Tuesday, July 22, 2014

Senator Vitter Urges SEC to appeal DC Circuit Stanford Ruling to Supreme Court

In the wake of the DC Circiuit panel's ruling that investors in the Stanford Ponzi scheme were not customers of the broker-dealer within the meaning of the Securities Investor Protection Act and that the SEC could not compel SIPC liquidation, Senator David Vitter urged the SEC to appeal the ruling to the U.S. Supreme Court. But it is very unlikely that the SEC will appeal this ruling to the Supreme Court. The SEC rarely if ever has appealed a ruling by a three-judge panel of the DC Circuit to the en banc DC Circuit let alone to the Supreme Court. From the Business Roundtable v. SEC case years ago to the recent ruling on the resource extraction disclosure regulation implementing Section 1504 of the Dodd-Frank Act, tha panel ruling is almost always the last word.

Also, this was a bi-partisan unanimous ruling by Judge Srinivasan (Obama appointee), Chief Judge Garland (Clinton appointee) and Senior Circuit Judge Sentelle (Reagan appointee).

Saturday, July 19, 2014

European Central Bank Chief Wants Swift Implementation of Accounting Standard for Valuing Financial Instruments

The President of the European Central Bank, Mario Draghi, called for the speedy implementation of IFRS 9 on the valuation of financial instruments. It is very important to have IFRS 9 as part of global accounting standards as swiftly as possible, he emphasized in recent remarks. More than 100 countries speak the same accounting language today, he noted in recent remarks, whereas a decade ago, no major economy used the International Financial Reporting Standards (IFRS). This momentum must be kept going and built upon, he said. The financial crisis would not have been as severe if there had been more integration, not less integration in Europe, he averred, and the future lies with more integration. The European Union has required the use of IFRS since 2005.

IFRS 9, to issue in July, completes the IASB’s response to the financial crisis by providing a comprehensive package of improvements to financial instruments accounting. IFRS 9 introduces a new, expected-loss impairment model that limits the ability of banks and others to defer the timely recognition of loan losses and provides a logical single classification approach driven by cash flow characteristics and how cash flow is managed.

It solves the so-called own credit issue, whereby banks and others are able to book large gains through their P&Ls as a result of the value of their own debt falling due to a decrease in credit worthiness. It allows companies, both within and outside of the financial sector, to better reflect their risk management activities in their financial statements. It also significantly reduces the complexity associated with the accounting for financial instruments.

E.U. Securities Commissioner to Propose Equivalency Decision on Derivatives Central Counterparties upon Successful Conclusion of Talks with CFTC

E.U. Commissioner for the Internal Market Michel Barnier said that he will soon propose that the European Commission adopt equivalence decisions on decisions on derivatives counterparties with a number of jurisdictions including the United States, but the U.S. will not be in the first round. In a statement, the Commissioner said that he intends to propose shortly that the European Commission adopt equivalence decisions that will allow derivatives central counterparties from five countries outside the EU, Japan, Singapore, Australia, Hong Kong and India, to clear E.U. derivatives trades. Equivalence decisions for other countries should follow shortly afterwards, said the Commissioner, including the U.S., whose central counterparties he described as truly global market infrastructures. He emphasized that the equivalence decisions will be done in full deference to the rules and regulatory regimes of those countries.

Commissioner Barnier also noted that technical talks with the CFTC are progressing well and he is confident that the E.U and the CFTC will be able to agree on outcomes-based assessments of their respective derivatives regulations and on aligning key aspects of margin requirements to avoid arbitrage opportunities. If the CFTC also gives effective equivalence to third country central counterparties, deferring to strong and rigorous rules in jurisdictions such as the E.U., the European Commission will be able to adopt equivalence decisions very soon, he predicted.

Chair Hensarling Says FSC Will Move Legislation Ending FSOC SIFI Designation

In remarks at the Cato Institute forum on the Dodd-Frank Act, Rep. Jeb Hensarling (R-TX), Chair of the House Financial Services Committee, said that the Committee, in its last major legislative initiative for the 113th Congress, will soon take up a too-big-to-fail legislative package that posits that Dodd-Frank did not end TBTF but actually codified it. One part of the legislative effort would be to repeal the ability of the Financial Stability Oversight Council (FSOC) to designate financial firms as systemically important financial institutions (SIFIs). The Chair said that FSOC can damage the economy with SIFI designations. In addition, designating asset managers as SIFIs could damage investors. The legislative package will also take up the reform of Title II of Dodd-Frank, which provides for an orderly liquidation authority for failed financial firms. The Chair also noted that the Committee will soon mark up legislation on Fed oversight that would bring more transparency and accountability to the Federal Reserve Board.

More broadly, Chairman Hensarling said that the Committee will continue to report out pieces of legislation on regulatory reform and correcting the unintended consequences of Dodd-Frank. He noted that the Committee has already reported out around 20 pieces of legislation to the House floor, many of which have been passed, some with overwhelming bi-partisan majorities.

