Saturday, April 12, 2014

South Carolina and 20 other States ask Supreme Court to Allow Asset discovery in Argentina Bond Case

In a case involving the assets of the Republic of Argentina being subject to creditors, the State of South Carolina and 20 other states urged the U.S. Supreme Court to reject the argument that foreign sovereigns are not subject to post-judgment discovery under FRCP 69 despite a prior waiver of sovereign immunity unless the creditor identifies the assets in advance. In their amicus brief, the states argued that requiring creditors to identify assets available to satisfy a judgment before obtaining discovery would effectively deprive them of any realistic opportunity to conduct asset discovery. Doing so would unduly impede enforcement of foreign sovereign debt obligations and further encourage sovereign debtors to remove attachable assets from the United States. Thus, the states asked the Court to protect the bargained-for rights of investors in foreign sovereign debt by holding that the Foreign Sovereign Immunities Act (FSIA) does not limit post-judgment asset discovery under Rule 69. The Court is reviewing a Second Circuit ruling that post-judgment discovery in aid of enforcing a judgment against a foreign state can be ordered with respect to all assets of a foreign state regardless of their location or use. Oral argument is set for April 21. Republic of Argentina v. NML Capital Ltd, Dkt. No. 12-842. Amici are States that have invested billions of dollars in foreign sovereign debt through their public pension funds. Those investments will be seriously jeopardized and State budgets may be severely impacted as a result if the Court accepts the proposition urged by the Republic of Argentina that foreign sovereigns may attract investors with the false promise that their debts will be enforceable in U.S. courts, only to change the rules and thwart enforcement when it comes time to collect on those debts. By waiving sovereign immunity, the foreign sovereign agrees to subject itself to judicial process in a U.S. court, pursuant to the Federal Rules of Civil Procedure. That includes post-judgment discovery under Rule 69. Many foreign sovereigns, particularly those with emerging economies or troubled financial pasts, are able to access affordable capital from U.S. investors, only if they agree to waive sovereign immunity and thereby allow their debts to be enforced in a U.S. court. That is precisely what the Republic of Argentina did here, said amici.

FCA Brings first Enforcement Action for Manipulation of U.K. Government Bonds

The U.K. Financial Conduct Authority has banned a bond trader from the industry and fined him £662,700 for deliberately manipulating a UK government bond. This is the FCA’s first enforcement action for attempted or actual manipulation of the government bond market. The FCA described the bond trader’s actions as "particularly egregious", falling far below the standards of integrity expected of FCA approved-persons. The investigation found this was the action of one trader on one day, and there is no evidence of collusion with traders in other firms. The bond trader agreed to settle at an early stage of the investigation, thereby qualifying for a 30 percent discount. Without this discount, the FCA would have imposed a fine of £946,800. The FCA found that the bond trader intended to sell his holding, worth £1.2 billion, to the Bank of England for an artificially high price during quantitative easing operations. His conduct was a clear case of market manipulation, said the FCA, designed to secure the price of the relevant bonds at an abnormal or artificial level. The FCA further found that the trader deliberately traded in an aggressive style when purchasing the bond, which gave a false or misleading impression as to the price of the bond and secured the price of the bond at an abnormal or artificial level. This was not trading for a legitimate reason or in accordance with accepted market practices. Indeed, the FCA found that the trading in the bond constituted market abuse in that it was behavior consisting of effecting transactions or orders to trade, otherwise than for legitimate reasons and in conformity with accepted market practices, which gave a false or misleading impression as to the price of the bond and secured its price at an abnormal or artificial level within the meaning of Sections 118(5)(a) and (b) of the Financial Services and Markets Act of 2000. Tracey McDermott, the FCA Director of Enforcement, said that the bond trader’s abuse took advantage of a policy designed to boost the economy with no regard for the potential consequences for other market participants and, ultimately, for tax payers. Fair dealing is at the heart of market integrity, she emphasized, and this enforcement action sends a clear message about how seriously the FCA views attempts to manipulate the market.

Senate Legislation would Clarify Dodd-Frank Leverage and Risk-Based Requirements

Senator Susan Collins (R-ME) has introduced legislation, S. 2102, that would clarify the leverage and risk-based requirements of the Dodd-Frank Act. Senator Collins is the author of Section 171 of Dodd-Frank, which is aimed at addressing the too big to fail problem by requiring large financial holding companies to maintain a level of capital at least as high as that required for community banks, equalizing their minimum capital requirements, and eliminating the incentive for financial institutions to become too big to fail. Section 171 allows the federal regulators to take into account the distinctions between banking and insurance, and the implications of those distinctions for capital adequacy. While it is essential that insurers subject to Federal Reserve Board oversight be adequately capitalized on a consolidated basis, noted Senator Collins in recent testimony before the Senate Subcommittee on Financial Institutions, it would be improper, and not in keeping with Congressional intent, for federal regulators to supplant prudential state-based insurance regulation with a bank-centric capital regime for insurance activities. Indeed, she affirmed that nothing in Section 171 alters state capital requirements for insurance companies under state regulation. The Collins legislation would add language to Section 171 to clarify that, in establishing minimum capital requirements for holding companies on a consolidated basis, the Federal Reserve is not required to include insurers so long as the insurers are engaged in activities regulated as insurance at the state level. The legislation also provides a mechanism for the Federal Reserve, acting in consultation with the appropriate state insurance authority, to provide similar treatment for foreign insurance entities within a U.S. holding company where that entity does not itself do business in the United States. In her testimony, Senator Collins pointed out that does not, in any way, modify or supersede any other provision of law upon which the Federal Reserve may rely to set appropriate holding company capital requirements

