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.

Senate Hearing Reveals Growing bi-partisan Support for Retrospective Review of Federal Regulations

Hearings before a Senate panel revealed a growing and deepening bi-partisan consensus to move forward with legislative reform of the federal regulatory process, including the retrospective review of existing regulations.  Senator Jon Tester (D-MT), Chair of the Subcommittee on Efficiency and Effectiveness of Federal Programs, said that many Senators support efforts to achieve meaningful reform of the federal regulatory process to make it more transparent and responsive to congressional intent.

Senator David Pryor (D-ARK) said that it is time to review the foundations of the federal  regulatory system. He mentioned that the Regulatory Accountability Act, S. 1029, which he is co-sponsoring, if done right, would make the regulatory system better, cheaper and fairer. Under S. 1029, an agency must state its statutory authority for adopting a regulation. Senator Pryor noted that the legislation  does not go after any one agency or one specific regulation. It amends the Administrative Procedure Act to place a stronger emphasis on early engagement between regulators and those affected by the regulations they issue. S. 1029 was introduced by Senator Rob Portman , the Ranking Member of the Subcommittee.

Retrospective review. Senator Angus King (I-ME) testified before the Subcommittee about his Regulatory Improvement Act, S. 1390, co-sponsored by Senator Roy Blunt (R-MO), which would provide an additional, expeditious mechanism through which a retrospective review of old regulations could be conducted. The bill is designed to deal with what Senator King called regulatory accumulation, which is a byproduct of the increasing number of entities vested with varying missions to protect the public. It is imperative to find a way to revisit old regulations to ensure that they are still relevant to present circumstances and are not in conflict with requirements from other regulating bodies.

Currently, he acknowledged, federal agencies embark upon periodic self-reviews in order to examine the utility of older regulations. However, the existing process is limited for a number of reasons, including  restricted budgetary and personnel resources, insufficient data collection, and competing priorities. The Regulatory Improvement Act would provide an additional, expeditious mechanism through which a review of old regulations could be conducted.

The Act would create an independent Regulatory Improvement Commission that would be tasked with reviewing outdated regulations with the goals of modifying, consolidating, or repealing regulations in order to reduce compliance costs, encourage growth and innovation, and improve competitiveness. The composition of the Commission would be determined by congressional leadership and the President, and the Commission would be tasked with identifying a single sector or area of regulations for consideration. After extensive review involving broad public and stakeholder input, the Commission would submit to Congress a report containing regulations in need of streamlining, consolidation, or repeal. This report would enjoy expedited legislative procedures and would be subject to an up-or-down vote in both houses of Congress without amendment.

Howard Shelanski, Director of the Office of Information and Regulatory Affairs OIRA), testified that retrospective review of existing regulations is a top priority.  Executive Orders 13563 and 13610 make clear that flexibility and removal of unnecessary burdens are essential elements of the federal rulemaking process, as is improving rules already on the books.

The OIRA chief said that retrospective review is a crucial way to ensure that the federal regulatory system is modern, streamlined, and does not impose unnecessary burdens. Even regulations that were well crafted when first promulgated can become unnecessary or excessively burdensome over time and with changing conditions. Similarly, rules that are not achieving their objectives may be in need of revision in light of experience, new evidence, or new technology. Retrospective review of regulations on the books helps to ensure that those regulations are continuing to help promote safety, health, welfare, and well-being without imposing unnecessary costs or missing the opportunity to achieve greater net benefits.

Executive Order 13610 asks agencies to report regularly on the progress of their retrospective review activities. Federal agencies have provided updates on their initiatives, he noted, many of which are new efforts that agencies added since their July 2013 listing of look-back plans. These efforts are already saving more than $10 billion in regulatory costs in the near term, with more savings to come.

While there ha been important progress on retrospective review, said the OIRA  chief, we need to do even better. OIRA is working with colleagues elsewhere in OMB and at the agencies on several ways to further institutionalize retrospective review as an essential component of government regulatory policy. As part of this effort, OIRA is considering and developing several components that will make regulatory look-back a more systematic priority for agencies. Such institutionalization of retrospective review, both to ensure follow-through on existing plans and to help agencies develop their future plans, will be one of OIRA’s  key objectives moving forward.

Senator Portman mentioned to the OIRA head that he is concerned about a possible conflict of interest inherent in an agency conducting a retrospective review of its own regulation. Mr. Shelanski said that he has not seen this conflict of interest. Indeed, the federal regulatory agencies appear anxious to conduct retrospective reviews in good faith.