Thursday, July 17, 2014

Senator Dodd Says Don't Do Dodd-Frank Act Corrections Bill Until Regulatory Implementation Completed

While supporting targeted changes to the Dodd-Frank Act, former  Senator Chris Dodd (D-CT) cautioned that the premature  opening up of Dodd-Frank  could cause more harm than good and open up a Pandora’s box since there are some who wish to weaken the legislation.  Senator Dodd recommended that any legislative changes to Dodd-Frank await the full regulatory implementation  of the Act by the SEC and other federal financial regulators. He added that federal agencies like the SEC still have many rules to adopt to fully implement the Act. Only after the entire law is implemented by regulations  will we  know what has to be done, he noted.  In addition, in remarks at the Bipartisan Policy Center,  Senator Dodd decried what he called the ``purposeful underfunding’’ of the SEC and CFTC  after Dodd-Frank gave them significant new duties. This agency underfunding  places the economy  at risk, he warned.

The Dodd-Frank Act is not biblical, he said, and there are good amendments being proposed.  For example, one change he supports is legislation to codify the exemption from margin requirements for non-financial derivatives end users.
The Senator reminded that the financial crisis that caused stunning carnage to the financial system  was caused by an outdated financial regulatory system.  The Dodd-Frank Act  created a financial regulatory infrastructure designed to prevent a future financial crisis. The Act, which  was the result of an open and accessible process,  created a framework for a 21st century financial regulatory system.  While Senator Dodd wanted a single prudential regulator, he could not get 60 votes for that.

He said that the Financial Stability Oversight Council is doing a remarkable job in making regulators work together and spot initial financial stability problems that could trigger another crisis. He also strongly emphasized that Dodd-Frank unmistakably  eliminated too big to fail.

Friday, July 11, 2014

Senate Panel Hears Testimony on Revising SEC Regulation NMS

A hearing before the Senate Banking Committee on the SEC’s regulation of the equity markets revealed a growing consensus that Regulation NMS, while it has served nobly over the past years, is in need of comprehensive reform to reflect dynamically changing markets. The testimony demonstrated that many of the concerns raised by market participants and investors are the outgrowth of SEC Regulation NMS, noted the Committee’s Ranking Member Mike Crapo (R-ID), and the overall patchwork approach to market trading infrastructure and stability taken by the SEC in the past. Senator Crapo sounded a word of caution as the SEC engages in a comprehensive review of market regulation. While it is important and prudent for regulators to periodically review existing regulations to ensure that they are still appropriate in today’s automated world, said the Ranking Member, any such holistic review of regulation should be based on empirical analysis, data-driven, and incorporate the input of market participants, industry and the investors who make the investments. In other words, Senator Crapo believes that everyone should have a seat at the table in this important discussion and everyone must be willing to roll up their sleeves to find the right solutions.

While much has been made recently of the potential dangers of automated trading, noted Senator Crapo, what is often forgotten is that technology and innovation have benefitted investors by leading to tighter spreads, lower costs and more efficient markets. Today, he noted, an individual retail investor has an easier time participating in the equity markets than at any time in the history of those markets. With fees under $10 a trade, the spreads between bid and ask prices for most stocks are as narrow as they have ever been, and with trading being done in a matter of sub-seconds rather than minutes, retail investors have been able to enjoy greater involvement in, and access to, the markets. To continue this level of investor participation, he emphasized that Congress and the SEC must ensure that the markets have the resiliency and capabilities to handle the evolving speed and complexity of today’s trading world.

Senator Richard Shelby (R-AL), a former Chair of the Banking Committee, expressed concern about investor confidence in the equity markets, particularly with retail investors. This is an overall concern of Senator Shelby as high frequency trading and dark pools become more pervasive in the equity markets. The very term ``dark pool’’ can impact investor confidence in the markets, again, particularly with retail investors.

Jeffrey Sprecher, ICE CEO, ( and in November of last year, ICE completed its acquisition of NYSE Euronext), testified that, while Regulation NMS sought to increase competition among markets and consequently increased fragmentation, the costs associated with maintaining access to each venue, retaining technologists and regulatory staff, and developing increasingly sophisticated risk controls are passed on to investors and result in unnecessary systemic risk. The fragmentation also decreases competition among orders, he noted. Orders routed to and executed in dark trading centers do not interact or compete with other orders, which detracts from the price discovery function that participants in lit markets provide. The lack of order competition in a fragmented market negatively impacts markets in the form of less liquidity, information leakage and wider spreads.

While Regulation NMS achieved its goal of increasing competition among markets, said the ICE CEO, the pendulum has swung too far at the cost of less competition among orders. Action must be taken to correct these trends and rebalance the trade-offs of yesterday, and consequently build the confidence of individual investors and companies seeking to access the public markets and to bring back the balance set out in the Securities Exchange Act of 1934.