Senate Legislation Would Enhance Disclosure around Municipal and Corporate Debt Securities

Bi-partisan legislation introduced by Senator Mark Warner (D-VA) would enhance the disclosure to investors in municipal and corporate debt securities. The bill is co-sponsored by Senator Tom Coburn (R-OK). The Bond Transparency Act, S. 2114, would amend the Exchange Act to provide that a broker, dealer, or municipal securities dealer that effects a riskless principal transaction must disclose to the customer, in writing, at or before the time of completion of the transaction, the amount of the difference between the customer's purchase price and the broker's, dealer's or municipal securities dealer's purchase price; or the customer's sale price and the broker's, dealer's, or municipal securities dealer's sale price. The Act would define a riskless principal transaction to mean a transaction in which a broker, dealer, or municipal securities dealer receives a customer order to buy or sell any municipal securities and, after receiving the customer order, buys the municipal securities from, or sells the municipal securities to, another person, while acting as principal for its own account, to complete the customer order; and any other transaction the SEC identifies by rule as a riskless principal transaction.

U.K. FCA Chief says Behavioral Economics is a Game Changer

The U.K. Financial Conduct Authority has embedded behavioral economics in its regulation of the financial markets, according to FCA Chief Executive Martin Wheatley. There is now little doubt that behavioral economics could have a profound impact on many of the most serious challenges facing regulators and policymakers today. The FCA is already seeing significant possibilities across a range of UK markets. There is also opportunity for behavioral economics to support more specific issues like complexity; consumer inertia; marketing and the impact of firm communications to consumers. In recent remarks, The FCA is active in all these areas, he noted, using behavioral analysis to help collect better management information. Behavioral economics is quickly becoming a game changer, he noted, not just for firms and investors, but potentially for the shape of regulation for many years to come. The FCA is interested in its potential to change corporate behavior or help investors consumers as well as for the opportunities it offers for self-reflection. One of the areas the FCA is investigating is whether behavioral economics can offer the FCA insights into how individuals within organizations behave and respond to regulation. This goes to learning about the way the FCA intervenes within markets. It could help answer the question of whether day-to-day interventions, which the FCA relies on, are as effective as the agency imagines them to be.

ESMA proposes Standards under revised Transparency Directive

The European Securities and Markets Authority (ESMA) has proposed standards under the revised Transparency Directive, particularly around shareholdings notification requirements. ESMA also sets out the proposed content of an indicative list of financial instruments which should be subject to the notification requirements laid down in the Directive, and outlines the processes for updating that list. ESMA considered whether the 5 percent notification threshold should only be used to disclose Article 9 and 10 holdings or if this should also include holdings of Article 13 financial instruments. According to the first alternative, two separate buckets of up to 5 percent each would exist; one consisting of Article 9 and 10 shares and another with Article 13 financial instruments. Thus, a credit institution or investment firm could hold as a market maker or in its trading book a combined position in a share of up to the double of the actual respective threshold. According to the second alternative, all Article 9, 10 and 13 holdings should be aggregated in a single bucket up to the 5 % threshold.

Monday, March 31, 2014

Hong Kong SFC Proposes to Restrict Dark Pools to Institutional Investors

In what appears to be a first for a major financial market, the Hong Kong Securities and Futures Commission proposed restricting dark pools to institutional investors. The Commission also proposed risk management measures for dark pools, which are electronic trading systems that do not display public quotes. In light of the lack of pre-trade transparency in dark pools and their impact on the price discovery function in the securities market, the SFC found widespread and justified concern that the dark pools, and those operating them, should be subjected to consistent, appropriate and effective levels of regulation. Ashley Alder, the SFC’s Chief Executive Officer, noted that the proposals aim to strike a balance between market development, market integrity and investor protection, taking into account the needs and circumstances of the Hong Kong market.

At least at this stage, the Commission is proposing that only institutional investors should be allowed access to dark pools. Given that some dark pools have complex execution or order processing methodologies, the SFC is concerned that retail investors might find it difficult to understand the operation of, and the risks associated with, these crossing networks. Lack of understanding by retail investors, as well as the opaqueness and potential conflicts of interest inherent in these dark pools, might well place this group at greater risk than more sophisticated investors.

Neither the E.U. nor the U.S. restrict dark pools to institutional investors. Neither does Australia, but the Australian Securities and Investment Commission imposes a meaningful price improvement rule that appears to have caused a decline in dark liquidity and to have increased the average size of  trades in dark pools. Similarly, Canada does not restrict types of investors, but does impose a minimum size requirement for dark pool orders.

Given that the desired objective is to restrict participation, the Commission believes that it is preferable to specifically address this issue rather than to introduce other measures which might have this effect, but which might also give rise to other complications. For example, introducing minimum sized orders is challenging from a definitional perspective and also from the perspective of striking the correct balance when setting the minimum level.

