Wednesday, October 01, 2014

Four Senators Urge SEC to Quickly Finalize General Solicitation Investor Protection Rules

Four U.S. Senators urged the SEC to act promptly and without further delay to finalize and strengthen proposed investor protections for private securities offerings in the wake of the Commission’s rule allowing general solicitation and advertising of private securities offerings under Regulation D. A year ago the SEC implemented the JOBS Act ending of the ban on general solicitations and, so, for the last year, issuers have been allowed to use highway billboards, internet advertisements, cold calls to senior living centers, and promotional T-shirts to market their securities to investors, with no education for investors and limited disclosure of risks. In a letter to SEC Chair Mary Jo White, Senators Elizabeth Warren (D-MA), Jack Reed (D-RI), Carl Levin (D-MI) and Ed Markey (D-MA) expressed deep concern that, for the last year the Commission has allowed private securities offerings to take place using general solicitation and advertising without adequate investor protections.

Two safeguards are especially important and should be adopted without further delay, said the Senators. First, general solicitation materials that will be used by issuers, especially for private investment funds, should be filed with the Commission, and should contain risk disclosures. Such requirements will provide the Commission and other regulators with a more complete understanding of the general solicitation landscape, they noted, and will deter misleading advertisements.

Mutual funds, which generally are less risky to investors than private securities offerings, are required to submit advertising materials for review by regulators and are required to include specific risk disclosures in their advertisements. The Senators believe that private securities offerings, especially for private investment funds, should be subject, at minimum, to the same standards as mutual funds. They noted that similar requirements for submission of materials and uniform disclosure of past performance were recommended by the Commission’s Investor Advisory Committee in 2012.

Second, issuers should be required to file a Form D before engaging in general solicitation, and those who engage in general solicitation without filing the required Form D registration form, or who file improperly, should not be allowed to rely upon the Securities Act registration exemption until corrective action is taken. In the view of the Senators, current rules, coupled with lax enforcement, have resulted in an environment where there are few, if any, meaningful consequences for issuers that fail to file a Form D in a timely manner.

Form D is an important tool for federal and state securities regulators to be able to track and monitor offerings, and to target surveillance and education efforts appropriately. Without it, fear the legislators, a regulator’s first sign of a problematic offering may be a phone call from an investor who faces a lost retirement. The current regulation does not require a Form D to be filed until two weeks after an offering has commenced, and for many offerings, provides little incentive to file at all. Requiring pre-filing and adding a real consequence for failing to properly file with the Commission, such as the potential loss of the issuer’s Securities Act exemption, would provide better information to regulators and a much-needed incentive for issuers to comply with the filing requirements.

Tuesday, September 30, 2014

New Mexico Proposes Crowdfunding Exemption

[This story previously appeared in Securities Regulation Daily.]

By Jay Fishman, J.D.

The New Mexico Regulatory and Licensing Department, Securities Division, proposed crowdfunding exemption rules to bring local issuers and state residents together for capital raising through community investing. The Securities Division, to promote crowdfunding, would remove some of the restrictions that typically apply to exemptions and registrations.

A summary of the proposed crowdfunding rule provisions is here.

Sunday, September 28, 2014

Barnier Says Fight for Regulatory Convergence Must Continue with New E.U. Commission

As his tenure as E.U. Financial Services Commissioner winds down, Commissioner Michel Barnier called on his prospective successor, Lord Hill, to continue the effort to have mandated cross-border financial regulatory convergence included in the trade talks with the United States and convince U.S. regulatory partners that this approach will not lower standards but will achieve greater financial stability. In remarks at the Eurofi Financial Forum, he noted that the objectives of global convergence and deference to other jurisdictions are broadly shared. This is the only sensible way forward, he emphasized, as the key to efficient financial markets is for global financial regulators to cooperate, trust and rely on each other.

Regarding derivatives, Commissioner Barnier said that the Path Forward with the CFTC, agreed in July 2013, sets the foundations, both for the EMiR and the MiFID rules. His office is now in near daily discussions with the CFTC and its Chair Tim Massad on the details. The E.U. wants to find practical solutions in the coming weeks, he said, but noted that it takes two to tango. The American side must also deliver, he explained.

He called for a similar cooperative Framework for cross-border resolution of failed financial firms. The U.S. has Title II of Dodd-Frank and the E.U. has the Recovery and Resolution Directive. The objective of the Framework must be deference to each other's rules, he said, not making foreign financial institutions subject to double requirements.

On international financial reporting standards, IFRS, he is much more pessimistic. The prospect that these standards will be used by all major jurisdictions is even dimmer today than in past years, despite E.U. efforts and the time he has spent in IASB meetings. This remains an issue of major concern.

Friday, September 26, 2014

Industry Working Group Calls for SEC to Reform Proxy Voting System

[This story previously appeared in Securities Regulation Daily.]

By John Filar Atwood

A working group led by the Securities Transfer Association (STA) has taken a number of steps to improve the proxy voting process, but said that the overly complex system needs substantive reforms from the SEC to make it more transparent and to ensure more accuracy in the vote count. The group, which includes Broadridge Financial Solutions, Depository Trust Co., Investment Company Institute and others, released a report on the work it has done to improve the back-office “plumbing” in the proxy voting system.

The group was formed after the release of a report in 2011 by the University of Delaware that evaluated the mechanics of providing electronic confirmation to investors that their proxy votes were cast as directed. The University of Delaware report identified a number of problems in the proxy voting system, and recommended solutions that could be implemented without amending federal regulations. STA, Broadridge and others formed the working group to address the problems identified in the report.