House Panel Approves bi-partisan Legislation that Could Provide Basis for JOBS Act 2.0

A bi-partisan piece of legislation introduced by Rep. Stephen Fincher (R-TN) and Rep. John Delaney (D-MD) that would build on and expand the JOBS Act of 2012 by making improvements to the IPO process for emerging growth companies has been marked-up and approved by the House Financial Services Committee in a 56-0 vote. The Improving Access to Capital for Emerging Growth Companies Act, H.R. 3623, would reduce the number of days that emerging growth companies must have a confidential registration statement on file with the SEC from 21 days to 15 days before they can conduct a road show.

H.R. 3623 would also allow a one-year grace period for an issuer that began the IPO process as an emerging growth company to complete its IPO as an emerging growth company. Rep. Fincher described the reforms worked by H.R. 3623 as simple, technical improvements to the JOBS Act that improve the IPO process and allow emerging growth companies to continue growing and providing jobs. He noted that, since the passage of the JOBS Act in April 2012, which established the emerging growth company category in Title I, more than 200 companies have registered with the SEC as emerging growth companies. At the one-year anniversary of the JOBS Act, he noted, a study by Ernst & Young showed that approximately 78 percent of all publicly filed IPO registration statements and approximately 83 percent of the IPOs that went effective since April 2012 were filed by emerging growth companies. (See Cong. Record, Nov. 22, 2013, p. E1756) IPO Process reformed.

During the mark-up, Rep. Delaney said that the bill creates a more streamlined IPO process without sacrificing investor protection. He added that for an emerging growth company the IPO process is a difficult moment, which can be costly, timely and cumbersome. But, at the same time, said Rep. Delaney, investor protection is at its highest during the IPO process. The SEC does a full review of the filing, he noted, and this is the time when the audit firms establish all the important accounting policies for the company and the underwriters conduct due diligence. In addition, most of the offerings are usually sold to institutional investors, who engage in significant diligence.

H.R. 3623 also directs that, with respect to an emerging growth company, within 30 days of enactment, the SEC must revise its general instructions on Form S-1 to indicate that a registration statement filed or submitted for confidential review by an issuer prior to an initial public offering may omit financial information for historical periods otherwise required by Regulation S-X as of the time of filing or confidential submission of the registration statement, provided that the omitted financial information relates to a historical period that the issuer reasonably believes will not be required to be included in the Form S-1 at the time of the contemplated offering. Another proviso is that prior to the issuer distributing a preliminary prospectus to investors, the registration statement is amended to include all financial information required by Regulation S-X at the date of the amendment.

Saturday, March 08, 2014

House Panel Holds Hearing on Legislation to Prevent Volcker Rule Divestiture of Legacy Debt Securities of CLOs

A hearing conducted by the House Capital Market subcommittee revealed tentative industry support for draft legislation clarifying that nothing in the Volcker Rule should be construed to require the divestiture of any debt securities of collateralized loan obligations, if such collateralized loan obligations were issued before December 31, 2013. At the same time, Rep. Carolyn Maloney (D-NY), the Subcommittee’s Ranking Member is concerned that the draft bill could create loopholes in the Volcker Rule, but she allowed that she could support a more narrowly tailored bill. Rep. Andy Barr (R-KY), the author of the draft legislation, 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. But Rep. Stephen Lynch (D-MA) said that the draft bill goes beyond the relief needed by completely exempting legacy CLOs. It is not necessary to grandfather all CLOs, said Rep. Lynch, and could even be dangerous by opening up the Volcker Rule to gaming by the industry. The discussion draft would also clarify that a banking entity will 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 banking entity 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 or trustees, investment manager, investment adviser, or commodity trading advisor of the fund, provided that the collateralized loan obligation is predominantly backed by loans.

U.K. Court Affirms FCA Enforcement Action Against Collective Schemes

The U.K. High Court ruled that two investment schemes and a number of other firms were collective investment schemes promoted and operated without Financial Conduct Authority. The FCA had launched an enforcement action in July of 2013 in respect of two investment schemes. The defendants in the case had structured their schemes to try to avoid the need to be regulated by the FCA. However, the High Court agreed with the FCA that the schemes were unauthorized collective investment schemes and could not be lawfully operated by the defendants. Tracey McDermott, the FCA's Director of Enforcement, stated that the court’s ruling contributes to the FCA objective to protect consumers and enhance the integrity of the financial system. Collective investment schemes are complicated and investors put their money into the operator’s hands with no real control over what happens to their money. The Director noted that this ruling shows that, even if operators have deliberately tried to structure their scheme to avoid regulation, the court will still look at whether those operating the scheme should in fact be regulated for consumer protection.