The SFC does not rule out the future possibility of retail investors being permitted to become users of dark pools. This might be possible by treating retail and institutional investors differently. For example, retail participation might be restricted to transactions in listed or traded securities and only during exchange trading hours. This, combined with a meaningful price improvement requirement resembling that which is in place in Australia, might result in a dark pool operator being obliged to ensure that the orders of retail investors are transacted in the lit markets unless genuine price improvement can be achieved in the event of a transaction being effected in a dark pool.

The SFC recognizes that behind an institutional investor conducting transactions in a dark pool there might be retail clients for whom the institutional investor is acting. The SFC proposes to address this by imposing an obligation on dark pool operators to ensure that their clients and the clients of their group companies do not conduct transactions in dark pools unless they are institutional investors. The SFC is also aware that some dark pool operators consider this obligation to be unnecessarily onerous. While recognizing that this obligation might be inconvenient, the SFC believes that it can be met by dark pool operators, with the active assistance of their group companies.

Moreover, the SFC considers this obligation to be essential in order to prevent operators from attempting to circumvent the spirit of the proposed user restrictions by the positioning of a group company between the operator and the person ultimately responsible for the placing of an order and then treating the group company as its client and turning a blind eye to the identity of the person ultimately responsible for the order.

Risk Management. The SFC proposes that a dark pool operator should ensure that it has effective controls to monitor and prevent the crossing of orders which may be erroneous, interfere with the operation of a fair and orderly market, or be in breach of any legal or regulatory obligations. Moreover, a dark pool operator should conduct regular post-trade reviews of transactions conducted in its pool to identify any suspicious market manipulative or abusive activities, any market events or system deficiencies, such as unintended impact on the market, which call for further risk control measures, and any breaches, whether actual or potential, of any requirements relating to fair and orderly trading in its ALP or which might constitute market misconduct.

U.K. FCA Adopts Crowdfunding Regulations

The U.K. Financial Conduct Authority adopted regulations to facilitate crowdfunding, which the FCA describes as a way businesses can raise money through online portals to finance their activities. The new regulations provide protections such as minimum capital standards and the requirement for firms to have arrangements in place to continue to administer loans in the event that the crowdfunding platform fails. The crowdfunding regulations take effect on April 14, 2014.
To some extent, crowdfunding already falls within the scope of regulation by the FCA if it involves a person carrying on a regulated activity in the U.K., such as arranging deals in investments, or the communication of a financial promotion in relation to securities. If a crowdfunding platform enables a business to raise money by arranging the sale of equity or debt securities, or units in an unregulated collective investment scheme, then this is investment-based crowdfunding. As such, it is regulated by the FCA and the firm operating the crowdfunding platform needs to be authorized, unless an exemption is available. The new regulations will apply FCA Principles and core FCA provisions to firms running loan-based crowdfunding platforms.
In order to create a proportionate framework that balances regulatory costs against benefits, the FCA does not prescribe how firms should address or disclose the relevant risks. Nor is the agency proposing to set requirements for minimum standards of due diligence at this stage. At present, it is for firms to determine the risks present in their business models and to develop appropriate processes to deal with them. The FCA believes that this approach provides adequate investor protection and sufficient flexibility for firms to operate and arrange finance for small and medium-sized  enterprises.
However, greater prescription is an option that the FCA may consider in the future, depending on how the market evolves. The FCA vowed to review the market and its regulatory approach to crowdfunding in the coming years.
The FCA firmly believes that the high-level rules it is adopting are proportionate for this market at this time. The FCA does not consider it appropriate to mandate specific disclosures or the form and content of those disclosures since business models vary across the market. Instead, the rules require firms to consider the nature and risks of the investment, and the information needs of their customers, and then to disclose relevant, accurate information to them. The high-level approach puts the onus on firms to provide appropriate, useful information, and not to over-burden consumers with too much detail.
Although the FCA does not require specific types of information or ban specific terms or disclosure practices, the Authority cautioned firms that they may only use terms such as protected or secure, or make comparisons of returns to savings accounts, when that is fair, clear and not misleading. Regarding taxation, the FCA expects firms to provide sufficient explanation of the position so that customers can understand their tax obligations. The explanations should enable investors to perform their own calculations and compare net returns with those of other investments.  

European Commission responds to ESMA Request for E.U.-wide Definition of Derivative

Responding to a request from the European Securities and Markets Authority  (ESMA) to provide a consistent definition of derivative and derivative contract across the E.U., the European Commission essentially said that the vehicle to do this would be standards under MiFID II and asked for ESMA’s assistance. In a letter to ESMA Chair Steven Maijoor, the Commission  said that it shared ESMA’s view that it is essential to have a fully consistent transposition throughout the Union of the relevant MiFID provisions defining derivative and derivatives contracts, in particular to avoid the negative effects caused by any inconsistent application of the European Market Infrastucture Regulation (EMIR). However, the Commission said that it would be inappropriate for it to prejudge the imminent work on the delegated acts for MiFID II by developing Level 2 proposals under the current MiFID, the preamble of which does not contain specific recitals to frame the definition.

