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

In remarks before the European Parliament, Economic and Monetary Affairs Committee, CFTC Chairman Gary Gensler addressed implementation of the Dodd-Frank Act.

Mr. Gensler noted Congress gave the CFTC flexibility as to setting implementation or effective dates of the rules to implement the Dodd-Frank Act.  Rules will not be implemented in the order they are finalized.  Implementation dates may be conditioned upon other rules being finalized.

According to Mr. Gensler, the CFTC is looking at phasing implementation dates based upon a number of considerations, possibly including asset class, type of market participant and whether the requirement would apply to market platforms, like clearinghouses, or to specific transactions, such as real time reporting.  The CFTC is considering whether a rule might become effective for one asset class or one group of market participants before it is effective for other assets or other groups of market participants.  

Mr. Gensler stated “regardless of the eventual effective dates of the swaps rules, to provide regulatory certainty to the market, rules relating to mandatory clearing, real time reporting, the trading requirement, margin and business conduct standards will apply only prospectively to those transactions that are executed after the rules go into effect.”

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

In remarks before the IA Watch Annual IA Compliance Best Practices Seminar, Carlo V. di Florio, Director, Office of Compliance Inspections and Examinations, or the OCIE,  of the SEC, offered his views on some matters of import to private equity groups and hedge funds.

Private Equity Groups and Conflicts of Interest

According to Mr. di Florio, the OCIE intends to look at conflicts of interest when examining SEC registered investment advisers that advise private equity funds.  “One area regarding private funds that we are already thinking about concerns how private equity firms and their advisers manage conflicts of interest. The Technical Committee of IOSCO has a report out that describes a number of potential conflicts of interest in the private equity arena, and the Institutional Limited Partners Association has issued a set of Private Equity Principles recently that are designed to address many of these conflicts. When we conduct a risk-focused examination, such as of fund advisers to large private equity funds, we will be looking for conflicts such as these, and for evidence that advisers have been vigilant in identifying such potential conflicts and putting in place effective plans or controls to address them.”

Use of Expert Networks

Mr. di Florio also offered guidance on the use of expert networks.  He stated “One aspect of these cases that I want to highlight is how it underscores the need for advisers to have reasonable policies to prevent insider trading. Information networks when properly designed are just another type of research and hiring them is consistent with what institutional investors should do. I am not suggesting that advisers must avoid using expert networks, but that they should address any increase to their compliance risks that expert networks may pose, and build appropriate controls around information obtained from expert networks, at both the front end and the back end.

Front-end controls could include such things as reviewing the terms of agreements with expert network firms, having adviser staff read and acknowledge the adviser’s insider trading policies, and pre-approving every conversation with an expert. It might mean having, at least occasionally, “chaperoned” conversations — that is, a compliance person is a silent listener to the conversation between the expert and the adviser’s money manager/analyst. The adviser might also want to conduct an evaluation of the controls that are in place at expert networks with which the adviser does business. The adviser might also want to either avoid being involved with an expert who is an employee of a public company, or having extra controls in place.

Back-end controls could include obtaining certifications from adviser employees who use expert networks that they are not trading in on insider information. It could also include testing trading — see what trades the adviser staff makes after the expert conversation; and test at least some of the trades in specific companies against press releases, earnings announcements and 8-k filings. These might also include policies and procedures to monitor personal trading of employees or agents who may have access to material nonpublic information.”

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Section 929W of the Dodd-Frank Wall Street Reform and Consumer Protection Act added subsection (g), “Due Diligence for the Delivery of Dividends, Interest, and Other Valuable Property Rights,” to Section 17A of the Securities Exchange Act of 1934, or the Exchange Act. Subsection (g) directs the SEC to:

  • Revise Exchange Act Rule 17Ad-17, “Transfer Agents’ Obligation to Search for Lost Securityholders” to extend to brokers and dealers the requirement of Rule 17Ad-17 to search for lost securityholders;
  • Add to Rule 17Ad-17 a requirement that “paying agents” notify “missing securityholders” in writing that the paying agent has sent the missing securityholder a check that has not yet been negotiated;
  • Add to Rule 17Ad-17 an exclusion for paying agents from the notification requirements when the value of the not-yet-negotiated check is less than $25; and
  • Add to Rule 17Ad-17 a provision clarifying that the written notification requirements shall have no effect on state escheatment laws.

