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| | ______January 19, 2010 | | Volume 5, No. 3 |
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| Insights from Winston & Strawn |
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As we have reported in recent briefings, on December 11, 2009, the U.S. House of Representatives passed the Wall Street Reform and Consumer Protection Act of 2009, which included a component entitled the Private Fund Investment Advisers Registration Act of 2009 (the "Registration Act"). The Registration Act would require most advisers to hedge funds, private equity funds and other private funds to register as investment advisers under the Investment Advisers Act of 1940, as amended (the "Advisers Act"). While the Registration Act represents the view of the House on these issues, it will have to be reconciled with whatever legislation is finally passed in the Senate. Briefing.
While the Registration Act does provide for some exemptions to registration, the number of new registrants is certain to overwhelm the Securities and Exchange Commission ("SEC"). We can all agree that we would like the SEC to be in a position to uncover the next Bernard Madoff but requiring registration is only the first step (recall that Mr. Madoff's firm was registered under the Advisers Act). It is arguably more important for the SEC to have the expertise and resources necessary to sufficiently monitor and examine registrants.
If one of the main goals of this new legislation is to monitor advisers that pose a systemic risk, we may be better served to focus less on additional registrants and more on monitoring and auditing those advisers to private funds that could truly have an impact on the financial system, whether as a result of their size, use of leverage or involvement with counterparties. For example, the Registration Act provides an exemption from registration for advisers to "venture capital funds." The House declines to define the term "venture capital fund" and delegates this difficult task to the SEC. If one assumes that venture capital funds warrant an exemption because the typical venture capital fund does not utilize significant amounts of leverage, it seems that there are other private equity funds (venture capital funds are typically viewed as a subset of private equity funds) and even some hedge funds that should also be exempt under this reasoning. Furthermore, if the strategy employed by venture capital funds is another reason behind this exemption, arguably all private equity funds should be exempt. The Registration Act also provides for an exemption for advisers that have less than $150 million in assets under management. While higher than many proposals, this threshold still seems low if we are talking about "systemic risk."
While it is true that it is difficult to predict where the next crisis is hiding, the Registration Act also gives the SEC the power to require reporting from unregistered investment advisers. Additional reporting obligations for certain unregistered investment advisers could help bridge the gap so that the SEC can monitor trends and potential risks of unregistered advisers while focusing most of their attention and resources on advisers that are more likely to pose a threat to the financial system.
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| In the News |
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- Senate Committee May Omit Consumer Financial Protection Agency.
The Senate Banking Committee may omit a proposed consumer financial protection agency from its financial regulatory reform bill. In an effort to obtain bipartisan support, Committee Chairman Senator Christopher Dodd will consider eliminating the proposed agency if existing regulators receive increased authority to monitor consumer protection measures. Consumer Protection. - Financial Crisis Responsibility Fee Proposed.
On January 14th, the Obama Administration proposed a Financial Crisis Responsibility Fee that would require financial firms with more than $50 billion in consolidated assets, to pay $90 billion over 10 years. Covered institutions would include insured depository institutions, bank holding companies, thrift holding companies, insurance or other companies that owned insured depository institutions, and securities broker-dealers. The corresponding U.S. subsidiaries of a foreign firm that aggregate more than $50 billion of assets would also be subject to the fee. Financial Crisis Responsibility Fee. - Financial Crisis Inquiry Committee Holds Hearings.
On January 13th and 14th, the Financial Crisis Inquiry Committee held its first public hearings. The prepared statements of the Committee's commissioners and witnesses are available on the Committee's website, www.fcic.gov/hearings/. Witnesses included SEC Chairman Mary L. Schapiro, who stated that the SEC staff is broadly reviewing the regulation of asset-backed securities including disclosures, offering process, and reporting of asset-backed issuers. The staff is also considering several proposed changes designed to enhance investor protection. Schapiro Testimony. The Committee will seek testimony from Federal Reserve Board Chairman Ben Bernanke, as well as former regulators including Alan Greenspan and Christopher Cox. Future Witnesses. Lanny A. Breuer, assistant attorney general in the Justice Department's criminal division, testified that the division is investigating the underwriters of subprime mortgages as well as those who securitized and sold them. Criminal Investigations. - Special Bankruptcy Court Considered for Financial Firms.