Currently, EMIR refers to a list of financial instruments in MiFID to define derivative, which does not work because of different transpositions of MiFID across Member States. This in turn, said ESMA,  means that there is no single, commonly adopted definition of derivative or derivative contract in the European Union, thus preventing the convergent application of EMIR. In a letter to Michel Barnier, Commissioner for the Internal Market, ESMA said that this is particularly true in the case of foreign-exchange forwards and physically settled, commodity forwards. ESMA noted that differences in the definitions of derivative or derivative contract throughout the E.U. would result in the inconsistent application of EMIR, whose primary objective is regulating derivatives transactions.

Definition of derivative. The Commission acknowledges that ESMA has identified a lack of clarity about the precise delineation between FX forward contracts and currency spot contracts under MiFID. The Commission agrees with the important need for clarity and consistency in this regard and assured ESMA that it will urgently assess the options for action to ensure consistent application of the legislation. Article 4(2) of MiFID already empowers the Commission to clarify the definitions in Article 4 through the adoption of a delegated act, in order to take account of developments on financial markets, and to ensure the uniform application of the Directive.

But the Commission said that it would be inappropriate for it to prejudge the imminent work on the delegated acts for MiFID II by developing Level 2 proposals under the current MiFID, the preamble of which does not contain specific recitals to frame the definition. The Commission thus invited ESMA, as a part of its preparation for its advice to the Commission under MiFID II, for which it is going to receive a mandate before the summer, to also assess the status of physically settled commodity forwards. In addition, and in order to ensure the consistent application of MiFID, ESMA could also consider issuing guidelines.

E.U. Parliament and Council Reach Deal on Legislation on Orderly Resolution Authority for Failed Financial Firms

The European Parliament and Council reached agreement on legislation to establish a Single Resolution Mechanism to orderly resolve failed and failing financial institutions and investment firms. The resolution authority is backed by an appropriate resolution funding arrangement and a robust decision-making process. A Single Resolution Fund would be constituted to which all the financial institutions in the participating Member States would contribute.  Parliament is expected to pass the legislation in April, with subsequent approval by the Council. The Single Resolution Mechanism would enter into force on January 1, 2015, while bail-in and resolution functions would apply from one year later, as specified under the Bank Recovery and Resolution Directive.
In case of a cross-border failure of a major financial firm, noted Commissioner for the Internal Market Michel Barnier, the Single Resolution Mechanism will be much more efficient than a network of national resolution authorities and will help avoid risks of contagion. While the Single Resolution Mechanism might not be a perfect construction, he continued, it will allow for the timely and effective resolution of a cross border financial institution, thus meeting its principal objective.
Resolution Board. Centralized decision-making would be built around a strong Single Resolution Board and would involve permanent members as well as the Commission, the Council, the European Central Bank (ECB) and the national resolution authorities. In most cases, the ECB would notify the Board, the Commission, and the relevant national resolution authorities that a financial institution is failing. If the Board finds that there is a systemic threat and no private sector solution in sight,  it would adopt a resolution scheme including the relevant resolution tools and any use of the Resolution Fund. 
The Commission, is responsible for assessing the discretionary aspects of the Board's decision and endorsing or objecting to the resolution scheme. The Commission's decision is subject to approval or objection by the Council only when the amount of resources drawn from the Single Fund is modified or if there is no public interest in resolving the financial firm. Where the Council or the Commission object to the resolution scheme, the Board would have to amend the resolution scheme, which would then be implemented by the national resolution authorities. If resolution entails State aid, the Commission would have to approve the aid prior to the adoption by the Board of the resolution scheme.
Resolution Fund. The Resolution Fund has a target level of €55 billion and can borrow from the markets if decided by the Board in plenary session. The Fund would be owned and administrated by the Board. The Single Fund would reach a target level of at least 1 percent of covered deposits over an eight-year period. During this transitional period, the Single Fund, established by the Regulation, would comprise national compartments corresponding to each participating Member State.
The resources accumulated in those compartments would be progressively mutualized over a period of eight years, starting with 40 percent of these resources in the first year. The establishment of the Single Fund and its national compartments and the decision-making on its use would be governed by the Regulation, while the transfer of national funds towards the Single Fund and the activation of the mutualization of the national compartments would be provided for in an inter-governmental agreement established among the participating Member States in the Single Resolution Mechanism.
 German Finance Minister. German Finance Minister Wolfgang Schäuble welcomed the basic agreement on the Single Resolution Mechanism. The legislation will create a sensible decision-making mechanism with effective controls over the funds while minimizing risks to taxpayers, he averred. The main tenets of the agreement are a bail in feature envisioning the clear involvement of private creditors from day one. In addition, there will be more rapid payment into the future resolution fund and progressive mutualization. Finally, the Minister noted that there will be no joint liability for participating Member States.
 In recent remarks at a financial stability forum in Frankfurt, the Minister emphasized that the Single Resolution Mechanism must have efficient decision-making procedures. He cautioned that the resolution of failed and failing financial firms must not be delayed by national interests or conflicts. That is why Germany wants resolution decisions to be taken solely by the resolution board to the maximum extent that this is legally possible.