Subsection (g) also requires the Commission to “adopt such rules, regulations, and orders necessary to implement this subsection no later than one year after the date of enactment of this subsection.” The SEC has published for comment proposed amendments to Rule 17Ad-17 to implement the statutory requirements.

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The SEC brought civil insider trading charges against Rajat Gupta in an administrative proceeding.  In so doing, the SEC used newly granted authority under the Dodd-Frank Act to seek civil penalties in an insider trading case.  Mr. Guta has now sued the SEC, claiming the provisions of the Dodd-Frank Act cannot be applied retroactively.  According to Mr. Guta’s complaint:  “Against the history of Galleon-related actions for civil penalties already brought in this Court, there is no benign and non-discriminatory explanation for the Commission’s applying Dodd-Frank retroactively against Mr. Gupta, or more generally for filing the action against him administratively, rather than in federal court, as it has invariably done with similarly situated defendants. To the contrary, the only plausible inference is that the Commission is proceeding how and where it is against Mr. Gupta for the bad faith purpose of shoring up a meritless case by disarming its adversary.”

The complaint also attempts to infer misconduct by the SEC:  “Counsel for Mr. Gupta emailed to the Staff of the Enforcement Division a 35-page Wells submission on behalf of Mr. Gutpa at approximately 10:45 p.m. on Friday, February 25, 2011. Hard copies of the submission were, with the Staffs permission, not delivered until the morning of Monday, February 28, 2011. Yet by that Monday afternoon, the Staff had purportedly received authorization from the Commission to proceed against Mr. Gupta—even though there is no public record of the Commission meeting to consider thoroughly the submission Mr. Gupta was invited to, and did, submit. As a result, Mr. Gupta was deprived of the chance to have his submission scrutinized in a deliberate fashion by its intended audience—the five Commissioners.”

See this case for factors the court may consider on whether the Dodd-Frank Act can be applied retroactively.

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

 

The Financial Stability Oversight Council, or FSOC, convened its fourth meeting today at the U.S. Department of the Treasury.  At the meeting the FSOC approved a Notice of Proposed Rulemaking, or NPR, regarding designations of financial market utilities for heightened supervision and an NPR on the FSOC’s FOIA Regulations.

Section 804 of the Dodd-Frank Act gives the FSOC the authority to identify and designate as systemically important a financial market utility, or FMU, if the FSOC determines that its failure or disruption could create or increase the risk of significant liquidity or credit problems spreading among financial institutions or markets and thereby threaten the stability of the U.S. financial system.  An FMU designated by the FSOC as systemically important would become subject to the heightened prudential and supervisory provisions of Title VIII of the Dodd-Frank Act.

Through this proposed rule, the FSOC is seeking to gather additional information to inform the rule by which it will designate FMUs as systemically important. This is the second step in the FSOC’s rulemaking process for designating systemically important FMUs.  An advance notice of proposed rulemaking was discussed and approved for public comment at the FSOC’s November meeting.  The NPR will have a 60-day public comment period, with FSOC action on the final rule expected later this year. 

Section 112 of the Dodd-Frank Act provides that the Freedom of Information Act (FOIA), including the exceptions thereunder, shall apply to any data or information submitted to the FSOC.  This NPR would implement the requirements of the FOIA as applied to the FSOC by setting forth procedures for requesting access to FSOC records. 

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

Section 766 of the Dodd-Frank Act amends the Securities Exchange Act by adding Section 13(o), which provides that “[f]or purposes of this section and section 16, a person shall be deemed to acquire beneficial ownership of an equity security based on the purchase or sale of a security-based swap, only to the extent that the SEC, by rule, determines after consultation with the prudential regulators and the Secretary of the Treasury, that the purchase or sale of the security-based swap, or class of security-based swap, provides incidents of ownership comparable to direct ownership of the equity security, and that it is necessary to achieve the purposes of this section that the purchase or sale of the security-based swaps, or class of security-based swap, be deemed the acquisition of beneficial ownership of the equity security.”  Section 766 and Section 13(o) become effective on July 16, 2011.