Vote confirmation. One issue the working group set out to address was the inability of the current proxy voting system to confirm to investors that their votes at shareholder meetings are recorded by the tabulator according to their instructions. Concern over vote conformation is widespread, and the SEC raised the issue in its 2010 concept release on the proxy voting system.

The University of Delaware proposed a process by which tabulators, nominees, and proxy service providers would furnish each other with sufficient information to permit an investor to confirm that its vote was submitted to the tabulator and tallied properly. Using this and other University of Delaware recommendations as a starting point, the working group developed new procedures to permit investors to receive electronic confirmation that their proxy votes were cast as instructed, develop best practices for determining, reporting and resolving vote discrepancies presented to the vote tabulator, improve the early-stage vote entitlement process, and strengthen the coordination among parties involved in the omnibus proxy process.

Over-voting. The working group said that one significant problem in the vote confirmation process is where votes are submitted in excess of what the tabulator knows to be the maximum share position for a nominee at the Depository Trust Co. This problem, referred to as “over-voting,” makes it difficult for the tabulator to reconcile the total voted shares for each nominee against the number of shares entitled to be voted. The current procedure used by many tabulators is to initially accept the submitted votes and then attempt to resolve the discrepancy using its exception processing procedures.

The working group reported that it has not yet formed a consensus on a uniform method for how a tabulator should handle unresolved vote discrepancies. STA believes that voting discrepancies will occur until there is an SEC rule that requires pre-mailing reconciliation of eligible shares at both the nominee and beneficial owner levels. Progress is being made to improve reconciliation at the nominee level, according to the working group, but the brokerage community still does not uniformly reconcile eligible voters and shares at the investor level before a proxy distribution is made.

Pilot project. In order to test new communications and reconciliation systems, the members of the working group initiated a pilot project for the 2014 proxy season that involved 26 issuers, Broadridge, several broker-dealers, and five transfer agent tabulators. Participants in the pilot reported that, at present, resolving the reconciliation requests involves manual processing steps that are very time-consuming and cumbersome. The working group concluded that the development of automated systems to replace manual ones is critical to sustain more widespread use of the communications portal.

The working group concluded that while progress has been made in providing investors with the ability to receive electronic confirmation that their votes were cast as directed, more work needs to be done. The end result of vote confirmation cannot be accomplished with complete accuracy until other proxy voting issues within the street name system are addressed, the group said, the most important of which is reconciliation of the entitlement of each investor to vote a share position as of the record date.

Thursday, September 25, 2014

Commissioner Giancarlo Criticizes CFTC Cross-Border Guidance, Calls for “Reset”

[This story previously appeared in Securities Regulation Daily.]

By Lene Powell, J.D.

CFTC guidance on the cross-border application of Dodd-Frank swaps regulation has fragmented global swaps markets and risks a trade war over swaps market clearing and execution, said CFTC Commissioner J. Christopher Giancarlo.

“I am here today to call for a reset in the EU and CFTC cross-border regulatory relationship in the spirit of the Pittsburgh G-20 accord. I call for this reset to avoid a trade war in financial markets akin to that which worsened the Great Depression,” said the commissioner in remarks prepared for delivery to the Burgenstock Conference in Switzerland.

Recently, the CFTC largely beat a court challenge to its cross-border guidance by industry groups, though the court warned the CFTC to be ready to defend the guidance if the agency ever uses it in an enforcement action or other lawsuit.

Market fragmentation. According to Giancarlo, the CFTC started a rift in cross-Atlantic swaps regulation when it issued an Interpretative Guidance in July 2013 that asserted that all swaps entered into by a US person, no matter where transacted, had a “direct and significant” connection with US commerce requiring the imposition of CFTC transaction rules. The CFTC followed the guidance with an Advisory in November 2013 that said that CFTC trading rules apply if a trade is “arranged, negotiated, or executed” by personnel or agents of a non-US swap dealer located in the US, even if no US person is party to the trade.

The combined effect is that CFTC has dictated that non-US market operators and participants must abide by the CFTC’s “peculiar, one-size-fits-all” swaps transaction-level rules for trades involving US persons or supported by US based personnel, said the commissioner. In conjunction with lack of coordination between the US and EU on recognition of clearinghouses, this has fragmented global swaps markets into regional ones, by Balkanizing pools of trading liquidity and market pricing.

Risk of trade war. Likening the CFTC’s cross-border rules to the Smoot-Hawley Tariff Act of 1930, which sharply increased tariff rates on many imported agricultural and manufactured goods and touched off retaliation from trade partners, Giancarlo said the CFTC’s interpretative guidance in July 2013 was “wreaking havoc” and forcing US financial institutions to retreat from what were once global markets.

A trade war would be disastrous for the US and EU, said Giancarlo. The US must retain deep and liquid capital markets to maintain its reserve currency status and its standard of living. Fragmentation causes smaller and disconnected liquidity pools and less efficient and more volatile pricing for market participants and end-user customers, as well as greater risk of market failure in the event of economic crisis. For its part, the EU desperately needs investment in economic development and job creation. European investment capital comes overwhelmingly from banks, which are significant participants in the US derivatives markets. EU banks cannot afford to retreat from those markets, he said.

Call for cooperation. The US and EU must reach an accord on how to regulate derivatives execution and clearing in a harmonious manner across jurisdictions. “Flourishing capital markets are the answer to US and European 21st century economic woes, not trade wars and protectionism,” said the commissioner.