With nod to SEC, the Fed Will Keep its Finger on the Pulse of Crowdfunding

The SEC regulations implementing the crowdfunding provisions of the Jumpstart Our Business Startups (JOBS) Act will influence the environment for crowdfunding in general and for community development finance specifically, said Federal Reserve Board Governor Jeremy Stein. In remarks at the Crowdfunding for Community Development Finance Conference in Washington, D.C., he noted that the crowdfunding implementing regulations are welcome and timely, because in many communities the traditional resources for community development are shrinking and the field is actively seeking to identify new sources of funding. 

Crowdfunding is a way in which businesses, including business start-ups, can raise money through online portals (crowdfunding platforms) to finance or re-finance their activities and enterprises. The JOBS Act provides for an exemption from SEC registration for online crowdfunding offerings, subject to investor protection provisions and some restrictions.

More broadly, Gov. Stein emphasized that the Fed is interested in crowdfunding even though it does not have a direct regulatory role because it is  important for the central bank to keep its finger on the pulse of financial innovation and the changing dynamics of the financial services industry. While noting that financial innovation can offer both opportunities and pitfalls, the official added that by carefully and even-handedly studying each new product or service at an early stage in its lifecycle the Fed can better understand both the potential benefits, as well as any risks for adverse impacts on households and communities.

Sunday, March 23, 2014

House Panel Approves Bi-Partisan Legislation Exempting Smaller Companies from Using XBRL in SEC Reports

The House Financial Services Committee has marked up and approved by a 51-5 vote bi-partisan legislation exempting smaller public companies from requirements relating to the use of Extensible Business Reporting Language (XBRL) for periodic reporting to the SEC. The Small Company Disclosure Simplification Act (H.R. 4164), was introduced by Rep. Robert Hurt (R-VA), Vice Chair of the House Capital Markets Subcommittee, and is co-sponsored by Rep. Terri Sewell (D-AL). Rep. Hurt believes that the legislation would streamline regulations for small public companies and remove a disincentive for companies to access capital in the public markets. Public companies are required to provide their financial statements in an interactive data format using XBRL. XBRL tags certain data points in issuers’ reports and exports them in a standardized format. XBRL is reported in a unique computing language, one that requires specific expertise outside the bounds of traditional financial or accounting training. Rep. Hurt noted that a glaring example of a regulation where costs currently outweigh potential benefits is related to the use of XBRL. The bill offers a commonsense solution to this problem, ensuring that regulations are not hampering the success of smaller companies. Currently, he continued, in order to comply with the XBRL regulation, small companies must expend tens of thousands of dollars on average. However, evidence suggests that less than ten percent of investors actually use XBRL.

In light of E.U. action, SEC Urged to Make Sustainability Reporting a Top Priority

Noting that the E.U. Parliament and Council of the European Union recently reached agreement on legislation requiring the reporting of non-financial information, such as on the environment and board diversity, the Forum for Sustainable and Responsible Investment urged the SEC to enhance mandatory corporate environmental, social and governance disclosure and make sustainability reporting a top priority at the Commission. In a letter to the SEC, the Forum said that there is an increasing demand from international investor and accounting bodies for corporate sustainability reporting. The E.U. Parliament is expected to approve the sustainability legislation in April, after which the Council will formally adopt it. The Forum also noted that the Toronto Stock Exchange and the Chartered Professional Accountants of Canada recently issued guidance on environmental and social disclosure, which discussed principles for environmental and social business conduct, mandatory disclosure requirements, developments in key performance indicators and other global initiatives to advance sustainability disclosure.

In Letter to AG, Senator Warren and House Leaders Urge Vigorous Prosecution of Mortgage Fraud

In a letter to U.S. Attorney General Eric Holder, Senator Elizabeth Warren (D-MA), House Financial Services Committee Ranking Member Maxine Waters (D-CA) and Oversight and Government Reform, Committee Ranking Member Elijah Cummings (D-MD) expressed concern that the investigation of mortgage fraud has not been a top priority for the DOJ and that DOJ has publicly and repeatedly reported inaccurate statistics regarding its efforts to prosecute mortgage fraud cases. In the letter to the AG, they requested a meeting to review a recent report by the DOJ’s Inspector General finding that in many instances the investigation of mortgage fraud was not a top priority at the DOJ and to understand the steps that will be taken to ensure that DOJ’s effort to identify and prosecute those responsible for fraudulent mortgage practices is equal to the harm caused by those practices.

House Oversight Chair Supports Legislation to Keep PCAOB Outside of Budget Sequestration