The ICE CEO detailed a number of measures that should be taken. For example, he said that order competition should be enhanced by giving deference to regulated, transparent trading centers where orders compete and contribute to public price discovery information. Limited exceptions could apply for those with unique circumstances. He also called for a ban on maker-taker pricing schemes at trading venues. Rebates that were used to encourage participants to quote on regulated, transparent markets add to complexity and the appearance of conflicts of interest.

Mr. Sprecher urged a lowering of the statutory maximum cap on exchange fees. Regulation NMS set a cap of what regulated transparent markets can charge to access a quote. In combination with giving deference to regulated, transparent markets and eliminating maker-taker rebates, the SEC should require lowered exchange access fees.

He also called for a revamp of the current market data delivery system. ICE supports the SEC taking a closer look at the current Securities Information Processors and proprietary data feeds to adopt policies that promote fairness. More broadly, in order to increase transparency in the way that markets operate, the SEC should demand that all trading centers report trade executions in real time, and all routing practices should be disclosed by those trading centers and brokers who touch customer orders.

Kenneth Griffin, CEO of Citadel, a global asset management firm, testified that as the SEC considers various reform ideas and assertions about problems with the current equity market structure, the Commission needs a rich set of data to analyze methodically, which will ensure that the SEC has the best information available when making these critical decisions.

He said that Regulation NMS and the foundational regulations that preceded it, along with technological advances, have helped unleash an enormous degree of competition among market centers. But in recent years, the costs that each new market center imposes on the market in terms of additional complexity and operational risk have started to outweigh the marginal benefits of a new competing market center.

Mr. Griffin said that specific regulatory action is needed to restrike this balance by requiring that market centers have sufficient resources and make sufficient investments in operational excellence. Over time this will reduce fragmentation by eliminating marginal market centers that rely on the low cost of market entry and operation.

More granularly, the Citadel CEO called for a reduction in access fees to reflect declining transaction costs and the broadening of caps on access fees. Under Regulation NMS, he explained, the charge to liquidity takers in today’s maker-taker system is called an access fee. The current NMS maximum access fee of 30 cents per 100 shares is now significantly greater than the cost of providing matching services by the exchanges, he noted, and should be reduced to reflect the current competitive reality. Exchanges are permitted to share the access fees they charge with liquidity providers in the form of exchange rebates. A meaningful reduction in the maximum access fee would materially reduce such rebates.

In general, exchange rebates encourage exchanges and liquidity providers to be more competitive. Exchange rebates also reward and encourage displayed liquidity, which greatly benefits the price discovery process. Banning exchange rebates would dampen competition between exchanges and would result in less posted liquidity and could result in wider quoted spreads. Mr. Griffin noted that the SEC has wisely focused on disclosure and other mechanisms to manage any potential conflicts of interest that may arise as a result of these fee structures.

Citadel believes that a reduction in the minimum tick size for the most liquid low priced securities combined with a reduction in the maximum permitted access fee would serve the best interests of all market participants. More importantly, he urged the SEC to close gaps by adopting an access fee cap in important segments of the market that have no access fee cap. Specifically, he asked the SEC to expand the access fee cap to include quotes that are not protected by Regulation NMS. He also urged the Commission to implement a parallel and proportionate access fee cap for sub-dollar stocks. The SEC should also move forward with its proposed rulemaking to cap access fees in the options markets.

BATS Global Markets CEO Joe Ratterman applauded the SEC’s plan for a continuous and comprehensive review of the state of the national market structure under Banking Committee oversight. Such a review is timely, he testified, because changes after the implementation of Regulation NMS reflect a relatively recent and dramatic evolution in the manner in which securities trade.

Specifically, Mr. Ratterman supports the review of current SEC rules designed to provide transparency into execution quality and broker order routing practices. In particular, Rules 605 and 606 of Regulation NMS require execution venues to periodically publish certain aggregate data about execution quality and require brokers to publish periodic reports of the top ten trading venues to which customer orders were routed for execution over the period, including a discussion of any material relationships the broker has with each venue. In his view, the publication of this data has helped better inform investors about how their orders are handled.

Nonetheless, he continued, these rules were adopted nearly 15 years ago and the market has evolved significantly enough to warrant re-examining whether additional transparency could be provided that would benefit investors. For example, advances in technology now permit significant market events to occur in millisecond time frames, and audit trails are granular enough to capture that activity.

However, the current requirements of Rule 605 effectively allow a trading venue to measure the quality of a particular execution by reference to any national best bid or offer in effect within the one-second period that such order was executed. Given the frequency of quote updates in actively traded securities within any single second, compliance with this requirement may not in all cases provide adequate transparency into a particular venue’s true execution quality. In addition, the scope of Rule 605 could be extended to cover broker-dealers, and not just market centers. Transparency could further be improved by amending Rule 606 to require disclosure about the routing of institutional orders, as well as a separate disclosure regarding the routing of marketable and non-marketable orders.