Giancarlo praised a recent decision to seek comment on three different approaches to the cross-border application of CFTC rules for margin for uncleared swaps, commending it as a portent of greater accord in global regulatory reform. He said he will encourage the CFTC to replace the guidance with a formal rulemaking that recognizes outcomes-based substituted compliance for competent non-US regulatory regimes. The best route to swaps regulation involves deference to home country regulators within the Pittsburgh G-20 framework, and Giancarlo hopes the staffs of the CFTC, European Commission (EC), and European Securities and Markets Authority (ESMA) will redouble their efforts to craft a workable basis for the EC to issue its equivalence determination for the US.

Wednesday, September 24, 2014

Senate Legislation Would Address Inversions and Earnings Stripping

Fearing a wave of corporate inversion mergers unless Congress acts, Senators Charles Schumer (D-NY) and Richard Durbin (D-IL) introduced legislation, S. 2786, to address corporate inversions, specifically targeting the practice of earnings stripping in which inverted companies load their U.S. subsidiary up with excessive debt that is “owed” to the foreign headquarters so they can deduct interest payments on this debt, further allowing the company to avoid paying U.S. taxes.

The Schumer-Durbin legislation is the first Senate Democratic proposal to address the practice of earnings stripping by companies that move their domicile overseas and is designed to work in harmony with the efforts of Senate Finance Committee Chair Ron Wyden (D-OR) and Senator Carl Levin’s (D-MI) efforts to put together a comprehensive package of legislative proposals to address corporate inversions. In a nod to Republican concerns that corporate inversions should be addressed as part of broader tax reform legislation, Senator Schumer said that proposals to address the recent wave of corporate inversions could also be used as a bridge to comprehensive corporate tax reform.

Key Senator Urges SEC to Quickly Finalize Crowdfunding Rules

Senator Mark Warner (D-VA), a key member of the Banking Committee, strongly urged the SEC to quickly finalize in the coming weeks the regulations implementing the crowdfunding provisons of the JOBS Act. In a letter to SEC Chair Mary Jo White, he said that Title III crowdfunding will unleash new growth opportunities for entrepreneurs. While recognizing that the SEC is making sincere efforts on the difficult issue of state preemption in this area, Senator Warner urged the Commission to find a solution quickly so as not to hold up this important tool that can help democratize financing for entrepreneurs.

Similarly, he also urged the Chair to lead the Commission forward, albeit with care, to finalize regulations implementing Regulation A+ provisions of the Act, while maintaining key investor protections in the qualified purchaser' definition within Title IV of the JOBS Act.

More broadly, the Senator feels strongly that the U.S. will benefit from significant economic development when JOBS Act rulemakings are completed and the focus is squarely on fostering a maturing crowdfunding industry. Congress and the SEC must move forward to strike a balance on state preemption, investor protection and other issues, he said, and avoid entangling entrepreneurs in too much regulatory red tape.

Two years after the passage of the JOBS Act, he emphasized, it is time for crowdfunding rules to be in place to provide clarity for market participants and support the economic activity that will follow.

Tuesday, September 23, 2014

Virginia Proposes Adding Prefatory Language to BD Unethical Rule to Avoid Federal Preemption

[This story previously appeared in Securities Regulation Daily.]

By Jay Fishman, J.D.

The Virginia Division of Securities and Retail Franchising within the State Corporation Commission proposed adding prefatory language to a broker-dealer/agent unethical practice rule provision to avoid having the provision become federally preempted by the National Securities Markets Improvement Act of 1996 (NSMIA).

Compensation disclosure provision. The provision pertains to Virginia Securities Act rule Section 21 VAC 5-20-280 A (32), which deems unethical a Virginia-registered (or required to be registered) broker-dealer’s “failure to advise a customer, both at the time of solicitation and confirmation of sale, of any and all compensation related to a specific securities transaction to be paid to the agent including, commissions, sales charges, or concessions…”

The Division’s concern is that this provision, by requiring compensation disclosures both at the time of solicitation and on confirmation of sale, creates a writing and record requirement specifically at the point of confirmation of sale that may conflict with or exceed federal securities law and SEC rule requirements. The Division is particularly concerned that the provision would conflict with NSMIA 15 U.S.C. § 78o(i)(1), which declares that no state law, rule, regulation or order on broker-dealer bond, capital, custody, margin, financial responsibility, recordkeeping or reporting requirements may differ or exceed federal requirements.

To avoid possible preemption, the Division proposed prefatory language limiting application of the compensation disclosure provision to “solicitation of a purchase or sale of over-the-counter unlisted non-NASDAQ equity securities.” The Division, however, reiterates from a December 16, 2013 policy statement that: (1) broker-dealers and broker-dealer agents are not relieved from an obligation to make adequate material disclosures of agent compensation in a securities transaction at the point of sale; and (2) the Division may investigate and bring enforcement against any broker-dealer or broker-dealer agent for failing to make adequate material disclosures about agent compensation at the point of sale.

Public comments. Interested persons may submit written comments on the proposal, or request a hearing on it, by referencing Case No. SEC-2014-00041 on all correspondence. Comments and/or hearing requests may be submitted in writing to Joel H. Peck, Clerk, State Corporation Commission, c/o Document Control Center, P.O. Box 2118, Richmond, Virginia 23218. Comments and/or hearing requests may, alternatively, be submitted electronically by following instructions on the Commission’s website at

Comments and/or hearing requests must be received on or before November 5, 2014.