Subjecting the PCAOB and FASB to sequestration would jeopardize the independence of the accounting standards setting and auditing process and provide the Federal government with unintended and unprecedented control over these institutions, noted Rep. Michael Conaway (R-TX), Co-Chair of the Congressional Caucus on CPAs and Accountants. He added that this type of control is precisely what Congress sought to avoid when it made the PCAOB and FASB independent of the Federal budget process in the Sarbanes-Oxley Act. Rep. Conaway, who is also Chair of the House Commodities and Risk Management Subcommittee is supporting legislation, H.R. 4270, that would exempt the PCAOB from budget sequestration. In remarks on the House floor, Chairman Conaway said that high-quality accounting and independent audit oversight is critical to providing transparent, consistent, comparable, relevant, and reliable financial information to investors. Because of the complexity and the competing stakeholder interests associated with accounting standards, Congress has repeatedly determined that the establishment and enforcement of these standards should be managed by independent, private-sector organizations. Cong. Rec. March 16, 2014, p.E287. In order to insulate the PCAOB and FASB from coercion and to protect their independence, Congress authorized these organizations to collect fees as dedicated sources of funding in the Sarbanes-Oxley Act. These fees are not federal dollars, emphasized the Chair, who added that they never touch the Treasury or any other governmental entity, and are not subject to appropriation. In fact, Section 109(c)(1) of Sarbanes-Oxley specifically says that accounting support fees and other receipts of the PCAOBand FASB shall not be considered public monies of the United States. Importantly, neither the PCAOB nor FASB has any budget authority, or the ability to obligate and expend funds on behalf of the Federal government. Section 109(i) of Sarbanes-Oxley clarifies their independence further by stating that nothing in this section shall be construed to render either the PCAOB or FASB subject to procedures in Congress to authorize or appropriate public funds, or to prevent such organization from utilizing additional sources of revenue for its activities. Despite this clear Congressional intent to keep the PCAOB and FASB independent of the Federal budget process, the OMB included them both in the President’s Budget, making them subject to sequestration. Yet, because their revenues are not federal monies, sequestering their funds would have no impact on the Federal budget and would not reduce the deficit one dollar. In order to implement Congressional intent and maintain the independence of the accounting and auditing community, noted Chairman Conaway, Congress must exempt these private, non-profit organizations from the President’s Budget and clarify that these and other similarly situated entities are not subject to current or future sequestration. Rep. Conaway inserted into the RECORD a bipartisan letter signed by nine members of the Congressional Caucus on CPAs and Accountants that, while focusing on FASB, is equally applicable to the PCAOB and shows the bipartisan concern that protecting the independence of these organizations has. The letter notes that high-quality accounting standards are critical to providing transparent, consistent, comparable, relevant, and reliable financial information to investors. Because of the complexity and the competing stakeholder interests associated with accounting standards, Congress has repeatedly determined that the establishment of these standards should be managed by an independent, private-sector body. Congress statutorily authorized the SEC to designate FASB as the entity responsible for developing financial accounting and reporting standards for all nongovernmental, private-sector entities that issue financial statements in accordance with GAAP. Congress has determined that independent, private-sector funding sources are necessary in order for those entities to remain objective and unbiased. Therefore, Congress authorized the collection of fees as dedicated sources of funding to insulate FASB from coercion and to protect its independence.

Sunday, March 16, 2014

House Panel Approves Legislation Preventing Volcker Rule Divestiture of Legacy Debt Securities of CLOs

The House Financial Services Committee marked up and approved legislation clarifying that nothing in the Volcker Rule should be construed to require the divestiture, prior to July 21, 2017, of any debt securities of collateralized loan obligations, if such debt securities were issued before January 31, 2014. The vote to approve was 53-3. Introduced by Rep. Andy Barr (R-KY), the Restoring Proven Financing for American Employers Act, H.R. 4167, would amend the Volcker Rule to exclude certain debt securities of collateralized loan obligations from the prohibition against acquiring or retaining an ownership interest in a hedge fund or private equity fund.

Rep. Barr, a key member of the House Financial Services Committee, said that the legacy debt securities of collateralized loan obligations must be protected from the medicine that the Volcker Rule prescribes, which in his view would be far more damaging to the credit markets than the perceived illness of suffering loses from CLO paper. Congress must grandfather existing CLO investments, emphasized Rep. Barr.

The legislation would also clarify that a financial institution would not be considered to have an ownership interest in a collateralized loan obligation if there is no indicia of ownership other than the right of the firm to fire or remove for cause, or to participate in the selection or removal of, a general partner, managing member, member of the board of directors, investment manager, investment adviser, or commodity trading advisor of the fund, provided that the collateralized loan obligation is predominantly backed by loans.

H.R. 4167 provides that an investment manager or investment adviser must be deemed to be removed for cause if the investment manager or adviser is removed as a result of a breach of a material term of the management or advisory agreement or the agreement governing the collateralized loan obligation; the inability of the investment manager or adviser to continue to perform its contractual obligations or any other action or inaction by the investment manager or investment adviser that has or could reasonably be expected to have a materially adverse effect on the collateralized loan obligation, if the manager or adviser fails to cure or take reasonable steps to cure such effect within a reasonable time.

An amendment offered by Rep. Carolyn Maloney (D-NY), and approved by voice vote, added as a removal for cause a removal for a comparable event that threatens or could reasonably be expected to threaten the interests of the holders of the debt securities.

European Commission Adopts Standards Defining Material Risk Takers Subject to Bonus Cap

The European Commission adopted regulatory standards identifying material risk takers at financial institutions and investment firms who will be subject to caps on bonuses and other compensation regulations. The application of standard quantitative and qualitative criteria could lead to the inclusion of additional staff in the category of material risk taker. The standards were proposed by the European Banking Authority and have now been endorsed by the Commission.