The Senate Banking Committee is considering the establishment of a special bankruptcy court for financial firms as part of its regulatory reform measures. Bankruptcy.
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| Banking Agency Developments |
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- FDIC Advisory Committee on Community Banking to Meet.
On January 13th, the FDIC announced that the Advisory Committee on Community Banking will meet in Washington, DC. on January 28th. The Committee will provide advice and recommendations on a broad range of policy issues that have a particular impact on small community banks throughout the United States and the local communities that they serve, with a focus on rural areas. 75 FR 1784. - Federal Reserve Board Approves New Credit Card Rules.
On January 12th, the Federal Reserve Board approved a final rule amending Regulation Z (Truth in Lending) to protect consumers who use credit cards. Credit card issuers must comply with most aspects of the rule beginning on February 22, 2010. Among other things, the rule limits unexpected increases in credit card interest rates by generally prohibiting increases in a rate during the first year after an account is opened and increases in a rate that applies to an existing credit card balance; prohibits the issuance of a credit card to a consumer who is younger than the age of 21 unless the consumer has the ability to make the required payments or obtains the signature of a parent or other cosigner; requires creditors to obtain a consumer's consent before charging fees for transactions that exceed the credit limit; limits the high fees associated with subprime credit cards; bans creditors from using the "two-cycle" billing method; and prohibits creditors from allocating payments in ways that maximize interest charges. Federal Reserve Board Press Release (with links to the text of the final amendments). - FDIC Proposes Linking Executive Compensation to Insurance Assessments.
On January 12th, the FDIC published an Advance Notice of Proposed Rulemaking on whether certain employee compensation structures pose risks that should be captured in the deposit insurance assessment program. FDIC Press Release. Comptroller of the Currency John C. Dugan and OTS Acting Director John Bowman both oppose the proposal. Opposition. - OCC Issues Examination Procedures for Tenants Protection Act.
On January 8th, the OCC issued examination procedures for the Protecting Tenants at Foreclosure Act of 2009, which was effective May 20, 2009, and will expire on December 31, 2012. OCC Bulletin 2010-2.
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| Treasury Department Developments |
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- FinCEN Issues Ruling on Address Confidentiality Programs.
On January 12th, the Financial Crimes Enforcement Network published its November 3, 2009 Ruling on customer identification requirements as they relate to customers who are issued a post office box address as part of their participation in a state-run address confidentiality program ("ACP"). In an effort to support states that have established an ACP, FinCEN authorizes the following exception to the requirement that a financial institution obtain a customer's residential or business street address: a customer who participates in a state-created ACP shall be treated as not having a residential or business street address and a secretary of state, or other state entity serving as a designated agent of the customer consistent with the terms of the ACP, will act as another contact individual for the purpose of complying with FinCEN's rules. Therefore, a financial institution should collect the street address of the ACP sponsoring agency for purposes of meeting its CIP address requirement. FIN-2009-R003.
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| Commodity Futures Trading Commission |
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- CFTC Proposes Energy Market Position Limits.
On January 14th, the CFTC voted to propose for comment position limits for futures and option contracts in the major energy markets. In addition, the proposed rules would establish consistent, uniform exemptions for certain swap dealer risk management transactions, while maintaining exemptions for bona fide hedging. Energy Rule Fact Sheet. See also Questions and Answers.