Sunday, September 21, 2014

House Passes Consolidated Package of Securities and Regulatory Reform Measures

The House of Representatives passed a bi-partisan package of securities, tax, and regulatory reform legislation by a vote of 253 to 163, with 32 House Democrats voting for the measure. The Jobs for America Act, H.R. 4, contains two bills that have received broad bi-partisan support in the House Financial Services Committee.

The first is the Business Capital Access and Job Preservation Act, Division II, Title I of H.R. 4, which would exempt advisers to certain private equity funds from the new SEC registration requirements imposed by Title IV of the Dodd-Frank Act. Specifically, the measure exempts from SEC registration private equity fund advisers that have not borrowed and do not have outstanding a principal amount in excess of twice their funded capital commitments. The bill was introduced by Rep. Robert Hurt (R-Va.), Jim Himes (D-Conn.), and Scott Garrett (R-N.J.), Chair of the Capital Markets Subcommittee.

The second is the Small Business Mergers, Acquisitions, Sales, and Brokerage Simplification Act, Division II, Title I, Originally sponsored by Rep. Bill Huizenga (R-Mich.), this measure would amend Section 15(b) of the Securities Exchange Act to reform the regulation of M&A brokers. Representative Huizenga noted that current federal law treats the sale of a small privately held business as if it were a Wall Street investment firm selling securities of a public company. The legislation establishes a streamlined and commonsense approach that allows for the sale of small- and mid-size businesses while maintaining the necessary safeguards, protecting jobs, and allowing for continued economic growth.

HR 4 has also packaged together a number of stand alone regulatory reform measures.

Regulatory Accountability Act (Sub B, Title II): Introduced by Judiciary Committee Chair Bob Goodlatte (R-VA), this measure would require federal regulators to think through new regulations better and with more public input and to adopt the least costly method of effectively implementing the law.

Regulatory Flexibility Improvements Act (Sub B, Title III): Introduced by Regulatory Reform, Commercial and Antitrust Law Subcommittee Chair Spencer Bachus (R-AL), this legislation requires federal agencies to better consider and lower adverse impacts on small businesses before they issue new regulations.

Regulations from the Executive in Need of Scrutiny (REINS) Act (Div. IV, Title I): Introduced by Rep. Todd Young (R-IN), this measure would require federal agencies to submit major regulations to Congress for approval and guarantees that no major regulations become effective until Congress approves them.

All Economic Regulations are Transparent Act (Sub B, Title I): Introduced by Rep. George Holding (R-NC), this legislation would require regulators to provide more timely, detailed information and greater transparency regarding planned or proposed regulations and prevents new rules from taking effect if they fail to do so.

Sunshine for Regulatory Decrees and Settlements Act (Sub B, Title IV): Introduced by Rep. Doug Collins (R-GA.), this measure would prevents secret settlement deals between federal agencies and pro-regulatory plaintiffs that result in new federal regulations for everyone.

Unfunded Mandates Information and Transparency Act: Introduced by Rep. Virginia Foxx, this measure would close a loophole in the Clinton-era Unfunded Mandates Reform Act (UMRA) by adding the SEC and other independent regulatory agencies to UMRA’s regime. Currently, according to Rep. Foxx, independent regulatory agencies, such as the SEC, the FCC, the CFPB and other federal agencies, can impose significant costs and burdensome requirements with little meaningful accountability and oversight. Signed by President Bill Clinton in 1995, the Unfunded Mandates Reform Act was bipartisan legislation that basically says that regulators have to evaluate a regulation’s cost and find less costly alternatives before adopting a major rule. In 1995, UMRA was imposed upon the executive agencies but not on independent federal agencies such as the SEC. Since the enactment of UMRA, those independent agencies have grown and so have their regulations.

Friday, September 19, 2014

Commissioner Gallagher Questions Opaque Fixed Income Markets, Outdated Equity Market Structure

[This story previously appeared in Securities Regulation Daily.]

By Matthew Garza, J.D.

In two speeches delivered on Tuesday, Commissioner Daniel Gallagher asserted that the equity market structure is out of date, and expressed alarm over opaqueness in the debt markets. He called for the SEC to increase its resources and step up efforts to increase transparency in the debt markets, and undertake a holistic review of equity market structure. Gallagher’s comments were made in a morning speech to the Georgetown University Center for Financial Markets and Policy Conference on Financial Markets Quality, and a speech later in the day at the 2014 SRO Outreach Conference.

Contrary to claims that the markets are “broken” or “rigged” in favor of high speed traders, assertions that gained popularity after publication of “Flash Boys” by Michael Lewis, Gallagher said investors are doing better today than when trading was dominated by manual processes. Such claims are “overwrought,” he said, citing data showing that new technology has lowered transaction costs, improved liquidity, increased market access, and reduced volatility.

But not all is well, Gallagher said, expressing concern over the “troubling asymmetry of information” in the market structure for fixed income products, which he said was far more likely to disadvantage retail investors than high frequency trading. He called for a holistic review of the equity market structure, including Regulation NMS, the SRO model, and securities information processors (SIPs). “We need the Commission and its expert staff to reoccupy the market structure playing field,” he said.

Regulation NMS. The Commission said Regulation NMS, which he pointed out was adopted by a split 3-2 vote, should be put under a microscope and its underlying assumptions should be reexamined. He singled out the trade through rule, which requires trading centers to route orders to the venue displaying the national best bid or offer, as a good example of a rule that is “non-market based.” A better approach was suggested by former commissioners Glassman and Atkins, who recommended that the broker’s duty of “best execution” be clarified. Best execution could involve more factors than simply the national best bid or offer, he said. He also suggested that the duties of brokers should also be deliberated when considering how to prevent technology failures, rather than focusing solely on the responsibilities of the exchanges.