Commissioner for the Internal Market Michel Barnier said that the adoption of the standards is an important step towards ensuring that the capital requirement rules on remuneration are applied consistently across the E.U. The standards are designed to provide clarity on who new E.U. rules on bonuses actually apply to, which is the key to preventing circumvention. In addition, the European Banking Authority has a mandate to ensure consistent supervisory practices on remuneration rules among competent authorities. Commissioner Barnier pledged that the Commission will remain vigilant to ensure that the new rules are applied in full.

There is a rebuttable presumption that staff at financial firms are material risk takers if their total remuneration exceeds € 500 000 per year, or they are included in the 0.3% of staff with the highest remuneration in the financial firm, or their remuneration is equal or greater than the lowest total remuneration of senior management and other risk takers. The presumption can be rebutted under only very strict conditions. For staff members with a total remuneration of €500 000 or more, any rebuttal of the presumption that the member of staff is a material risk taker needs to be notified to the competent authority. For staff with a total remuneration of €750 000 or more, or for staff included in the 0.3% of the highest earners, prior approval from the competent authorities is required. For staff with a total remuneration of €1 000 000 or more, competent authorities must inform the EBA of any intended approval before the decision is made. In each case, the burden of proof will rest squarely on the financial firms to demonstrate that, despite the very high remuneration, the staff member in question does not in fact have any material impact on the firm’s risk profile, on the basis of the business unit they are working in, as well as of their duties and activities.

In addition to staff identified as material risk takers under the absolute quantitative standards, staff at financial institutions and investment firms must be identified as having a material impact on the firm’s risk profile if they meet one or more of the 15 qualitative criteria set out in the technical standards related to the role and decision-making power of staff members, such whether they are a member of the firm’s management body, a senior manager, or the staff member accountable to the management body for the activities of the firm’s independent risk management function, compliance function or internal audit function. Two other of the 15 qualitative criteria are whether the staff member heads a material business unit or has managerial responsibility in a material business unit and reports directly to the staff member who heads that unit. Another criteria is whether the staff member heads a function responsible for legal affairs, finance including taxation and budgeting, human resources, remuneration policy, information technology, or economic analysis.

The standards were adopted under the Capital Requirements Directive (CRD IV), which entered into force on July 17, 2013 and which strengthened the rules regarding the relationship between the variable component of total remuneration, such as bonuses, and the fixed component, such as salary. Beginning January 1, 2014, the variable component cannot exceed 100% of the fixed component of the total remuneration of material risk takers. Under certain conditions, shareholders can increase this maximum ratio to 200%.

Supreme Court Oral Argument in Fraud-on-the-Market Case Reveals Effort to Avoid Overruling Basic

The U.S. Supreme Court heard oral argument in a case involving the continued efficacy of the fraud-on-the-market presumption of reliance in securities fraud actions endorsed by the Court in its 1988 ruling in Basic, Inc. v. Levinson. It became clear during the arguments that the Justices, with their abiding sense of precedent and respect for stare decisis, were looking for a way to come to grips with the argument that the efficient market theory underlying the presumption may not be relevant without directly overruling the Basic decision. Justice Kennedy, for example, seized on the event study idea enunciated by a group of law professors in their amicus brief. Other Justices explored the event study position as a way to avoid the dramatic consequences of overruling the Basic decision. Halliburton v. Erica P. John Fund, Dkt. No. 13-317,

In their amicus brief, the law professors said that an event study measuring the effect of an event, such as an earnings announcement, on a company’s stock price is the best available tool to show reliance and examine market distortion. They described an event study as the gold standard for determining if the market relied on a misstatement.

Arguing for the petitioner, Aaron Streett urged the Court to overrule Basic v. Levinson because it was wrong when it was decided and it is even more clearly erroneous today. Basic substituted economic theory for the bedrock common law requirement of actual reliance that Congress embraced in the most analogous express cause of action, argued counsel, and substituted economic theory for the bedrock common law requirement of actual reliance.

Justice Kennedy noted that the law professors offer what the Justice called a ``midway position’’ that there should be an event study. In his view, this position would be a substantial answer to the challenge to the economic premises of the Basic decision. Even under the Basic framework, reasoned Justice Kennedy, at the merits stage there has to be something that looks very much like an event study. That being said that you are going to do an event study anyway, he continued, why not have it at the class certification stage. But Justice Sotomayor was concerned that this would turn the class certification into a full-blown merits hearing. Chief Justice Roberts said that an event study would be a lot more difficult and laborious to show than market efficiency in a typical case.

Justice Alito questioned how accurately an event study could distinguish between the effect on price of the facts contained in a disclosure and an irrational reaction by the market, at least temporarily, to the facts contained in the disclosure. Mr. Streett said that event studies are very effective at making that sort of determination.

David Boies, for the respondent, emphasized that the premise of the Basic decision was not economic theory, but rather commerce. It is also a premise of Congress. It is the premise of the securities laws that when you make fraudulent misrepresentations you make them public and it affects the market price.

But it must affect the market price almost immediately, said Justice Alito, adding that why should a purchaser an hour or two after the disclosure be entitled to recovery if in that particular market there is a lag time in incorporating the new information.

Justice Kennedy asked if the event study theory is flawed. Mr. Boies replied that it is not, adding that you can have event studies that try to determine whether or not a particular price movement was related to a particular piece of information.