The BATS CEO also noted that all exchanges are given a significant competitive advantage regardless of their size by virtue of the order protection rule under Regulation NMS. While this was necessary in an era where legacy exchanges routinely ignored their competitors, he noted, current practices have reduced the need for regulatory protections of smaller venues. Recent events provide evidence that market forces ultimately can correct for venues that add only marginal value. The existing concentration of exchanges among scale providers means that in some cases the marginal operating cost for a new exchange is near zero.

The cost and complexity of connectivity to a small venue for market participants, however, can be substantial. Thus, he urged the SEC to revise Regulation NMS so that, until an exchange achieves greater than a de minimis level of market share, perhaps 1 percent, in any rolling three-month period, they should no longer be protected under the order protection rule; and they should not share in any NMS plan market data revenue.

Monday, July 07, 2014

Senate and House Companion Bills Would Provide Tax Credit for Angel Investors

Senator Chris Murphy (D-CT) introduced legislation that would provide incentives to angel investors to invest significant capital in startups. The Angel Tax Credit Act, S. 2497, would allow them to claim a tax credit equal to 25 percent of their aggregate qualifying equity investments of $25,000 or more to U.S.-based high-tech startups. Establishing this incentive, said Senator Murphy, would help create a funding pipeline to grow startups and target job growth in the science, technology, and engineering fields so the United States can continue its leadership in these fields. A companion bill, H.R. 4931, has been introduced in the House by Rep. Steve Chabot (R-OH).

SEC Amicus Urges Supreme Court to Give 1933 Act Section 11 the Broad Reach Congress Intended

In a Supreme Court case involving the contours of liability under Section 11 of the Securities Act, the SEC filed an amicus brief  contending that a  statement of opinion is actionable under Section  11  if it lacked a basis that was reasonable under the circumstances, even if it was sincerely held. The Commission rejected the assertion that  a statement of opinion is actionable under Section 11 only if it is not sincerely held, on the theory that the only fact expressly stated by the opinion is that the speaker holds that opinion.  The SEC said that this view overlooks that Section 11 applies to both misstatements and omissions. Section 11 creates an express cause of action for a registration statement that contained an untrue statement of material fact or omitted to state a material fact necessary to make the statements not misleading.  Omnicare, Inc. v. Laborers District Council Construction Industry Pension  Fund, Dkt. No. 13-435.

The Court took the case on appeal from the Sixth Circuit to answer the question of whether in a Section 11 action a plaintiff who seeks to impose liability for a statement of opinion in a registration statement  and who alleges that the opinion lacks a reasonable basis must also allege that the maker of the statement did not subjectively hold that opinion. The SEC said that, since an opinion can be misleading either because it is insincere or because it lacks foundation, the Sixth Circuit correctly held that a Section 11 plaintiff need not allege that the defendant disbelieved the opinion. But, continued the SEC, the appeals court erred in suggesting that a statement of opinion is actionable whenever it is ultimately proved incorrect.  Section 11 liability should be determined based on the facts at the time  the statement was made, said the Commission, not at a later time.

The SEC asserted that imposing Section 11 liability for statements of opinion that are not genuinely held or lack a reasonable basis furthers Congressional intent and fulfills the purposes of the Securities Act, which focuses on disclosure to investors.  The registration statement plays a foundational role, continued amicus, it must be filed before any security can be sold and, if it contains any material misrepresentations or omissions, the SEC may prevent the sale of the security and a purchaser of the security may sue for damages.


In enacting Section 11, Congress built on common law principles to create a far-reaching cause of action under which liability could be imposed for misstatements and omissions. Congress dispensed with  proof of scienter,  reliance,  and causation and allowed only limited affirmative defenses once it was established that a registration included a material misstatement or omission.  In the SEC’s view, the imposition of liability for a statement of opinion that is not genuine  or that lacks a reasonable basis is consistent with this scheme because it ensures that registration statements are both literally true and do not omit information that would matter to a reasonable investor. The Commission has consistently recognized  that a genuinely held statement of opinion may be materially misleading when it lacks a reasonable basis.

Friday, July 04, 2014

E.U. Securities Commissioner Leaves Legacy of Financial Reform and Regulatory Congruence

The tenure of E.U. Commissioner for the Internal Market Michel Barnier has been historic and his legacy will be farreaching. In the aftermath of the global financial crisis, Commissioner Barnier ushered in a series of financial reform measures involving derivatives, credit rating agencies, hedge funds and private equity fiunds,  mutual funds, and financial instruments. On his watch, the E.U. also set up a Recovery and Resolution regime similar to the orderly resolution authority established by the Dodd-Frank Act. While the U.S. enacted the omnibus Dodd-Frank Act to deal with many areas of financial reform, the E.U. took the path of many disctrete pieces of legislation.

