements of, reliance on credit ratings with such standards of creditworthiness that each agency determines to be appropriate.

The proposed OCC rule would remove references to credit ratings in the OCC’s non-capital regulations.  In particular, the OCC proposes to amend the definition of “investment grade” in 12 CFR Part 1 to no longer reference credit ratings.  In addition to following the standard under the proposed rule, national banks and federal savings associations would be expected to continue to maintain appropriate ongoing reviews of their investment portfolios to verify that they meet safety and soundness requirements appropriate for the institution’s risk profile and for the size and complexity of the portfolios.

The proposed guidance clarifies steps national banks should take to demonstrate they have properly verified their investments meet the newly established credit quality standards under 12 CFR Part 1 and steps national banks and federal savings associations should take to demonstrate they met due diligence requirements when purchasing investment securities and conducting ongoing reviews of their investment portfolios.  Additionally, when purchasing corporate debt securities, Federal savings associations will need to follow requirements to be established by the Federal Deposit Insurance Corporation pursuant to 12 U.S.C. 1831e(d) (as amended by section 939(a)(2) of the Dodd-Frank Act).

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

When the SEC proposed rules on the conflict minerals requirements of the Dodd-Frank Act, it indicated that the statutory provision contemplates that issuers must use due diligence in their supply chain determinations. It also indicated at that time that it would not be appropriate for the SEC to prescribe any particular guidance for conducting due diligence because the conduct undertaken by a reasonably prudent person may vary and evolve over time.  The SEC stated however that that an issuer whose conduct conformed to a nationally or internationally recognized set of standards of, or guidance for, due diligence regarding conflict minerals supply chains would provide evidence that the issuer used due diligence in making its supply chain determinations.  The SEC also noted that the Organisation for Economic Cooperation and Development, or OECD, is developing due diligence guidance for conflict mineral supply chains.  The US State Department subsequently endorsed the OECD framework.

The OECD recently issued a report the objective of which was to establish a baseline of current due-diligence practices of downstream companies, meaning the smelter to the final product.  A separate report was issued on “upstream companies,” meaning the mine to smelter supply chain which is not discussed here.  It is anticipated that this is the first of three reports that will be issued over the next ten months as part of the pilot implementation of the OECD’s Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas and the Supplement on Tin, Tantalum, and Tungsten (the three metals are referred to as the 3Ts in the report).

The pilot implementation of the OECD Guidance focuses on how companies implement due diligence in the supply chains of tin, tantalum, and tungsten, especially as the due diligence relates to minerals potentially sourced from Africa‘s Great Lakes Region. The pilot is intended to test and assist with the implementation of the Guidance’s 3T Supplement, share information, and discern best practices, tools, and methodologies for implementing the Guidance.  The following companies have allowed their names to be publicly disclosed as participating in the pilot program to some extent or another: Alcatel Lucent, Alpha (Cookson), Boeing Company, Circuit Connect, Epic Technologies, Flextronics, Ford Motor Company, Foxconn, Freescale, General Electric Company, Lighting Division, Hewlett Packard, KEMET, Lockheed Martin Corporation, Nokia, Oracle, Panasonic Corporation, Royal Philips Electronics, Siemens, Texas Instruments, TriQuint and UNISEM.

The report notes that since the SEC rules on Section 1502 of the Dodd-Frank Act are still pending, many companies participating in the pilot who are subject to Dodd-Frank Act requirements are taking risk-averse approaches that fall roughly into two categories:

  • One set of companies are moving aggressively to verify their supply chain as conflict-free as soon as possible.
  • The other approach is to wait before making any significant investments in due diligence until U.S. Dodd-Frank legal requirements are clarified in the SEC rules.

The report speaks to the complexity of company mineral supply chains (in some instances up to nine layers deep from the company to the smelter), which makes obtaining information a challenge.  Most companies only have visibility into their immediate (Tier 1) supply base, with some having visibility into Tier 2.

Not surprisingly, participants are having difficulty in receiving information from suppliers.  One participant noted  “Suppliers indicate to us that they estimate the quality of the data received from their (sub-tier) suppliers as limited, and that they have no means to validate that the provided information is correct and complete. We do receive reporting templates filled out by suppliers for which we have our doubts whether the data is correct.  Sometimes there are obvious contradictions in their statements  . . . An unexpectedly large part of the suppliers are declaring that they are not using any of the 3Ts in their products/components.  Suppliers might want to give (us) as the customer the “right/correct” reply, and they might not always be willing to share all the information and feel the risk of losing business when their answers are not in line with what they think (we) want to hear.”