Chief Justice Roberts asked Deputy Solicitor General Malcolm Stewart if the feasibility and prevalence of event studies were around in 1988 when Basic was decided. They were around, he replied, but were probably much less sophisticated. But they could be used to establish both market efficiency and the price impact of the misstatement.  

Justices Kagan and Kennedy both asked how adopting the law professors’ position on event studies would affect the securities industry and individual decision making regarding securities. Mr. Stewart understands the event study position to be advocating a shift away from analyzing the general efficiency of the market and focusing only on the effect or lack of effect on the particular stock. In that sense, he said,  the consequences of adopting the event study position would not be nearly as dramatic as overruling Basic.

Mr. Streett said that Basic’s judicially-created presumption preserves an unjustified exemption from Rule 23 that benefits only securities plaintiffs. He contended that the most direct course of action would be to overrule Basic altogether and require a showing of actual reliance.

Justice Ginsburg noted that the Basic presumption of reliance is a rebuttable presumption that does not rely strictly and exclusively on an economic theory. The Exchange Act, probability and common sense would also lead to the reliance presumption. Justice Kagan observed that it is a presumption that is dependent on the facts in a particular case.

Justice Alito queried how often defendants have been successful in rebutting the Basic presumption of reliance. It is virtually impossible to do so, replied Mr. Streett, adding that it is very unusual outside of the Second Circuit, which allows rebuttal with regard to price impact. Outside of the Second Circuit, rebuttal of the reliance presumption is as rare as hen’s teeth, said counsel. While the Basic Court thought that the presumption could be rebutted, he continued, it has turned out that the federal courts have treated it as essentially irrebuttable.

Mr. Boies noted that the fraud-on-the-market presumption is a substantive doctrine of federal securities law. It has been ratified by Congress in the Private Securities Litigation Reform Act and the Securities Litigation Uniform Standards Act. These pieces of legislation were enacted against the backdrop of the fraud-on-the-market theory.

Justice Scalia cautioned that to act on the assumption that the courts are going to do what they have been doing is quite different from approving what they have been doing. Congress passed the PSLRA and SLUSA under the assumption that the courts were going to continue Basic. That is not necessarily a ratification of Basic, said the Justice, but just an acknowledgement of reality.  

Appeals Panel Upholds ESMA Decision to Deny CRA Status to a Firm

The Board of Appeal of the European Supervisory Authorities upheld a decision by the European Securities and Markets Authority (ESMA) refusing to register a firm as a credit rating agency. This is the first appeal against a decision by ESMA refusing an applicant registration as a credit rating agency. ESMA is the primary regulator of credit rating agencies in the European Union.

In its decision, the Board of Appeal unanimously decided that the appeal should be dismissed, and that ESMA’s refusal decision should be confirmed. It stated that it accepted the firm’s point that the registration of a credit rating agency by ESMA is a new process, and recognized that the procedures will to an extent take time fully to work out. Nevertheless, because of the responsibilities placed on credit rating agencies and their importance in the financial system generally, the Board said that the onus must be on an applicant to satisfy ESMA that the relevant requirements are met. The application and its contents must be very clear, and it is not ESMA’s responsibility as regulator to remedy deficiencies.

Securities Group Comments on CFTC Cross-Border Guidance

The ABA Securities Association urged the CFTC not to adopt the U.S. personnel test for non-U.S. swap dealers contemplated by the Commission staff’s cross-border derivatives guidance and to re-consider the U.S. personnel test applicable to foreign Branches under the guidance. The CFTC staff guidance would apply to U.S. transaction-level requirements to a non-U.S. swap dealer regularly using personnel or agents located in the U.S. to arrange, negotiate, or execute a swap with a non-U.S. person. Similarly, there are issues raised by a related U.S. personnel test for determining whether, in conjunction with other factors, a swap is executed with the foreign branch of a U.S. swap dealer (requirement that, in order for a swap to be considered one that is with the foreign branch of a U.S. bank for purposes of the Cross-Border Guidance, the employees negotiating and agreeing to the terms of the swap (or, if the swap is executed electronically, managing the execution of the swap), other than employees with functions that are solely clerical or ministerial, must be located in the foreign branch or in another foreign branch of the U.S. bank.

In the view of the Securities Association, applying Title VII of the Dodd-Frank Act to non-U.S. swap dealers or foreign branches on the basis of the conduct of U.S.-based personnel will not in any way help advance the Dodd-Frank Act’s objective of mitigating systemic risk or increasing market transparency. Instead, the staff interpretation will impose unnecessary compliance burdens on swap market participants, encourage them to relocate jobs and activities outside the United States to accommodate non-U.S. client demands, and fragment market liquidity.

The securities group urged the CFTC to avoid competitive disparities between different categories of swap dealers by applying analogous treatment of the conduct of U.S. personnel to non-U.S. swap dealers (whether or not a guaranteed affiliate or an affiliate conduit) on the one hand, and foreign branches, on the other hand. In other words, identical U.S. personnel activity conducted by two different firms operating in the U.S. should be subject to the same U.S. personnel conduct rules. Such differences have and will continue to result in inappropriate competitive disparities that are inconsistent with the Commission’s objective of establishing a legal framework that furthers the public interest.