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

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the presumption of reliance despite strong entreaties to overrule the 1988 Court ruling in Basic, Inc. v. Levinson as outdated and possibly even flawed when rendered.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

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

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

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

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

True and Fair and Fairly Present both Transcend IFRS and GAAP

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

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

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

House Panel Shines Light on Financial Stability Board in SIFI Designations

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

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

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

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

Justice Ginsburg Short Concurring Opinion is Mouse that Roared in Halliburton

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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


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

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

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

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

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

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

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

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

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

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

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

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

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

In Letter to Treasury, Senator Crapo says OFR Asset Management Study Flawed because no SEC Input

Senator Mike Crapo (R-ID), Ranking Member on the Banking Committee, is concerned that the asset management study conducted by the Office of Financial Research was a flawed effort that failed to take into account the perspectives of and data from the SEC and market participants. In a letter to Treasury Secretary Jacob Lew in his capacity as Chair of the Financial Stability Oversight Council, Senator Crapo said that the study resulted in a flawed evaluation of the asset management industry and , even worse, a move towards designating asset management firms as systemically significant financial institutions without an accurate understanding of the role they play in the financial system.

He went on to say that the OFR should have engaged in a more transparent and productive way with the SEC and market participants by setting up a transparent process for soliciting comment from the industry and the SEC. who is the primary regulator of asset managers. But unfortunately the OFR did not do this leading to a complete lack of peer review.

This is important, said the Senator because FSOC appears to be contemplating whether or not to designate some asset management firms as systemically important financial institutions. To the extent FSOC intends to rely on information in the OFR study, it is critical that the study contains the best data available and reflects a proper  public comment process.

Chief of German Financial Regulatory Authority Urges Orderly Resolution Regime for Derivatives Central Counterparties

While investors tend to be at a disadvantage to providers of financial products and thus need the protection of an appropriate regulatory framework, noted Dr. Elke König, President of the German Federal Financial Supervisory Authority (BaFin),  investors have the right to invest in risky instruments and should not be spoon feed by regulators. In remarks at the agency’s annual conference in Frankfurt am Main, the BaFin chief said that regulators cannot cocoon consumers and investors and ring-fence or prohibit all offerings that are even slightly risky. Dr. König emphasized that anyone who takes away the right of private investors to invest their money in risky assets encroaches on their individual freedom to an unreasonable degree and harms competition. 

Regulators must keep this in mind, even when they are discussing how to regulate the unregulated parts of the financial  markets, said BaFin’s President. But she hastened to add that the market as it stands is by no means over-regulated. In fact, a number of important regulatory steps still have to be taken. For example, the requirement to clear standardized OTC derivatives through central counterparties has not solved everything, she observed, what is logically now needed is a regulatory framework for the orderly resolution of central counterparties.        

BaFin’s President also emphasized the importance of creating a cross-border resolution regime for systemically important financial institutions. She noted that the European Union has already laid the foundation for such a regime. The flaw she sees is its scope: If the goal is to abolish the de facto state guarantee for systemically important financial institutions, she reasoned, policy makers and regulators must design a global resolution regime that is effective cross-borders

Similar to investor protection, financial stability is a question of the right amount of regulation. 
What is needed here is a regulatory framework that protects the public good of financial stability and mitigates the destructive forces of a crisis, explained Dr König, adding that at the same time market participants must be given enough room to innovate and do business.

Senate Author of JOBS Act Title III Has Problems with SEC Proposed Crowdfunding Regulations

Senator Jeff Merkley (D-OR), the author of the JOBS Act crowdfunding Title said that the SEC proposed regulations implementing the crowdfunding provisions are seriously flawed and do not properly carry out legislative intent in a number of areas. In a letter to SEC Chair Mary Jo White, he said that in some instances the Commission is ignoring the plain intent of the JOBS Act and proposing the least investor protective approach possible. For example, the Senator said that permitting a funding portal to rely on the investor's representations concerning compliance with investment limits above $2,000 is a recipe for disaster for vulnerable investors and must be changed.

Self-certification would permit a single investor to be easily over-exposed to crowdfunding, he noted, an inherently high risk investment, through what could easily be check-the-box style agreements. A self-certification approach opens the door to investors being defrauded across one or more platforms, he cautioned, which is an especially serious risk in affinity fraud cases. Again, these are precisely the risks that the Act was intended to prevent.

By specifically applying the investment caps across all platforms, continued Senator Merkley, the JOBS Act contemplates the development of a central data repository, perhaps located at the relevant national securities association, where platforms can check whether investors are safely within the scope set out in the Act across the marketplace. He noted that the proposal does not establish such a repository or set forth any path towards its establishment; and thus fails to implement the plain meaning of the statutory language. Testing, supervisory oversight, and other mechanisms to ensure investors are protected should also be more fully considered.