Commissioner Barnier has always recognized that the financial crisis was global in nature and that the regulatory solution must be globally consistent, congruent and harmonized. In that spirit, he recenly called on U.S. and E.U. trade negotiators to include the harmionizaiton of derivatives regulation in their talks so that regulatory convergence and the avoidance of arbitrage can elevated to a Treaty level since it does not apprear that voluntary harmonization is working in this area. Commissioner Barnier said that global derivatives markets need worldwide standards and national rules that work together seamlessly.


Sunday, June 29, 2014

Congress Very Unlikely to Disturb Supreme Court's Endorsement of Basic Presumption of Reliance

The ruling by the Supreme Court in Halliburton was a strong reaffirmation of the fraud-on-the-market presumption of reliance in securities fraud actions, albeit tempered by the introduction of price impact at the class certification stage. By a 6-3 vote, the Court re-endorsed the presumption of reliance despite strong entreaties to overrule the 1988 Court ruling in Basic, Inc. v. Levinson as outdated and possibly even flawed when rendered. But make no mistake, this decision was a strong endorsement of Basic by a Court that greatly respects stare decises and a Chief who is very loathe to overrule precedent. Basic, Inc. will likely survive  long into the future since it is highly unlikely that Congress will legislatively overrule what has to be now called a landmark opinion in the field of securities regulation.

The perfect time for Congress to take action on the Basic presumption of reliance was the Private Securities Litigation Reform Act of 1995, which effected a major, comprehensive overhaul of private securities fraud actions when Basic was only seven years old. Instead, Congress left Basic untouched/ I believe that the rule is that when Congress legislates in the same field in which the Supreme Court has ruled, and leaves the Court's ruling intact, Congress is presumed to have sub silentio endorsed the ruling, which it is presumed to be aware of. It is very rare for Congress to overrule legislatively a Supreme Court ruling. In fact, while not totally sure, I do not believe that it has ever happened in the field of Supreme Court securities opinions. For many years the late Senator Arlen Specter of Pennsylvania tried very hard to obtain a legislative overruling of the Supreme Court's ruling in the Central Bank case essentially prohibiting aiding and abetting liability in private securities fraud actions. It never happened.

Friday, June 27, 2014

Volcker and Barnier Call for Treaty-Like Treatment of Cross-Border Financial Regulation Harmonization

Two prominent figures on different sides of the Atlantic have recently called for elevating the convergence of U.S. and E.U. financial regulations, especially in the area of cross-border derivatives, to treaty-like treatment. Michel Barnier, E.U. Commissioner for the Internal Market, called for including the cross-border convergence of financial regulations in the trade negotiations underway between the U.S and the E.U. And, in a recent speech, former Fed Chair Paul Volcker called for Bretton Woods type treatment of cross-border financial regulations, essentially calling for a Bretton  Woods Conference on financial regulation.

Despite the G20 calling for cross-border convergence and cooperation on financial regulation, Dodd-Frank Act provisions directing cross-border harmonization of the regulations implementing its provisions, and despite general jawboning that this was a global financial crisis that needs a global solution with globally coordinated regulations, it is really not happening because there is no enforceable mandate or mechanism to make it happen. I believe that this is what Commissioner Barnier and former Fed Chair Volcker have perceived and hence their calls for a Treaty and international agreements between sovereigns. In fact, sovereignty was also going to be the main roadblock to global harmonization and congruence of financial regulations. As I recall, Chairman Frank predicted this at the time of the enactment of Dodd-Frank Act. Despite increasing globalization, national sovereignty is still a powerful force. So, I believe Paul Volcker and Michel Barnier are correct in trying to elevate this issue to a Treaty level.

True and Fair and Fairly Present both Transcend IFRS and GAAP

When the U.K. Financial Reporting Council affirmed that the requirement that audited financial statements give a true and fair account of a company’s operations remains of fundamental importance under both U.K. GAAP and IFRS and the true and fair principle can override the mechanistic application of a particular accounting standard it was also affirming that US GAAP and IFRS have this in common. The analogous U.S. principle is that financial statements must fairly present the company’s financial picture. What both of these principles convey is that there is something higher than the application of accounting standards in deciding if financial statement present an accurate picture of the company. In other words, you cam mechanically comply with accounting standards and still fail to present an accurate picture of a company's financial condition. 

Another similarity is that the true and fair principle and the fairly present principle are both judicially-created, Circuit Judge Friendly in the US and Lord Hoffman and Dame Arden in the UK, outside of the realm of the accounting standard setters. True and fair is all important, said the FRC, such that where directors and auditors do not believe that following a particular accounting policy will give a true and fair view they are legally required to adopt a more appropriate policy, even if this requires a departure from a particular accounting standard.

To be sure, in the vast majority of cases a true and fair view will be achieved by compliance with accounting standards and by additional disclosure to fully explain an issue, noted the FRC. However, where compliance with an accounting standard would result in accounts being so misleading that they would conflict with the objectives of financial statements, the standard should be overridden.