As of now the CFTC enforces Federal position limits on certain agricultural commodities and under the current Commodity Exchange Act the CFTC has only the jurisdiction to impose position limits on futures contracts, i.e., commodity derivatives that typically trade on regulated exchanges. The CFTC decided to impose Federal position limits on energy contracts to: (1) reduce the likelihood of another sharp increase in energy prices; (2) respond to legislators' demands to put regulatory breaks on perceived excessive speculation in energy contracts; (3) promote transparency; (4) simplify position aggregation procedures; and (5) streamline the definitions and the process for obtaining exemptions from hard position limits. At this time the exchanges only impose "hard" position limits on trading during the spot month (i.e., delivery month) and apply "soft" accountability levels on all other months. Federal position limits will apply across all exchanges, to all economically similar contracts and with respect to all months, not only the spot months. Several CFTC commissioners have expressed concerns that imposing "hard" Federal position limits will drive the trading into the OTC market or entirely offshore. They suggested that better timing for this rule would be: (a) after the proposed derivatives bill (such as H.R. 4173) is enacted into law; (b) after the CFTC has jurisdiction to also impose position limits on OTC positions; and (c) after the U.S. reaches agreements with international regulators to prevent the trading in these energy contracts from moving offshore. Comments are due in 90 days. - CFTC Proposes Off-Exchange Retail Forex Regulations.
On January 13th, the CFTC announced that it will publish for comment proposed regulations concerning off-exchange retail foreign currency transactions. The proposed regulations include registration, disclosure, recordkeeping, financial reporting, minimum capital, and other operational standards. The proposed regulations also include financial requirements. Leverage in retail forex customer accounts would be subject to a 10-to-1 limitation. All retail forex counterparties and intermediaries would be required to distribute forex-specific risk disclosure statements to customers and comply with comprehensive recordkeeping and reporting requirements. CFTC Release No. 5772-10.
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| Securities and Exchange Commission |
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New Final Rules
- SEC Adopts TARP Compensation Proxy Amendments.
On January 12th, the SEC published the adopting release and text of amendments to the proxy rules under the Securities Exchange Act of 1934, setting forth certain requirements for U.S. registrants subject to Section 111(e) of the Emergency Economic Stabilization Act of 2008. Section 111(e) requires companies that have received financial assistance under the Troubled Asset Relief Program to hold a separate shareholder advisory vote on executive compensation. The amendments implement this requirement by specifying and clarifying it in the context of the federal proxy rules. The amendments are effective 30 days after publication in the Federal Register, which is expected during the week of January 18. SEC Release No. 34-61335. Requests for Comment
- SEC Votes to Propose Rule Prohibiting Naked Sponsored Access.
On January 13th, the SEC voted to propose for comment amendments that would effectively prohibit broker-dealers from providing customers with "unfiltered" or "naked" access to an exchange or alternative trading system. The SEC also approved a new Nasdaq rule that requires broker-dealers offering sponsored access to Nasdaq to establish certain controls over the financial and regulatory risks of that activity. SEC Press Release. See also Schapiro Open Meeting Remarks; Walter Open Meeting Remarks; Paredes Remarks. On January 15th, Bloomberg reported that the SEC's proposal may cause high-speed traders to register as broker-dealers. Registration. The SEC also approved a new Nasdaq rule requiring broker-dealers offering sponsored access to Nasdaq to establish certain controls over the financial and regulatory risks of that activity. Other Developments
- SEC Announces Initiative to Encourage Individuals and Companies to Cooperate and Assist in Investigations.
On January 13th, the SEC announced a series of measures to strengthen its enforcement program by encouraging greater cooperation from individuals and companies in the agency's investigations and enforcement actions. First, the Division of Enforcement is authorizing its staff to use various tools to encourage individuals and companies to report violations and provide assistance to the agency. The new tools include Cooperation Agreements, Deferred Prosecution Agreements, and Non-prosecution Agreements. Second, the SEC streamlined the process for submitting witness immunity requests to the Justice Department. Third, the Commission has set out the way in which it will evaluate whether, how much, and in what manner to credit cooperation by individuals to ensure that potential cooperation arrangements maximize the Commission's law enforcement interests. In a newly issued policy statement, the SEC identifies four general considerations: the assistance provided by the cooperating individual, the importance of the underlying matter in which the individual cooperated, the societal interest in ensuring the individual is held accountable for his or her misconduct, and the appropriateness of cooperation credit based upon the risk profile of the cooperating individual. SEC Press Release. See also Delegation of Authority (SEC delegates to the Director of the Division of Enforcement the authority to submit witness immunity order requests to the Department of Justice). - Enforcement Division Names Specialized Unit Chiefs.