The SEC’s approach with respect to net worth and annual income is similarly unacceptable, said the Senator, since it would put the most vulnerable investors at risk. The Act was designed to favor investor protections, he pointed out, and the statutory language gives the Commission a choice of how to interpret it. Unfortunately, the proposal has chosen to interpret the statute in the least investor friendly approach, meaning that investors may choose between the greater of their net worth or annual income for their cap calculation. That is not consistent with the overall approach of the Act, emphasized Senator Merkley, who urged the Commission to reconsider its interpretations regarding investment caps. One of the worst things that could happen to the crowdfunding marketplace, he posited, would be if ordinary investors lost large amounts on securities-based crowdfunding in its early days.

The Senator is also very concerned regarding the lack of robust mandatory corporate governance provisions. The Commission must do more to ensure fairness, and not simply the timeliness of financial statements. Under the proposal, an issuer may use financial statements for the year prior to the most recently completed fiscal year, provided that the issuer was not otherwise already required to update the financial statements and updated financial statements are not otherwise available.

If more than 120 days have passed since the end of the issuer's most recently completed fiscal year, the issuer must use financial statements for its most recently completed fiscal year. While the issuer would be required to include a discussion of any material changes in the its financial condition of the issuer, Senator Merkly fears that this could allow issuers to submit financial statements that are more than a year out of date and that cover only a very limited portion of the issuer's existence, leaving out what could be critical information for investors.

The proposal permits a funding portal to rely on the representations of the issuer concerning compliance with the Act's requirements unless the intermediary has reason to question the reliability of those representations. In his view, permitting a funding portal to rely on the representations of an issuer upends the statutory design, and in doing so potentially exposes small businesses and start-ups to increased costs of having to figure out how to comply and also potentially exposes investors to serious risks from the failure of those small businesses and start-ups to adequately comply. Such an approach also exposes the entire crowdfunding marketplace if a reputation for weak compliance or fraud develops. Instead, the senator urged the Commission to adopt standards and guidance for what funding portals must do to ensure that an issuer has satisfied the fairly simple requirements of the Act with respect to the rights investors have in securities.

Senate Passes Legislation Carving Out Insurers from Dodd-Frank Act Capital Standards

In what may be the first of many tweaks of the Dodd-Frank Act by the 113th Congress, and this is probably the way it will be done in the Senate, by unanimous consent, the Senate passed legislation carving out insurers from Dodd-Frank Act capital standards. The changes were to Section 171 of Dodd-Frank (the Collins Amendment). It was never the intent of Congress to include insurance holding companies in the Collins Amendment. Senator Sherrod Brown (D-OH), a co-sponsor of the legislation, said that while capital standards are important, applying them to insurers does not match their risk profile. The Insurance Capital Standards Clarification Act, S. 2270, would add language to Section 171 clarifying that, in establishing minimum capital requirements for holding companies on a consolidated basis, the Federal Reserve is not required to include insurance activities so long as those activities are regulated as insurance at the State level. The legislation was introduced by Senator Susan Collins (R-ME). There is a House companion bill, H.R. 4510.

The measure 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 addition, the legislation directs the Fed not to require insurers which file holding company financial statements using Statutory Accounting Principles to instead prepare their financial statements using Generally Accepted Accounting Principles.

Senator Collins has noted the importance of recognizing that Section 171 allows the federal regulators to take into account the significant distinctions between banking and insurance, and the implications of those distinctions for capital adequacy. Indeed, she has written to the financial regulators on more than one occasion to underscore this point. For example, in a November 26, 2012, letter she stressed that it was not Congress's intent to replace State-based insurance regulation with a bank-centric capital regime. The Senator called upon the federal regulators to acknowledge the distinctions between banking and insurance, and to take those distinctions into account in the final rules implementing Section 171.

While the Federal Reserve has acknowledged the important distinctions between insurance and banking, it has repeatedly suggested that it lacks authority to take those distinctions into account when implementing the consolidated capital standards required by Section 171.

The  legislation 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.

U.K. Appeals Court Reinstates FCA Enforcement Action Dismissed Earlier Over Legal Aid Fee Dispute

The U.K. Court of Appeals reversed a Crown Court ruling stayed an indictment in an enforcement action begun by the Financial Conduct Authority alleging securities fraud. The lower could found that there was no realistic prospect of obtaining public defense advocates in a reasonable conscionable time-frame. The background to the court’s ruling was a decision by the Ministry of Justice to cut fees paid to legal aid counsel by 30 percent, which resulted in an inability to find defense counsel willing to take this complex case. Regina v, Crawley, et al., Court of Appeals, May 21, 2014.