House Panel Chair Says SEC Proposed Regulations Implementing JOBS Act Crowdfunding Provisions are Unacceptable in Global Competitive Context

At a hearing on cross-border financial regulation and international competitiveness conducted by the House Oversight and Investigations Subcommittee, Chairman Patrick McHenry (R-NC) said that the SEC proposed regulations implementing the crowdfunding provisions of the JOBS Act are too complicated. The SEC proposal is unacceptable, he added, in a world where capital knows no boundaries and the E.U. is implementing less burdensome crowdfunding regulations. In response to a question from the Chair on the cost and benefits of the crowdfunding proposal, Alon Hillel-Tuch, CFO of an established crowdfunding platform, said that intensive study has revealed that there are friction points in the SEC proposed regulations that add to the cost of compliance. Some of these frictions could be ameliorated by the SEC, he noted, but some may have to be dealt with by Congress. More broadly, the Chair said that, since financial regulation is now global and somewhat integrated, particularly those implementing the Dodd-Frank Act, Congress must become aware of the impact and costs of financial regulations as they involve U.S. competitiveness. He noted that the U.S. is currently a net importer of capital and a net exporter of financial services; and that the Dodd-Frank Act threatens this rubric. Subcommittee Ranking Member Al Green (R-TX) said that he does not oppose a congressional review of the efficacy of regulations in the global financial environment. But he added that Congress should amend Dodd-Frank, not end it, adding that Dodd-Frank is necessary and that many of its provisions have been emulated globally. He also noted that the SEC is woefully underfunded to the extent that some mission-critical projects may be compromised. He supports the President’s budget request for the SEC, which would increases the Commission’s budget 30 percent over the 2014 enacted levels.

Monday, March 03, 2014

House Passes Bi-Partisan Omnibus Federal Agency Regulatory Reform Legislation

The House passed by a vote of 236 to 179 omnibus federal regulatory reform legislation. Ten Democratic members voted for the bill. The vehicle for this Omnibus legislation is H.R. 2804, now renamed the Achieving Less Excess in Regulation and Requiring Transparency Act (ALERRT) Act. The bill includes the original H.R. 2804, the All Economic Regulations are Transparent (ALERT) Act, sponsored by Rep. George Holding (D-NC). The original H.R. 2804 is now Title I of the Omnibus bill. The other sections of the bill are the Regulatory Accountability Act (Title II), the Regulatory Flexibility Improvements Act (Title III) and the Sunshine for Regulatory Decrees and Settlements Act (Title IV). House Judiciary Committee Chair Bob Goodlatte (R-VA), the author of Title II of the legislation, said on the passage of the bill that the ALERRT Act was born out of concern for burdensome and unnecessary regulations.

Title I. Title I is the All Economic Regulations are Transparent (ALERT) Act, which would direct federal agencies to release detailed information each month about their proposed regulations. Under current law, the Administration is required to release a Unified Agenda of Federal Regulatory and Regulatory Actions twice a year, which sets forth each governmental agency’s proposed regulations. According to Rep. Holding, the Obama administration has continuously failed to release its agenda on time, if at all. He noted that the Unified Agenda and Regulatory Plan is vital to businesses that rely on it to anticipate forthcoming regulations and the affect that these regulations will have on their operations and plans, But there is currently no enforcement mechanism ensuring that an Administration’s agenda is released in a timely and publically-accessible manner.

In addition, Title I would force agencies to release detailed information each month about their proposed regulations. The bill would provide consequences for failing to release the Unified Agenda on time, by preventing new rules from becoming effective if an agency fails to provide proper notice that a rule is impending. Agencies would also be required to publish information about their regulations on the internet, along with cost-benefit studies. This requirement is designed to give business owners the time they need to comply with new regulations, and fully evaluate the effects they have on their businesses.

Title II. Title II of H.R. 2804 is the Regulatory Accountability Act, which was introduced by House Judiciary Committee Chair Bob Goodlatte (R-VA). The Title, as standalone H.R. 2122, was approved by the Committee by a vote of 13-9. This is regulatory reform legislation that increases government accountability over independent federal agencies such as the SEC and CFTC. Specifically, the bill would require federal regulatory agencies to choose the lowest cost alternatives that meet statutory objectives and improve agency transparency and fact finding. Chairman Goodlatte said that overreaching federal regulations unnecessarily burden job creation, and that approval of the legislation is an absolutely vital reform to the regulatory system that keeps the U.S. globally competitive. The bill would reform the Administrative Procedure Act, which Chairman Goodlatte called the “constitution” of federal regulation, and would successfully promote a regulatory system that will thrive for generations to come.