The reason for this rulemaking is to preserve the existing scope of SEC rules relating to beneficial ownership after Section 766 of the Dodd-Frank Act becomes effective. Absent rulemaking under Section 13(o), Section 766 may be interpreted to render the beneficial ownership determinations made under Rule 13d-3 inapplicable to a person who purchases or sells a security-based swap. In that circumstance, it could become possible for an investor to use a security-based swap to accumulate an influential or control position in a public company without public disclosure. Similarly, a person who holds a security-based swap that confers beneficial ownership of the referenced equity securities under Section 13 and existing Rule 13d-3, or otherwise conveys such beneficial ownership through an understanding or relationship based upon the purchase or sale of the security-based swap, may no longer be considered a ten percent holder subject to Section 16 of the Exchange Act.  Further, an insider may no longer be subject to Section 16 reporting and short-swing profit recovery through transactions in security-based swaps that confer a right to receive either the underlying equity securities or cash.  In addition, private parties may have difficulty making, or exercising private rights of action to seek to have made, determinations of beneficial ownership arising from the purchase or sale of a security-based swap. To preserve the application of the SEC’s existing beneficial ownership rules to persons who purchase or sell security-based swaps after the effective date of Section 13(o), the SEC is proposing to readopt without change the relevant portions of Rules 13d-3 and 16a-1.

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In written testimony before the House Subcommittee on Financial Institutions and Consumer Credit Committee on Financial Services, Elizabeth Warren commented on the Consumer Financial Protection Bureau’s priorities.

One area of focus will be mortgages.  The CFPB is working to eliminate some of the confusing and duplicative paperwork that consumers receive during the home loan process, moving toward a much simpler, shorter document that clearly spells out the information that consumers need when making the important decision to take out a mortgage.

Warren also stated credit cards will be an area of focus.  Professor Warren believes making credit cards easier to understand and compare can also spur innovation.  Instead of producing ever-more-complicated cards with more hidden fees and surprises, Professor Warren’s testimony stated card issuers would have additional incentives to produce innovations that are attractive to customers.  Competition would flourish, according to Professor Warren, but in ways that consumers can see – better customer service or lower or more predictable prices.

The CFPB will also focus on consumer education.  The Dodd-Frank Act required the CFPB to establish an Office of Financial Education.  Professor Warren stated this office will be a 21st-century resource for consumers who are looking to better understand how different products and services work, and will provide access to tools and information that can help consumers select the products that are best for them.

The CFPB will also process consumer complaints.  Later this year, the consumer bureau will also launch a consumer response center to receive complaints and to help consumers find answers for questions about consumer financial products and services.  As of March 1, 2011, the CFPB had received approximately 300 complaints.  Most of the complaints received fall into four categories.  Mortgages and home loan complaints account for about one-half of the total.  Credit cards are the subject of about 20 percent of the total complaints.  The other two large sources of complaints are deposit products and other consumer loan products, which each account for about five percent of the total.  Together, these four categories comprise approximately 80 percent of the complaints received.

Finally, the CFPB will focus on enforcement.  One of the CFPB’s chief responsibilities will be to supervise certain non-bank financial companies that provide consumer financial products and services.  These include mortgage brokers, mortgage lenders, mortgage servicers, payday lenders, and private student loan providers.  This will be the first time that many of these non-bank financial services companies will be subject to federal compliance examinations.

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

Pursuant to the Dodd-Frank Act, the FTC is authorized to prescribe rules under Section 553 of the Administrative Procedure Act, or APA, with respect to unfair or deceptive acts or practices by motor vehicle dealers. To explore consumer protection issues pertaining to motor vehicle sales and leasing, the FTC has given notice of its intent to host a series of public roundtables in 2011. The roundtables will provide an opportunity for regulators, consumer advocates, industry participants, and other interested parties to discuss consumer protection issues in connection with motor vehicle sales and leasing.

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

 

In remarks given to the Futures Industry Association, CFTC Chairman Gary Gensler outlined the process for finalizing CFTC rules related to the Dodd-Frank Act.

 Mr. Gensler noted the CFTC still needs to propose rules related to capital and margin, product definitions and the Volcker Rule. 