House Panel Shines Light on Financial Stability Board in SIFI Designations

The Congressional spotlight has shone strongly on the Financial Stability Board over the designation of  non-bank financial firms, particularly asset management firms, as systemically important financial firms (SIFIs) by the Dodd-Frank created Financial Stability Oversight Council (FSOC). A letter from House Financial Services Committee Chair Jeb Hensarling (R-TX), and co-signed by his five Subcommittee Chairs asked Treasury Secretary Jacob Lew and SEC Chair Mary Jo White to explain the role of the FSB in FSOC SIFI designations, especially of non-bank firms has apparently gone unanswered. At his recent appearance before the Committee, Secretary Lew said that the FSB and the FSOC operate on parallel tracks and that a SIFI designation by the Board will not necessarily be followed by an FSOC SIFI designation of the same entity. By statute, the Treasury Secretary is the permanent Chair of FSOC.

The FSB is an international body based in Basel, Switzerland that is developing methodologies for designating non-bank firms as global SIFIs (G-SIFIs), essentially under an imprimatur from the G20, which has given the FSB cred in the wake of he financial crisis. The FSB, formerly the Financial Stability Forum, has no writ under US law or treaty and is chaired by Mark Carney, who is also Governor of the Bank of England.

Thursday, June 26, 2014

E.U. and U.S. Audit Regulators Take Different Views on Audit Firm Rotation

A dichotomy has arisen in global auditor oversight as the European Union mandates audit firm rotation and the U.S. pulls away from it. E.U. legislation that just went into force would mandate auditor rotation after ten years, while the SEC and PCAOB appear to have considered and rejected the idea of audit firm rotation. The E.U. sees efficacy in a fresh set of eyes on the financial statements and the benefit of breaking audit firm concentration. The state of affairs represents a divergence that will not be changed any time soon. Very astute and informed oversight bodies have divergent views on mandatory audit firm rotation. Apparently, U.S. regulators believe that the Sarbanes-Oxley Act mandated engagement partner rotation goes far enough, while E.U. regulators believe that more is needed.

Justice Ginsburg Short Concurring Opinion is Mouse that Roared in Halliburton

The very short concurring opinion of Justice Ginsburg in the Supreme Court's Halliburton opinion looms very large, given that the opinion was joined by Justices Sotomajor and Breyer and the Court's opinion by Chief Justice Roberts and joined by Justices Kennedy and Kagan does not have a majority without it. This means that the concurring opinion tempers the Court's ruling endorsing the fraud on the market presumption of reliance in securities fraud cases announced in the 1988 Basic, Inc. v. Levinson opinion, but with the injection of the company's ability to inject price impact showings at the class certification stage. Three Justices, Scalia, Thomas and Alito, would have flatly reversed the Basic Inc. ruling.

The Ginsburg concurrence Justices joined the Court's opinion, making six votes to endorse the Basic presumption of reliance based only on the understanding  that the opinion would impose no heavy toll on securities fraud plaintiffs with tenable claims and that it is incumbent on the defendant to show price impact. Basic has survived because of this concurring opinion and so respect must be paid to it. It has become part of the Court's ruling.

Wednesday, June 18, 2014

U.K. Treasury Sets Bold Plans for Market Abuse Regulation Outside of Recently E.U Legislation

The U.K. Treasury announced a major overhaul of financial market regulation that will involve enhanced financial benchmark oversight beyond LIBOR and set the U.K. going its own way on the recently enacted E.U. legislation on market abuse. The Fair and Effective Markets Review will be led by Bank of England Deputy Governor for Markets and Banking, Minouche Shafik, with Martin Wheatley Chief Executive Officer of the Financial Conduct Authority, and Charles Roxburgh, Treasury Director General for Financial Services, as co-chairs.

In a statement, the Government said that it plans to extend the new legislation put in place to regulate the LIBOR benchmark to cover further benchmarks in the foreign exchange, fixed income and commodity markets. As part of expanding the tough U.K. criminal regime for market abuse, the U.K. will not opt in to recently enacted E.U. legislation providing criminal sanctions for insider dealing and market manipulation, including abuse of LIBOR and other financial benchmark. Treasury vowed that U.K. rules in this area will be as strong or stronger than those of the E.U., while preserving the flexibility to reflect specific circumstances in the U.K.’s globally important financial sector. FCA CEO Wheatley remarked that robust and reliable benchmarks are the bedrock of market integrity.

The U.K. will also extend the Senior Managers and Certification Regime to cover all financial institutions with a presence in the country, by bringing in foreign financial institutions with branches in the U.K.