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

The Federal Reserve Board has issued an updated set of frequently asked questions regarding Regulation II, which addresses debit card interchange fees and routing.  The updated FAQs can be distinguished from the older FAQs by the dates following the answers.  The rules regarding interchange fees result from the so called Durbin Amendment to the Dodd-Frank Act.

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

The FDIC and Treasury have issued a notice of proposed rulemaking to implement applicable provisions of the Dodd-Frank Act.  In accordance with the requirements of the Dodd-Frank Act, the proposed rules govern the calculation of the maximum obligation limitation, or MOL, as specified in section 210(n)(6) of the Dodd-Frank Act.  The MOL limits the aggregate amount of outstanding obligations that the FDIC may issue or incur in connection with the orderly liquidation of a covered financial company.

Title II of the Dodd-Frank Act establishes an Orderly Liquidation Authority, or OLA, to resolve a large interconnected financial company upon a determination that its failure and resolution under otherwise applicable law would have serious adverse effects on financial stability in the United States and the use of OLA would avoid or mitigate such adverse effects. Under section 201(a)(8) of the Dodd-Frank Act, a ‘‘covered financial company’’ is a ‘‘financial company’’ for which a systemic risk determination has been made pursuant to section 203(b) of the Dodd-Frank Act but does not include an insured depository institution. Once the Secretary of the Treasury makes a systemic risk determination, the FDIC can be appointed as receiver of the covered financial company.

In order for the FDIC to fulfill its obligations as receiver of a covered financial company, it may be necessary for the FDIC to borrow funds from the Treasury.  As noted, the MOL limits the aggregate amount of these obligations.  The FDIC and Treasury have determined that it would be most appropriate to adopt regulations that closely follow the statutory language for calculating the MOL, while defining certain terms referenced in the statute and seeking comment on those definitions. The terms in this proposed rule are defined solely for the purpose of calculating the MOL and are not applicable to any other statutory or regulatory requirements.

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

The SEC announced three settled enforcement actions against registered investment advisers for compliance failures.  The alleged instances of noncompliance demonstrate the types of things the SEC will be looking for when it begins examinations of advisers to private equity groups and hedge funds which will be required to register under the Dodd-Frank Act.

Some of the deficiencies cited by the SEC which are relevant to advisers to private equity groups and hedge funds are:

  • Failure to institute a compliance program and unsupervised advisory representatives.
  • Failure to establish, maintain, and enforce a written code of ethics, including failure to review access persons’ financial reports, failure to assess whether access persons are following required internal procedures, and failure to evaluate transactions to identify any prohibited practices.
  • Failure to maintain and preserve certain books and records.
  • Failure to review at least annually written compliance policies and procedures and the effectiveness of their implementation.
  • Using an off-the-shelf compliance manual that included language from both broker-dealer and investment adviser regulations, and not specifically tailored to the adviser’s business.
  • Appointing a Chief Compliance Officer with no prior experience in compliance and, other than talking to a consultant, doing nothing to prepare himself for the CCO role. Furthermore, the individual did not attend any training or continuing education on compliance after he assumed the CCO position.

One of the enforcement actions also demonstrate that the SEC will seek penalties personally from a Chief Compliance Officer.  That individual assumed the responsibilities of the CCO while living abroad.  However, the individual failed to perform any supervisory or compliance activities, other than requiring  that the two advisory representatives associated with the firm acknowledge receipt of the latest version of the compliance manual.  The individual agreed to pay a civil monetary penalty of $50,000.

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

It’s hard to understand the countless types of derivatives and how they are differentiated from non-derivative transactions.  So if someone writes an article explaining the topic in as near plain English as possible, its worth reading.  About the last place you would expect to find an understandable article on this topic is in a law review.  However, that is exactly what Timothy Lynch, a visiting professor at Indiana University, has done.  His article – “A Twenty-First Century Understanding of Derivatives” – will be published shortly in the Loyola University Chicago Law Journal.

While useful in understanding the structure and definition of derivatives transactions, I doubt Mr. Lynch’s primary conclusion, that derivative contracts entered into purely between speculators should be void based on public policy grounds, will be universally accepted.  Some will argue purely speculative transactions have social utility (probably the same people who argue insider trading should be legal) by providing liquidity and price discovery.  After all, it may not be the fact that some derivatives are entered into for speculative purposes is bad, but the volume of trading by speculators versus non-speculators is what matters.

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