On January 13th, the Enforcement Division named the leaders of the national specialized units that it has established in five priority areas dedicated to particular highly specialized and complex areas of securities law. The new Office of Market Intelligence will be led by Thomas A. Sporkin; the Asset Management unit will be led by Co-Chiefs Bruce Karpati and Robert B. Kaplan; the Market Abuse unit will be led by Daniel M. Hawke; the Market Abuse Unit Deputy Chief will be Sanjay Wadhwa; the Structured and New Products unit will be led by Kenneth R. Lench; the Structured and New Products Unit Deputy Chief will be Reid A. Muoio; the Foreign Corrupt Practices unit will be led by Cheryl J. Scarboro; the Municipal Securities and Public Pensions unit will be led by Elaine C. Greenberg; and the Municipal Securities and Public Pensions Unit Deputy Chief will be Mark R. Zehner. SEC Press Release.
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| Exchanges and Self-Regulatory Organizations |
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Chicago Board Options Exchange
- Rule Change Regarding DPMs Is Approved.
On January 12th, the SEC granted accelerated approval to the Chicago Board Options Exchange's proposed amendment of Rule 8.91 - Limitations on Dealings of DPMs and Affiliated Persons of DPMs. SEC Release No. 34-61336. - Proposal for Concurrent Listing of Strike Prices Is Immediately Effective.
On January 12th, the SEC granted immediate effectiveness to the Chicago Board Options Exchange's proposal for concurrent listing of $3.50 and $4 strikes for classes in both the $0.50 Strike and $1 Strike Programs. Comments should be submitted within 21 days after publication in the Federal Register, which is expected during the week of July 18. SEC Release No. 34-61331. Depository Trust Company
- Settlement Progress Payment and Principal and Income Withdrawal Cutoff Times Extended.
On January 8th, the SEC granted immediate effectiveness to the Depository Trust Company's proposed extension of the cutoff times for participants to request the return of Settlement Progress Payments, and the withdrawal of Principal and Income, to 3:20 p.m. eastern time. Comments should be submitted on or before February 5, 2010. SEC Release No. 34-61318. Financial Industry Regulatory Authority
- SEC Approves Consolidated Clearly Erroneous Transaction Rules.
On January 15th, the Financial Industry Regulatory Authority announced that the SEC has approved FINRA's proposed new rules governing clearly erroneous transactions. The new FINRA Rule 11890 Series replaces NASD Rule 11890, IM-11890-1 and IM-11890-2, and is part of a market-wide effort by multiple self-regulatory organizations to provide transparency and finality with respect to clearly erroneous executions. The new FINRA rules include: (1) a general rule defining the term "clearly erroneous" (Rule 11891), with accompanying supplementary material; (2) a rule governing clearly erroneous determinations for transactions in exchange listed securities (Rule 11892), with accompanying supplementary material; (3) a rule governing clearly erroneous determinations for transactions in OTC Equity Securities (Rule 11893), with accompanying supplementary material; and (4) a rule governing the review by the FINRA staff's Uniform Practice Code Committee that a transaction was clearly erroneous (Rule 11894). The new rules are effective February 15th. Regulatory Notice 10-04. - Books and Records Rule Adopted in Consolidated Rulebook.
On January 12th, the SEC approved the Financial Industry Regulatory Authority's proposal to adopt NASD Rule 3121 (Custodian of the Record), with minor technical changes, as FINRA Rule 4570 (Custodian of Books and Records) in the Consolidated FINRA Rulebook. SEC Release No. 34-61332. - FINRA Proposes Rule 3240 (Borrowing From or Lending to Customers).
On January 6th, the SEC published a proposal by the Financial Industry Regulatory Authority to adopt NASD Rule 2370 (Borrowing From or Lending to Customers) as FINRA Rule 3240 in the Consolidated FINRA Rulebook, with certain changes, and to delete Incorporated NYSE Rules 352(e), (f) and (g). The proposal also would add Supplementary Material regarding record retention requirements. Comments should be submitted on or before February 2, 2010. SEC Release No. 34-61302. International Securities Exchange
- Forex Market Maker Incentive Plan Is Immediately Effective.