SRO model. With regard to the exchanges, Gallagher again called for a review of the SRO model. “We need to revisit the fundamental question of whether or not national securities exchanges should still be SROs.” The exchanges have outsourced regulatory obligations and market surveillance to FINRA, and over 35 percent of securities transactions take place on alternative trading systems (ATSs), not exchanges, he pointed out. ATSs have no ownership limitations and no requirement to file rule changes with the SEC for notice and comment, giving them a distinct competitive advantage, said Gallagher.

“We must evaluate the SROs and markets as they are today and acknowledge that, in many cases, SROs today are fundamentally different from what Congress conceived of as self-regulation decades ago,” he said.

SIPs. Securities information processors, which have been at the center of recent technology failures, were seen as a public utility according to the legislative history of the Securities Acts Amendments of 1975, the commissioner said. Today there are two exclusive primary information processors for equity transactions, one for consolidated transaction data and consolidated quotation data, and the other for transactions executed pursuant to unlisted trading privileges. Each is owned by a major exchange. This lack of competition causes problems and, moreover, reliance on SIPS results in a single point of failure, as happened in August 2013 when a failure in the NASDAQ SIP led to a suspension of all trading in NASDAQ securities. “We must reconsider whether it is appropriate to continue to rely on the utility model, a relic of a mid-1970s congressional infatuation with utilities, with its built-in delays and potentially catastrophic crashes,” he said.

Fixed income markets. While FSOC focuses on designating systematically important financial institutions, an actual systematic risk is “percolating right under their noses,” namely the risk building in the fixed income markets, Gallagher said. There is approximately $3.7 trillion in outstanding municipal bonds, and over $11.3 trillion outstanding in the corporate debt market, a demonstration of the critical role debt financing plays in the U.S. capital markets. Retail participation is high, despite the fact that these markets are “incredibly opaque to retail investors,” he said.

Demand for fixed income investments has grown faster than equities, but the spreads to Treasuries continues to narrow, leaving these markets vulnerable to outflows with only a small increase in interest rates. “Inflationary hawks” in the meantime call for the Fed to increase rates, while “doves” worry about a subpar job market. If the Fed is forced to raise interest rates rapidly, it could “wreak havoc on the debt markets,” Gallagher claimed.

The SEC’s role. To counter this risk, the SEC should require greater price transparency in these markets, Gallagher believes. The SEC can address liquidity risks by facilitating electronic dealer-to-dealer and on-exchange transactions of these products, but only if the offering of the products is standardized. “The Commission must take the lead on this issue, but it is incumbent upon industry to find an efficient and expedient path forward,” he said.

Wednesday, September 17, 2014

U.K. Parliamentary Committee Questions Conventional Premises on High Frequency Trading

The U.K. Parliamentary Committee on Economics fired off a letter to the Financial Conduct Authority on high frequency trading questioning the premise that such trading increases liquidity. In a letter to FRC Chief Executive Martin Wheatley, the Committee cited a recent study indicating that trading speed does not necessarily improve liquidity. The Committee also cited recent testimony from Brad Katsuyama, president and chief executive of the US equity trading venue IEX, to the effect that high-frequency trading has created predatory practices

Mr Katsuyama.believes that the race s not really between high-frequency trading participants and slow manual traders; it is between high-frequency trading and the market centers themselves in that you have an extreme situation where the fastest participants are faster than the New York Stock Exchange. He thought markets today were unfair because trading venues, by selling technology to high-frequency trading firms, are no longer neutral. An entire infrastructure has been built around unfair trading.

The Committee noted that revisions to the Markets in Financial Instruments Directive (MiFIDII) will be implemented in the U.K. in two years time. CEO Wheatley has described these changes as bringing in “a long, and complex list of new rules.”

Mr Katsuyama thought that it would be difficult for direct regulatory action to prevent predatory trading or market volatility since every prevention technique really addresses the problem that just happened, not necessarily one that may happen in the future. Instead, he advocated more transparency and disclosure for trading venues, believing this would help stop predatory practice.

The Committee asks the FRC if the authority believes that predatory trading is an issue in U.K. equity markets and, if it does so believe, how does the Financial Conduct Authority think the issue should be best tackled. The Committee would also like to hear the FRC comment on Mr Katsuyama’s thoughts.

SEC and SBA Join Forces to Teach Entrepreneurs About JOBS Act

[This story previously appeared in Securities Regulation Daily.]

By Matthew Garza, J.D.

The SEC and the U.S. Small Business Administration announced that they will jointly host events to teach small business owners and entrepreneurs about new options for raising capital under the JOBS Act. A press release from the SEC did not specify the number of events to be held but said they are designed for existing and aspiring small businesses and will focus on new options for raising capital that are and will become available.

The events will discuss advertising options available since the SEC lifted the ban on general solicitation in Rule 506 and Rule 144A offerings in July 2013, and proposed rules intended to allow firms to offer and sell securities through crowdfunding.

The events will feature SEC staff from the Office of Small Business Policy, the Office of Investor Education and Advocacy, the Office of Minority and Women Inclusion, as well as the SBA’s Office of Investment and Innovation, and Office of Entrepreneurial Development. Representatives from these offices will be available to answer questions from attendees.

The first event will be held on September 25 from 2:00 – 4:00 p.m. at the University of Baltimore, Merrick School of Business Atrium & Auditorium. Registration is available at the SBA website.