Title II would require federal agencies to choose the lowest cost rulemaking alternative that meets statutory objectives, while permitting costlier rules when needed to protect public health, safety, or welfare, if the added benefits justify the added costs. It would improve agency fact-finding and identification of regulatory alternatives, and require regulators to use the best reasonably obtainable science.

Importantly, it would also require advance notice of proposed major rulemakings to increase public input before costly agency positions are proposed and become entrenched. It also would provide for on-the-record, but streamlined, administrative hearings in the highest-impact rulemakings, defined as those imposing $1 billion or more in annual costs. This is designed to allow interested parties to subject critical evidence to cross-examination.

Title III. Title III is the Regulatory Flexibility Improvements Act, which would revise the definition of "rule" in the Regulatory Flexibility Act to exclude a rule of particular and not general applicability relating to rates, wages, and other financial indicators and to define "economic impact" with respect to a proposed or final rule as any direct economic effect on small entities from such rule and any indirect economic effect on small entities that is reasonably foreseeable and that results from such rule.

It would also require initial and final regulatory flexibility analyses to describe alternatives to a proposed rule that minimize any adverse significant economic impact or maximize the beneficial significant economic impact on small entities. Moreover, the measure would require each federal agency to include in its regulatory flexibility agenda a description of the sector of the North American Industrial Classification System that is affected by a proposed agency rule which is likely to have a significant economic impact on a substantial number of small entities. It would also expand elements of initial and final regulatory flexibility analyses to include estimates and descriptions of the cumulative economic impact of a proposed rule on a small entity. Title III began as a standalone bill, H.R. 2542, introduced by Rep. Spencer Bachus (R-AL), the Chairman Emeritus of the Financial Services Committee.

Title IV. Title IV is the Sunshine for Regulatory Decrees and Settlements Act, originally introduced by Rep. Doug Collins (R-GA) as H.R. 1493. This measure would require federal agencies against which a covered civil action is brought to publish the notice of intent to sue and the complaint in a readily accessible manner, including by making such notice and complaint available online not later than 15 days after receiving service of such notice or complaint.

It would also require a court, in considering a motion to intervene in a covered civil action, to presume that the interests of the intervenor would not be adequately represented by the existing parties to the action and to consider the relationship of an intervenor that is a state, local, or tribal government to the defendant in such action.

It would require parties to a covered civil action to participate in mediation or alternative dispute resolution when attempting to settle an action and to include intervenors in such mediation or dispute resolution efforts.

Also, Title IV would require an agency seeking to enter a covered consent decree or settlement agreement to publish in the Federal Register and online, not later than 60 days after such decree or agreement is filed with a court: (1) the decree or agreement; and (2) a statement providing the statutory basis for the covered consent decree or settlement agreement and a description of the terms of such decree or agreement, including whether it provides for attorney fees. The agency would be required to accept public comments on a proposed consent decree or settlement agreement during the 60-day period.

House Passes Legislation Changing Structure and Funding of CFPB

The House of Representatives passed legislation completely changing the structure and funding of the Consumer Financial Protection Bureau, even renaming it the Financial Product Safety Commission .The Consumer Financial Freedom and Washington Accountability Act, H.R. 3193, passed by a bipartisan vote of 232 to 182, with ten Democrats voting for the bill. The legislation was authored by Rep. Sean Duffy (R-WI).

The legislation would replace the single CFPB Director with an accountable, five-member Commission, one of whom must be the Fed Vice Chair for Regulation. The Commissioners, who must have strong consumer protection experience, would be  appointed by the President and confirmed by the Senate to ensure that a diversity of viewpoints inform the CFPB’s regulatory and enforcement agenda, and to conform the CFPB’s governance to that of other federal agencies such as the SEC charged with consumer or investor protection. H.R. 3193 would also subject the CFPB to the regular appropriations process and make it a stand-alone independent agency rather than a bureau within the Federal Reserve System.

The measure would prohibit the CFPB from using a consumer’s private, personal financial information without the consumer’s knowledge and consent. According to Rep. Duffy, the CFPB is currently engaged in a massive, multi-million dollar data collection effort of consumers’ financial information.