On January 12th, the SEC granted immediate effectiveness to the International Securities Exchange's proposal relating to a market maker incentive plan for foreign currency options. Comments should be submitted within 21 days after publication in the Federal Register which is expected during the week of January 18. SEC Release No. 34-61334. International Swaps and Derivatives Association
- ISDA Launches Japan Corporate Calculation Agent City Protocol.
On January 12th, the International Swaps and Derivatives Association announced the launch of the 2010 Japan Corporate Calculation Agent City Protocol. The purpose of the Protocol is to enable parties to update the provisions of legacy single name Japan Corporate CDS transactions to match current trades. ISDA Press Release. New York Stock Exchange
- NYSE Regulation Delays Implementation of New Gap Quote Policy.
On January 11th, NYSE Regulation advised that it is delaying until further notice, the implementation of Information Memo 10-03 (January 7, 2010). That Information Memo described changes to the New York Stock Exchange and NYSE Amex Equities Gap Quote Policies. All requirements of the current policies, including the minimum size and value requirements of 10,000 shares or $200,000 in value, will continue to apply until further notice. See Information Memo 07-66 (July 5, 2007). Information Memo 10-06. - NYSE Regulation Adopting new System for Secure Communications.
On January 11th, NYSE Regulation advised members that it is introducing a new system for the secure transmission of certain electronic communications in order to ensure greater protection of certain confidential information. NYSE Regulation Information Memo 10-05. - NYSE Regulation Advises of SEC Fee Rate Changes.
On January 11th, NYSE Regulation advised members that the SEC has announced changes to certain fees charged to registered broker-dealers and other market participants pursuant to the Securities Act of 1933 and the Securities Exchange Act of 1934. The changes took effect on January 15, 2010. NYSE Regulation Information Memo 10-04. NYSE Amex
- New Class of Market Participants Established.
On January 7th, the SEC granted immediate effectiveness to NYSE Amex's proposed establishment of a new class of NYSE Amex Equities market participants referred to as "Supplemental Liquidity Providers" ("SLPs"). SLPs will supplement the liquidity provided by Designated Market Makers. SLPs will only be permitted to enter orders electronically from off the exchange floor, directly into exchange systems and facilities designated for this purpose. All SLP orders must be for a proprietary account; SLPs will not handle orders from public customers. Comments should be submitted on or before February 5, 2010. SEC Release No. 34-61308.
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| Federal Court Developments |
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- Reliance on Unauthenticated and Inadmissible Evidence Ends CFTC Market Manipulation Case.
On January 14th, the Fifth Circuit affirmed a trial court's entry of judgment as a matter of law in favor of a defendant whom the CFTC accused of attempting to manipulate the natural gas market and knowingly delivering false reports tending to affect the natural gas market price. The evidence upon which the CFTC relied was not properly authenticated and admissible as business records. The CFTC never called as a witness a person who could authenticate the records or who could testify as to whether the records were kept in the ordinary course of business as required by Federal Rule of Evidence 803(6). Without those records, the evidence did not support a finding that defendant violated the Commodity Exchange Act. CFTC v. Dizona. - SEC Failed to Establish a Causal Connection Between a Registered Representative's NASD Rule Violations and the Investors' Losses.
On January 12th, the D.C. Circuit found that a petitioner violated NASD rules when he engaged in securities transactions on behalf of two clients without telling his employer. The Court further upheld the fines and suspensions imposed for those rule violations. However, the Court granted the petition challenging the SEC order imposing restitution. In the instant case, sophisticated investors willingly sought to invest their money in a highly speculative venture involving a start-up company that eventually failed. The SEC failed to establish a causal connection between petitioner's violations and the investors' losses. The SEC's judgment awarding full restitution was neither adequately explained nor supported by agency precedent. Siegel v. SEC. - Securitization Rights and Champerty.
On January 11th, the Second Circuit held that a trust holding securitized commercial mortgages did not engage in champerty when it sued the originator of a defaulted mortgage for breaches of various representations and warranties. Defendant asserted the defense of champerty because the trust was assigned the right to sue as part of a settlement with the firm funding the defaulted loan. After the issue was certified to state court, the Second Circuit held that the trial court record did not support a finding of champerty. The trust already had an interest in the loan prior to the assignment, and there was no evidence the trust intended to generate new litigation costs by suing the originator. It is not champerty to acquire indemnification rights for reasonable costs and fees that were incurred in past legal actions. Trust v. Love Funding Corp. - Non-Recorded Mortgage Is Avoidable.