Tuesday, September 16, 2014

Swap Execution Facility Launches First Bitcoin Swaps

[This story previously appeared in Securities Regulation Daily.]

By Lene Powell, J.D.

A CFTC-registered swap execution facility (SEF) has launched the first regulated platform for bitcoin derivatives, as well as a bitcoin price index. The trading of USD/Bitcoin swaps will be subject to exchange and CFTC regulations. Institutional market makers have already offered to provide continuous markets over a range of tenors, the exchange said in a press release.

Christian Martin, CEO and co-founder of TeraExchange, said the new index would help the growing bitcoin trading community to accurately mark-to-market positions.

Bitcoin regulatory status. A widely-recognized virtual currency, bitcoin has begun to achieve regulated status in some instances. The IRS included it in a notice on the tax treatment of virtual currencies, which it said were treated as property for federal tax purposes.

The SEC has issued an investor alert on bitcoin investments, and pursued a Ponzi scheme based on the currency. In that case, a federal district court said that bitcoin-related investments were securities for the purpose of the federal securities laws because they met the definition of an investment contract. In recent testimony before the Senate Banking Committee, SEC Chair Mary Jo White said that the agency has not concluded that bitcoin is a security rather than a currency, so is not currently looking at rulemaking in this area.

Bitcoin index. TeraExchange is the index administrator and calculation agent for the new Tera Bitcoin Price Index, which uses a dynamic algorithm to compile and filter data in real time from widely used global bitcoin exchanges. The exchanges must execute and maintain an information sharing agreement with TeraExchange in order to be included in the index.

Monday, September 15, 2014

Center for Audit Quality Actively Embraces SEC Disclosure Initiative

The Center for Audit Quality embraces the SEC’s new and important disclosure initiative as one of the key components in the audit quality ecosystem, along with effective audit committees. In recent remarks at a public accountants seminar in Singapore, CAQ Executive Director Cindy Fornelli noted that disclosure effectiveness has been a subject of great interest for SEC Chair Mary Jo White.

The CAQ shares Chair White's view that disclosure can be improved, she observed, adding that effective disclosure is a hallmark of world-class capital markets. It is very important that financial disclosure is meaningful and as tailored as possible, and optimized in terms of how and where it is delivered. To this end, she noted that the CAQ has launched a new initiative with the Institute for Corporate Responsibility at the George Washington University School of Business, called the Initiative on Rethinking Financial Disclosure.

This initiative will harness the power of team competition. Several teams of graduate students at the School of Business are analyzing annual reports from prominent companies. This fall, they will present the SEC with their findings on how to improve these communications. A winning team will be selected by a panel of experts.

Shareholders Have Right to Open McGraw-Hill’s Books to Investigate Ratings Violations

[This story previously appeared in Securities Regulation Daily.]

By John M. Jascob, J.D.

Shareholders of The McGraw-Hill Companies, Inc. (McGraw-Hill) have the right under state law to inspect the company’s books for evidence of possible violations in the ratings for mortgage-backed securities, a New York appellate court has held. Reversing the decision below, the court granted the petitioners’ request for the purpose of investigating claims that Standard & Poor's Financial Services LLC (S&P), a McGraw-Hill subsidiary, issued inflated credit ratings on the securities in order to garner business from the issuers (Retirement Plan for Gen. Empls of the City of N. Miami Beach v. McGraw-Hill Cos., September 11, 2014, per curiam).

Optimistic credit ratings. The petitioners allege that McGraw-Hill’s management directed S&P as a credit rating agency to undertake a strategy of fraudulently issuing positive ratings on residential mortgage-backed securities and other complex financial products. As the complex mortgage-backed securities industry grew, McGraw-Hill allegedly directed S&P to further provide optimistic credit ratings in an effort to attract more business from the issuers and gain more revenue from the other services that S&P provided.

Books and records request. In November 2011, one of the petitioners made a written demand upon McGraw-Hill under the New York Business Corporation Law (BCL) and the common law to inspect books and records relating to the board of directors' oversight and management of S&P and the board's independence. Among other things, the demand sought records concerning policies and procedures regarding the board's oversight of S&P's policies and procedures for issuing credit ratings for mortgage-related securities; and policies and procedures for addressing and managing conflicts of interest, particularly those arising out of the "issuer pays" model for issuing credit ratings.

The parties then engaged in a series of discussions to determine whether they could compromise on the scope of the demand, but McGraw-Hill refused to produce any documents not specifically required under BCL Sec. 624, namely, a record of shareholders, shareholder meeting minutes, and profit and loss statements. When the discussions ultimately proved unfruitful, the petitioners went to court. The Supreme Court denied the petition, finding that the petitioners should have first made a demand upon McGraw-Hill and then, once McGraw-Hill rejected the demand, should have commenced a shareholders' derivative action rather than filing a petition under BCL Sec. 624.

Proper purposes. On appeal, the appellate court reversed, noting that New York law provides shareholders with both statutory and common law rights to inspect a corporation's books and records so long as the shareholders seek the inspection in good faith and for a valid purpose. The shareholders had a proper purpose because they sought to investigate alleged mismanagement and breaches of fiduciary duty by McGraw-Hill’s board in failing to oversee purported wrongdoing by S&P. This alleged wrongdoing, according to the petitioners, exposed McGraw-Hill to substantial potential liability in multiple civil actions and investigations.