Tuesday, June 17, 2014

U.K. Auditor Watchdog Affirms That True and Fair Financial Statement Overrides IFRS and GAAP

The U.K. Financial Reporting Council affirmed that the requirement that audited financial statements give a true and fair account of a company’s operations remains of fundamental importance under both U.K. GAAP and IFRS and the true and fair principle can override the mechanistic application of a particular accounting standard. True and fair is all important, said the FRC, such that where directors and auditors do not believe that following a particular accounting policy will give a true and fair view they are legally required to adopt a more appropriate policy, even if this requires a departure from a particular accounting standard.

In a formal statement, the Council emphasized that in order to properly discharge their legal and professional responsibilities auditors must stand back as they approach finalization of the financial statements and consider whether, viewed as a whole and in view of the issues that they have addressed in the course of the audit, the accounts give a true and fair view. In the US, the analogous principle is that financial statements must fairly present the company’s financial picture.

In the vast majority of cases a true and fair view will be achieved by compliance with accounting standards and by additional disclosure to fully explain an issue, noted the FRC. However, where compliance with an accounting standard would result in accounts being so misleading that they would conflict with the objectives of financial statements, the standard should be overridden.


True and fair is not something that is merely a separate add-on to accounting standards. Rather the whole essence of standards is to provide for recognition, measurement, presentation and disclosure for specific aspects of financial reporting in a way that reflects economic reality and hence that provides a true and fair vision

The FRC noted the concerns of some people that the IFRS requirement that financial statements be useful, coupled with the omission of true and fair in IFRS, means IFRS cannot be overridden in order to present a true and fair view. These concerns are misplaced, said the FRC, because the concepts of usefulness and true and fair are inseparable. For financial statements to be useful, reasoned the FRC, they must present a true and fair view.

The introduction of IFRS in the U.K. did not change the fundamental requirement for accounts to give a true and fair view and the concept remains paramount in the presentation of company financial statements, even though the routes by which that requirement is embedded may differ slightly. 


The true and fair concept has been a part of English law and central to accounting and auditing practice in the U.K. for many decades. There has been no statutory definition of true and fair. The most authoritative statements as to the meaning of true and fair have been legal opinions written by Lord Hoffmann and Dame Mary Arden in 1983 and 1984 and by Dame Mary Arden in 1993.

In a recent report commissioned by the U.K. authorities in light of evolving global standards, Martin Moore Q.C. endorsed the analysis in the opinions of Lord Hoffmann and Dame Arden and confirmed the centrality of the true and fair requirement to the preparation of financial statements in the U.K., whether they are prepared in accordance with international or U.K. accounting standards. In his opinion, Mr. Moore noted that, in relation to the gradual shift over time to more detailed accounting standards, that it does not follow that the preparation of financial statements can now be reduced to a mechanistic process of following the relevant standards without the application of objective professional judgment applied to ensure that those statements give a true and fair view.

Directors must consider whether, taken as a whole, the financial statements that they approve are appropriate. Similarly, auditors are required to exercise professional judgment before expressing an audit opinion. As a result, the Moore Opinion confirms that it will not be sufficient for either directors or auditors to reach such conclusions solely because the financial statements were prepared in accordance with applicable accounting standards.

The Moore Opinion also states that the true and fair view is of an overarching nature. The concept is dynamic, evolving and subject to continuous rebirth. The preparation of financial statements is not a mechanical process where compliance with GAAP or IFRS will automatically ensure that those statements show a true and fair view or a fair presentation of the financial statements. Such compliance may be highly likely to produce such an outcome, but does not guarantee it. Any decision or judgment made by the preparer of financial statements is not made in a vacuum but is made against the requirement to give a true and fair view.

Senator Brown Wants SEC Chair to Explain Propriety of Waivers for Large Financial Firms

Senator Sherrod Brown (D-OH), Chair of the Banking Subcommittee on Financial Institutions, urged the SEC to revoke privileges that provide exemptions from securities law and regulations to financial institutions subject to civil or criminal settlements or enforcement actions. These exemptions allow large financial institutions to act as investment advisors to mutual funds, and obtain the privileges of well-known seasoned issuer status, such as the use of shelf registration. In a letter to SEC Chair Mary Jo White, Senator Brown asked if the SEC has written policies and procedures guiding its decisions to grant waivers and what steps the Commission taken to ensure uniformity and consistency in the decision to approve or deny a request for a waiver.


He also asks the Chair if she, after more than a year in that position, has examined the policies and decisions surrounding waivers of securities laws and regulations and, if so, what determinations she has made about the appropriateness of the SEC’s policies. He further wants to know what changes, if any, have been made or intend to be taken and, if none have, why not. The Senator also requests a complete list of the waiver provisions available to financial institutions under U.S. securities law and regulations. While he looks forward to a response from Chair White, Senator Brown put no time deadline on his requests for information.

He is very troubled that for more than a decade, the three largest U.S.financial institutions had a total of 27 fraud cases brought against them and received 86 waivers. Of the three, only one had any of its privileges revoked. He noted that in April of 2014 the SEC granted a foreign bank, with more than $2.8 trillion in total assets, a waiver to continue operating as a well-known seasoned issuer after reaching a settlement involving criminal liability for manipulating the London Interbank Offering Rate (LIBOR).