On January 11th, the Eighth Circuit held that a bankruptcy court properly awarded summary judgment to the bankruptcy trustee in a suit seeking to avoid as a preferential transfer, the pre-petition transfer of a mortgage from the debtor to the bank. Because the bank failed to record the home mortgage prior to the borrower's filing of a Chapter 7 bankruptcy petition, Section 547(e)(2)(C) of the Bankruptcy Code deemed the transfer of the mortgage to have occurred immediately before the debtor filed his bankruptcy petition. Wells Fargo Home Mortgage, Inc. v. Lindquist.
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| Rules Effective Dates |
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- Amendments to Rules for Nationally Recognized Statistical Rating Organizations - Effective February 1, 2010.
The SEC is adopting rule amendments that impose additional
disclosure and conflict of interest requirements on nationally recognized statistical rating organizations ("NRSROs") in order to address concerns about the integrity of the credit rating procedures and methodologies at NRSROs. 74 FR 63831. - Proxy Disclosure Enhancements - Effective February 28, 2010.
The SEC is adopting rule amendments that will enhance information provided in connection with proxy solicitations and in other reports filed with the Commission. The amendments will require registrants to make new or revised disclosures about: compensation policies and practices that present material risks to the company; stock and option awards of executives and directors; director and nominee qualifications and legal proceedings; board leadership structure; the board's role in risk oversight; and potential conflicts of interest of compensation consultants that advise companies and their boards of directors. The amendments to disclosure rules will be applicable to proxy and information statements, annual reports and registration statements under the Securities Exchange Act of 1934, and registration statements under the Securities Act of 1933 as well as the Investment Company Act of 1940. The SEC is also transferring from Forms 10-Q and 10-K to Form 8-K the requirement to disclose shareholder voting results. 74 FR 68333. - Custody of Funds or Securities of Clients by Investment Advisers - Effective March 12, 2010.
The SEC is adopting amendments to the custody and recordkeeping rules under the Investment Advisers Act of 1940 and related forms. The amendments are designed to provide additional safeguards under the Advisers Act when a registered adviser has custody of client funds or securities by requiring such an adviser, among other things: to undergo an annual surprise examination by an independent public accountant to verify client assets; to have the qualified custodian maintaining client funds and securities send account statements directly to the advisory clients; and unless client assets are maintained by an independent custodian (i.e., a custodian that is not the adviser itself or a related person), to obtain, or receive from a related person, a report of the internal controls relating to the custody of those assets from an independent public accountant that is registered with and subject to regular inspection by the Public Company Accounting Oversight Board. Finally, the amended custody rule and forms will provide the SEC and the public with better information about the custodial practices of registered investment advisers. 75 FR 1455.
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| Winston & Strawn Speaking Engagements and Publications |
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- SEC Approves Proposal for Risk Management Controls for Direct Access Brokers and Issuance of Concept Release on Equity Market Structure.
On January 13th, the Securities and Exchange Commission held an open meeting at which the Commissioners voted unanimously to: (1) propose a new rule regarding risk management controls and supervisory procedures to manage financial, regulatory, and other risks, for brokers or dealers that provide their customers with unfiltered direct access to exchanges and/or alternative trading systems; and (2) publish a "Concept Release" on equity market structure that would invite public comment on a wide range of issues, including the performance of the current market structure, high-frequency trading, and undisplayed liquidity. Briefing. - SEC Approves Proposal Nasdaq Proposal to Improve Regulation of Sponsored Access.
On January 13th, the Securities and Exchange Commission approved a proposal by the Nasdaq Stock Market LLC to modify its rule governing electronic access to Nasdaq's order execution systems. As modified, Nasdaq Rule 4611 will govern the manner in which a Nasdaq member provides another entity with access to Nasdaq order execution systems using the member's market participant identifier. Briefing.
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