Rejecting McGraw-Hill’s contentions, the court reasoned that investigating alleged misconduct by management and obtaining information that may aid legitimate litigation are, in fact, proper purposes for a request under BCL Sec. 624, even if the inspection ultimately establishes that the board had engaged in no wrongdoing. Moreover, because the common law right of inspection is broader than the statutory right, the petitioners were entitled to inspect books and records beyond the specific materials delineated in the statute. Accordingly, the appellate court reversed and remanded the matter for a hearing to determine which records were relevant and necessary for the petitioners' purposes.

The case is No. 12438 650349/13.

Saturday, September 13, 2014

New Financial Services and Stability Czar Established for E.U.

In a groundbreaking move, the new European Commission will have a Commissioner for Financial Services, Financial Stability and Capital Markets, with complete oversight of securities and banking regulation across the E.U. This was generally and formerly the Internal Market portfolio filled by Michel Barnier, except that the new proposed Commissioner, Lord Hill of the U.K., will have a specific financial stability mandate. One reason for the creation of the new portfolio is to ensure that the Commission remains active and vigilant in implementing the new Directives and Regulations enacted in the wake of the financial crisis, especially supervisory and resolution rules for financial firms.

In just a few years the EU has put forward an ambitious and unprecedented series of regulatory and supervisory reforms to secure financial stability and improve the supervision of financial markets. Therefore, the Commission feels that the time has come to focus the existing expertise and responsibility in one place. The next frontier will also be to develop and integrate capital markets which are a better source of credit than bank credit when it comes to financing innovative projects and long-term investment.

The Commissioner for Financial Stability, Financial Services and Capital Markets will also be responsible for relations with the European Banking Authority (EBA); the European Insurance and Occupational Pensions Authority (EIOPA); the European Securities and Markets Authority (ESMA); the European Systemic Risks Board (ESRB) and the Single Resolution Board (SRB, which should be operational from 2015.

The final list of Commissioners-designate was adopted by the E.U. Council. The next and final step is that the European Parliament has to give its consent to the entire College of Commissioners.

Friday, September 12, 2014

New NASAA Working Group Aims to Improve BD Fee Disclosures

[This story previously appeared in Securities Regulation Daily.]

By John M. Jascob, J.D.

NASAA has formed a joint working group of state securities regulators and industry representatives in an effort to develop improved disclosures of broker-dealer fees. The formation of the working group follows a NASAA survey in April that uncovered not only a wide disparity in how broker-dealers disclose their fees to customers but also certain questionable practices regarding markups.

Mission. “Investors have a right to know how much they are paying for these services,” said NASAA President Andrea Seidt in a news release. “Our goal is to develop a model fee disclosure that is simple to read, easily accessible, and can be used effectively by investors to understand and compare fees.”

Model disclosure. The working group will consider various options in carrying out its mission, including development of a model fee disclosure form, accessibility and transparency guidelines, uniformity in fee language, and recommendations on how to notify customers of fee changes. When exploring model fee disclosure, the working group will focus on several areas, including presentation, customer comprehension, and timing and methodology of fee disclosure. The working group will also take into consideration the different types of firms comprising the industry, including wirehouse firms, independent broker-dealers, clearing firms, and introducing firms.

Membership. In addition to members of NASAA’s Broker Dealer Section, the working group will include representatives from FINRA, the Securities Industry and Financial Markets Association (SIFMA) and the Financial Services Institute (FSI). The working group will also include broker-dealer representatives from Signator Investments Inc., Prospera Financial Services, LPL Financial, Wells Fargo Advisors, Edward Jones, and Bank of America/Merrill Lynch.

Lack of uniformity. NASAA’s survey was prompted by actions taken by state securities regulators in Connecticut involving inappropriate fees charged by broker-dealers. A project group within NASAA’s Broker-Dealer Section conducted the survey by collecting select fee data from 34 broker-dealers starting in 2012. The survey found that disclosures explaining fees to clients ranged from a single paragraph to seven pages in length. Initial fee disclosures also lacked uniformity, whether by method of disclosure, terminology used, or location of the disclosure.

Questionable markups. In addition, the survey results revealed questionable markups on the fees charged to investors. For example, the project group contacted a clearing firm for a number of the broker-dealers in the survey pool to discern how much the broker-dealer was actually charged for various services and compare those underlying costs with fees charged to the customer. The data revealed that the broker-dealers had reaped a significant windfall by charging high markups for services delivered to their customers. In one case, a broker-dealer charged customers $500 to receive securities in certificate form, more than eight times the $60 cost the clearing firm had charged the broker-dealer for the same service.

Thursday, September 11, 2014

Rep. Hensarling Worries Anew About Financial Regulations

[This story previously appeared in Securities Regulation Daily.]

By Mark S. Nelson, J.D.

House Financial Services Committee Chairman, Jeb Hensarling (R-Tex.), gave a speech yesterday at The Allan P. Kirby, Jr. Center for Constitutional Studies and Citizenship at Hillsdale College in which he reiterated his worries about the growth of federal regulatory agencies’ power generally, and the emergence of new, less transparent financial regulators. Chairman Hensarling’s remarks singled-out the Financial Stability Oversight Council (FSOC) and the Consumer Financial Protection Bureau (CFPB), both Dodd-Frank Act creations, for his strongest criticism.

Chairman Hensarling called the FSOC the “least transparent” of federal agencies that is not among those handling national security or defense matters. Hensarling said he is concerned about the opaque nature of the FSOC’s mostly closed-door meetings and the potential breadth of its recommendations.

The chairman also said he views the Dodd-Frank Act’s reply to the 2008 financial crisis as moving too far to limit risk. Instead, Hensarling says the government should be promoting entrepreneurial risk-taking.