Finally, the legislation would prevent the CFPB from undermining the safety and soundness of U.S. financial institutions through regulatory overreach by changing its relationship with the Financial Stability Oversight Council (FS
Currently, under section 1023 of the Dodd-Frank Act, CFPB regulations may not be set aside unless two-thirds of the FSOC's voting membership votes to do so and the FSOC determines that the regulation puts the safety and soundness of the United States banking system or the stability of the financial system at risk. According to House Report No. 113-346 accompanying H.R. 3193, the current supermajority threshold and the requirement that the regulation have a pervasive negative effect on the entire banking system are too stringent, especially when the regulations in question have been crafted by a federal agency that lacks checks and balances in numerous other respects, and when one of the members voting on whether to set aside a CFPB regulation is the CFPB Director himself.
Thus, the legislation would change the vote required to set aside a CFPB regulation from two-thirds of the FSOC voting membership to a simple majority, excluding the Director of the CFPB. It would also modify the standard for the FSOC's review to permit a CFPB regulation be set aside if it is inconsistent with the safe and sound operations of U.S. financial institutions.

House Passes Bi-partisan Legislation adding SEC to Strictures of Clinton-era Unfunded Mandates Reform Act

The House of Representatives passed the Unfunded Mandates Information and Transparency Act, H.R. 899, that closes a loophole in the Clinton-era Unfunded Mandates Reform Act (UMRA) by adding the SEC and other independent regulatory agencies to UMRA’s regime. Currently, according to Rep. Virginia Foxx (R-NC), sponsor of H.R. 899, independent regulatory agencies, such as the SEC, the FCC, the CFPB and other federal agencies can impose significant costs and burdensome requirements with little meaningful accountability and oversight. The Unfunded Mandates Information and Transparency Act passed by a bi-partisan vote of 234 to 176, with 17 Democrats voting for the bill.

Signed by President Bill Clinton in 1995, the Unfunded Mandates Reform Act was bipartisan legislation that basically says that regulators have to evaluate a regulation’s cost and find less costly alternatives before adopting a major rule. In 1995, UMRA was imposed upon the executive agencies but not on independent federal agencies such as the SEC. Since the enactment of UNMA, those independent agencies have grown, and so have their regulations.


Unfunded mandates. H.R, 899 expands the scope of UNMA by closing current loopholes within UMRA that allow certain regulatory bodies to escape public reporting requirements and incentivize others to forego publicizing regulatory proposals. The legislation will correct this.

Specifically, H.R. 899 would impose stricter and more clearly defined requirements for how and when federal agencies must disclose the cost of federal mandates. It would ensure that those who will be affected by the regulations have the opportunity to weigh in on proposed mandates. In addition, the measure would equip Congress and the public with tools to better determine the true cost of regulations. It would also provide an accountability mechanism to ensure that the federal government and its independent regulatory agencies adhere to the provisions set forth by H.R. 899 and in its predecessor, UMRA.

Moreover, in order to ensure that agencies continue the regulatory look back process, H.R. 899 would allow a Chair or Ranking Member of any Congressional committee to request that any agency conduct a retrospective analysis of an existing federal regulatory mandate. This retrospective analysis provision is designed to educate Congress about the impact of a rule after it has been in effect, as well as to incentivize agencies to perform a proper analysis when first proposing regulations.

Rep. Foxx noted that, in order to ensure that agencies regulate responsibly, H.R. 899 essentially codifies most of the regulatory principles outlined in Executive Order 12866 issued by President Clinton and reaffirmed by President Obama in Executive Order 13563. Under Executive Order 12866, federal agencies must assess all costs and benefits of available regulatory alternatives, including the alternative of not regulating. Costs and benefits include both quantifiable measures and qualitative measures of costs and benefits that are difficult to quantify, but nevertheless essential to consider. Further, in choosing among alternative regulatory approaches, agencies should select those approaches that maximize net benefits, including potential economic, environmental, public health and safety, unless a statute requires another regulatory approach.

Finally, H.R. 899 would extend judicial review to the selection of the least costly or least burdensome regulatory alternative and to the principles of Executive Order  12866. In her testimony before Congress, former OIRA Administrator Susan Dudley advocated for expanding judicial review in this way to give agencies a greater incentive to carefully consider the least costly, most cost-effective or least burdensome alternative when regulating.


Statement of Administration Policy. While noting that his Administration is committed to ensuring that regulations are tailored to advance statutory goals in a manner that is efficient and cost-effective, and that minimizes uncertainty, President Obama said that he strongly opposes H.R. 899 because it would layer on additional, burdensome judicial review  to the regulatory process and introduce needless uncertainty into agency decision-making and undermine the ability of agencies to provide critical public health and safety protections.