Then, in early May, a foreign bank with nearly $1 trillion in assets entered into a plea agreement stemming from criminal charges of conspiracy to commit tax fraud. The same day that the agreement was announced, the SEC granted the financial institution two waivers allowing it to temporarily continue serving as an investment adviser under Section 9(a) of the Investment Company Act, and allowing its existing funds to retain an exemption under Rule 506 of Regulation D.

SEC Commissioner Kara Stein questioned the SEC’s April decision to grant the WKSI waiver. Senator Brown shares the Commissioner’s fear that the SEC’s waiver in this recent, LIBOR-related case may have enshrined a new policy that some firms are too big to bar. However, he does not believe that this policy is new, adding that it appears that these recent actions are an outgrowth of a policy that has existed for some time.

In his view, these recent decisions imply that the SEC’s policy appears to make waivers the rule rather than the exception. He urged the SEC to reconsider and revise a process that has now been questioned by the public, lawmakers, and a sitting SEC Commissioner. Removing privileges enjoyed by large firms will promote better behavior, increase accountability, and demonstrate to the financial markets that certain firms do not enjoy special treatment by virtue of their size.

Wednesday, June 11, 2014

Congress Grows Concerned About FSB Role in FSOC Designation Process for SIFIs

The role of the Financial Stability Board in the designation of non-bank systemically important financial institutions (SIFIs) has come into stark relief as the Dodd-Frank created Financial Stability Oversight Council considers the SIFI designation of non-bank entities, particularly asset management firms. The Board, formerly the Financial Stability Forum, has become more prominent with the financial crisis and imprimaturs from the G20 to carry out certain tasks in connection with the reform of financial regulation.

Congress has grown increasingly concerned with the role that the FSB plays in the FSOC designation of SIFIs. In a recent to SEC Chair Mary Jo White and Fed Chair Janet Yellen in their capacity as FSOC members, with a copy to Treasury as permanent FSOC Chair, Rep. Jeb Hensarling (R-TX), Chair of the Financial Services Committee, asked the Fed and SEC to respond by May 16, 2014 to a series of questions intended to allow Congress to understand the designation process. The letter was also signed by the Committee’s five Subcommittee Chairs: Rep. Scott Garrett (R-NJ), Capital Markets, Rep. Shelley Moore Capito R-WV), Financial Institutions, Rep. Randy Neugebauer (R-TX), Housing and Insurance, Rep. Patrick McHenry (R-NC), Oversight and Investigations, and Rep. John Campbell (R-CA), Monetary Policy and Trade.

The House Chairs are troubled that sweeping power in this area has been invested in the FSB, which they described as an unincorporated Swiss association with no authority under U.S. law or treaty. In their view, the FSB’s semi-official status as an offshoot of the G20 makes it an inappropriate forum for decisions of this importance. Noting that the FSB is a complete black box, the House Chairs do not believe U.S. sovereignty should be surrendered on financial regulation to what the call an ``international old boy’s club’’ that deliberates in secret. The letter requests information on how FSOC’s designation process relates to the Board’s process and seeks assurance that decisions on the systemic importance of U.S. firms is not being outsourced to the G20. The House leaders asked for a response by May 16. I have not yet seen a response to the letter.

In any event, the issue will not go away and is partially responsible for pending legislation to enhance the transparency of FSOC and its designation process. At a recent hearing on the process that FSOC uses to designate SIFIs, Chairman Hensarling said that FSOC should cease and desist making new SIFI designations until Congress comes to an understanding of how the designation process works.

Tuesday, June 10, 2014

Senators Nelson and Warren urge SEC-CFTC Study on High Fees and Commissions on Managed-Futures Funds

Senators Bill Nelson (D-FL) and Elizabeth Warren (D-MA) have asked the CFTC, in conjunction with the SEC, to study what specific disclosures and additional investor information might improve the opportunity for investors in all managed-futures funds to retain more of the substantial profits that the industry is making and keeping through what appear, from financial press reports, to be unreasonably high fees, commissions, and expenses. In a letter to CFTC Chair Gary Gensler, the Senators said that one improvement for the protection of unwary investors would be to require that managers of these managed-futures funds clearly explain in writing how severely fees and commissions can consume or affect gross profits over time.  Senator Nelson chairs the Special Committee on Aging, of which Senator Warren is a member.


The legislators emphasized that individual investors, especially senior investors looking to find a suitable place to place their retirement savings, should be made aware of these managed-future funds’ fees and commissions and the draining effect of such upon their investments.  Although these funds are purported to be for sophisticated investors, some of these firms have a very low minimum investment that can be made from an Individual Retirement Account (IRA). The Senators are very concerned about the potential impact that these fees could have on the retirement security of the persons who invest in these funds.