Said Hensarling: “The raison d’etre of the Dodd-Frank Act was the risk of the ‘shadow banking system.’ Yet a far greater danger is instead posed by the ‘shadow regulatory system.’”

As for the CFPB, the chairman said its “Orwellian” name suggests its wide reach. “Arguably, the Bureau is the single most powerful and least accountable federal agency in our nation’s history,” said Hensarling. He noted the CFPB has one appointed director who lacks accountability to the president or to Congress because he can be removed only for cause, and the CFPB skirts the congressional appropriations process. He also noted that the CFPB by law gets deference from courts.

Chairman Hensarling also said the CFPB is now engaged in a broad effort to gather financial data on consumers. The chairman likened this effort to the recently revealed surveillance efforts of the National Security Agency.

The chairman urged passage of the REINS Act, more aggressive use of the congressional budget process, and renewed efforts to expand federalism via use of the Tenth Amendment.

Wednesday, September 10, 2014

House Members Urge New Approach to CLOs and Risk Retention Regulations

Leading House Members are concerned about provisions on open market collateralized loan obligations (CLOs) in the proposed Dodd-Frank risk retention rules and their potential adverse effect on credit availability. In a bi-partisan letter to SEC Chair Mary Jo White and Fed Chair Janet Yellen, Rep. Scott Garrett (R-NJ), Chair of the Capital Markets Subcommittee of the Financial Services Committee, and Rep. Jim Himes (D-CT), a leading member of the Committee, expressed specific concern that the approach outlined in the rc-proposal of the risk retention rules requiring CLO managers to retain 5 percent of the CLO's fair value could impede the issuance of new CLOs. With very limited balance sheets, noted the letter, very few CLO managers could retain a 5 percent share of a CLO.

The House members want to ensure that the risk retention requirements are properly tailored to the unique structure of open market CLOs, which are a vital source of corporate finance. The letter was also signed by Rep. Patrick McHenry, Chair of the Oversight and Investigations Subcommittee. Open market CLOs do not engage in originate to distribute securitizations, noted the House Members, and so simply applying the standard risk retention rules designed for such securitizations to open market CLOs does not make sense.

The legislators asked the SEC and Fed to consider a new approach to risk retention that envisions the creation of a qualified open market CLO that would have to meet a series of strict criteria designed to protect investors and to ensure that a CLO's portfolio is conservatively invested, and that the interests of the CLO manager is aligned with the CLO investors. The House Members believe that this approach could provide a workable solution tor most managers of open market CLOs and ensure the continued flow of credit to companies.

This modified risk retention requirement would apply only to CLOs that meet specific criteria. For example, the portfolio would have to consist almost entirely of U.S. dollar denominated senior secured commercial loans and could contain no re-securitizations or derivatives other than basic interest rate or FX hedges. The portfolio would also have to be diversified such that no more than 3.5 percent of a CLO's assets could relate to any single borrower, and no more than 15 percent of its assets could relate to any single industry, thereby reducing the chance that a few individual defaults could cause significant losses for a CLO investor. The borrowing companies would have to be overwhelmingly based in the United States. The CLO's equity would have to equal at least 8 percent of the value of its assets, which would provide, a substantial cushion for CLO debt investors.

Even more, the qualified CLO approach would require managers of open market CLOs to retain 5 percent of the equity of a qualified CLO rather than 5 percent of fair value. In the view of the House Members, this level of retention would still be a significant commitment for thinly capitalized CLO managers, and would still likely force some managers out of the market. However, this approach would allow most CLO managers to continue to participate in this important market, thereby avoiding a dramatic reduction in CLO financing and resulting harms to the public interest.

PCAOB Alerts Auditors to Standards on Testing Revenue

[This story previously appeared in Securities Regulation Daily.]

By Anne Sherry, J.D.

Its inspections staff having observed significant audit deficiencies with respect to revenue, the PCAOB has issued a Staff Audit Practice Alert highlighting requirements for testing revenue recognition, presentation, disclosure, and controls. The alert notes that the auditing matters are likely to remain relevant under the converged FASB/IASB accounting standard on revenue recognition set to take effect at the end of next year.

Importance. The alert points to the importance of revenue as a driver of a company’s operating results. PCAOB standards require auditors to presume that improper revenue recognition is a fraud risk, and many fraudulent financial reporting cases have involved intentional misstatement of revenue. Because of revenue’s importance, it is a significant area of focus in PCAOB inspections. Inspections staff continue to observe frequently significant audit deficiencies with respect to revenue, according to the alert.

Issues discussed. The practice alert addresses issues surrounding testing revenue recognition, presentation, and disclosure, including testing the recognition of revenue from contractual arrangements; evaluating the presentation of revenue as gross versus net; testing whether revenue was recognized in the correct period; and evaluating whether the financial statements include the required disclosures regarding revenue. Other aspects of testing revenue include responding to fraud risks; testing and evaluating controls over revenue; applying audit sampling procedures to test revenue; performing substantive analytical procedures to test revenue; and testing revenue in companies with multiple locations.

Particular personnel. The paper urges auditors to take note of the matters discussed in planning and performing audit procedures, and audit firms to revisit their audit methodologies and implementation of those methodologies to assure compliance with PCAOB auditing standards. It is particularly important for the engagement partner and senior engagement team members to ensure that engagement teams appropriately implement the auditing standards and for engagement quality reviewers to focus on these matters in their reviews, the staff noted. Finally, audit committees may wish to discuss with their auditors their approach to auditing revenue.