 

Some rules are slated for early finalization.  Mr. Gensler noted:

  • This group may include the entity definitions rule and the associated swap dealer and major swap participant registration requirements. It also may include a final rule on the end-user exception from clearing.
  • There are two process rules that the CFTC has discussed finalizing early. These relate to the process for mandatory clearing and Part 40 for rule submissions from clearinghouses and exchanges.
  • The CFTC is also discussing finalizing the large trader reporting rule early, as it is important for the CFTC to accomplish many of its surveillance and position limits initiatives.
  • The CFTC may look to consider some of the rules relating to enforcement, such as the whistleblower rule and the anti-manipulation rule, in the early group.
  • There are also some rules that CFTC proposed early in the process and thus may be ready soonest for Commission consideration. These include the fair credit reporting rule, consumer information privacy rules, conflicts of interest, removing references to credit rating agencies and the related revisions of Rule 1.25 and the definition of agricultural commodities.

 

Gensler described a set of rule clusters he referred to as the “middle group:”

  • Rules relating to clearinghouses, such as risk management, financial resources, participant eligibility, recordkeeping and straight-through processing.
  • Rules relating to business conduct standards for swap dealers – both internal and external. This includes rules related to sales practices, trading documentation, confirmation, portfolio reconciliation and compression requirements, recordkeeping, conflicts of interest and risk management.
  • Rules relates to data. It includes rules governing swap data repositories (SDRs) and swap data recordkeeping and reporting requirements.
  • Regulations for trading platforms, such as designated contract markets (DCMs), swap execution facilities (SEFs) and foreign boards of trade, as well as real-time reporting and block trading rules.
  • There are a number of other rules that might be included in this middle phase. These include agricultural swaps, governance for DCOs, DCMs and SEFs, and segregation for uncleared swaps.
  • Rule relates to position limits. 

Finally, Gensler described the “late group.”  This group could include the disruptive trading practices interpretive order, product definitions, capital and margin requirements, supervision and testing requirements and conforming rules.  In addition, amongst the late rules, the CFTC may consider finalizing the joint rule with the SEC regarding reporting requirements for investment advisors as well as the CFTC’s similar rule on commodity pool operators.   Rules in the late group probably will not be considered until the late summer and early fall.

 

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

The Board of Directors of the Federal Deposit Insurance Corporation, or FDIC, approved a Notice of Proposed Rulemaking, or NPR, to further clarify application of the orderly liquidation authority, or OLA, contained in Title II of the Dodd-Frank Act. The FDIC believes the NPR builds on the interim rule approved by the FDIC on January 18, 2011, which clarified certain discrete issues under the OLA. The NPR establishes a comprehensive framework for the priority payment of creditors and for the procedures for filing a claim with the receiver and, if dissatisfied, pursuing the claim in court.  According to the FDIC, the NPR also clarifies additional issues important to the implementation of the OLA, including how compensation will be recouped from senior executives and directors who are substantially responsible for the failure of the firm.  The NPR, along with the interim final rule, is intended by the FDIC to provide clarity and certainty about how key components of OLA will be implemented and to ensure that the liquidation process under Title II reflects the Dodd-Frank Act’s mandate of transparency in the liquidation of covered financial companies.

In addition to the priority of claims and the procedures for filing and pursuing claims, the NPR defines the ability of the receiver to recoup compensation from persons who are substantially responsible for the financial condition of the company under Section 210(s) of the Dodd-Frank Act.  Before seeking to recoup compensation, the receiver will consider whether the senior executive performed his or her responsibilities with the requisite degree of skill and care, and whether the individual caused a loss that materially contributed to the failure of the financial company. However, for the most senior executives, including those performing the duties of CEO, COO, CFO, as well as the Chairman of the Board, there will be a presumption that they are substantially responsible and thus subject to recoupment of up to two years of compensation. An exception is created for executives recently hired by the financial company specifically for improving its condition. 

The NPR also ensures that the preferential and fraudulent transfer provisions of the Dodd-Frank Act are implemented consistently with the corresponding provisions of the Bankruptcy Code. The proposed rule conforms to the interpretation provided by the FDIC General Counsel in December 2010. 

Finally, the NPR clarifies the meaning of “financial company” under OLA. Under the proposal, a financial company will be defined as “predominantly engaged” in financial activities if their organization derived at least 85 percent of its total consolidated revenue from financial activities over the two most recent fiscal years. This rule will enhance certainty about which financial companies could be subject to resolution under OLA. 

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