 In ordering that the proceedings on the indictment be resumed, the appeals panel said that the lower court ruling involved errors of law or principle and, in any event, was not reasonable in the sense that a number of the conclusions reached were not reasonably open to the court based on the evidence and, in any event, the ultimate finding did not constitute a reasonable exercise of the discretion open to the lower court.

In the appeals panel’s view it was wrong, for present purposes, to seek to link, effectively as one, the FCA as prosecuting authority and those responsible for the provision of legal aid or to speak of  its own failure as if there was a joint enterprise in which both were involved.

While some prosecutions are brought by independent bodies such as the FCA  and some are brought by the Crown, said the panel, it is beyond peradventure that neither of them has any power or ability to affect the exercise by the Lord Chancellor or the Ministry of Justice of its statutory responsibilities for legal aid.

This dispute arose because the Lord Chancellor has restricted legal aid funding and independent practitioners are not presently minded to accept contracts under that scheme, a view which  they are fully entitled to take. It is, however, said the panel, undeniably the responsibility of the Lord Chancellor to address the need to provide legal representation for those involved in the most complex of cases and the present difficulties clearly flow from his decision to reduce the funding. How the present problem has arisen and whoever is to blame is neither here nor there.

The appeals went on to say that it is wrong as a matter of principle to conclude that the State has violated the process of the court or that what has happened jeopardizes the integrity of the criminal justice system, as opposed to its effective operation. To that extent, the panel ruled that the primary reason given by the trial judge for staying the prosecution was flawed.

Similarly, the  finding of the judge that there was no realistic prospect of competent advocates with sufficient time to prepare being available in the foreseeable future could not be sustained; neither was it reasonable for him to reach it. In any event, it was unjustifiable to proceed on the basis that the position was fixed, said the panel. Indeed, it had changed in the weeks that had elapsed and, whether or not the Bar accepted legal aid cases on the present terms, further discussion could not be ruled out.

The appeals court pointed out that it was not saying that there could not come a time when it may be appropriate to order that this indictment be stayed. That time, however, remains very much in the future, observed the panel,  and problems about representation will have to have developed considerably before such an exceptional order could be justified.

Senate Author of JOBS Act Crowdfunding Title has Serious Concerns with SEC Proposed Regulations

Senator Jeff Merkley (D-OR), the author of the JOBS Act crowdfunding Title said that the SEC proposed regulations implementing the crowdfunding provisions are seriously flawed and do not properly carry out legislative intent in a number of areas. In a letter to SEC Chair Mary Jo White, he said that in some instances the Commission is ignoring the plain intent of the JOBS Act and proposing the least investor protective approach possible. For example, the Senator said that permitting a funding portal to rely on the investor's representations concerning compliance with investment limits above $2,000 is a recipe for disaster for vulnerable investors and must be changed.

Self-certification would permit a single investor to be easily over-exposed to crowdfunding, he noted, an inherently high risk investment, through what could easily be check-the-box style agreements. A self-certification approach opens the door to investors being defrauded across one or more platforms, he cautioned, which is an especially serious risk in affinity fraud cases. Again, these are precisely the risks that the Act was intended to prevent.

By specifically applying the investment caps across all platforms, continued Senator Merkley, the JOBS Act contemplates the development of a central data repository, perhaps located at the relevant national securities association, where platforms can check whether investors are safely within the scope set out in the Act across the marketplace. He noted that the proposal does not establish such a repository or set forth any path towards its establishment; and thus fails to implement the plain meaning of the statutory language. Testing, supervisory oversight, and other mechanisms to ensure investors are protected should also be more fully considered.

The SEC’s approach with respect to net worth and annual income is similarly unacceptable, said the Senator, since it would put the most vulnerable investors at risk. The Act was designed to favor investor protections, he pointed out, and the statutory language gives the Commission a choice of how to interpret it. Unfortunately, the proposal has chosen to interpret the statute in the least investor friendly approach, meaning that investors may choose between the greater of their net worth or annual income for their cap calculation. That is not consistent with the overall approach of the Act, emphasized Senator Merkley, who urged the Commission to reconsider its interpretations regarding investment caps. One of the worst things that could happen to the crowdfunding marketplace, he posited, would be if ordinary investors lost large amounts on securities-based crowdfunding in its early days.

The Senator is also very concerned regarding the lack of robust mandatory corporate governance provisions. The Commission must do more to ensure fairness, and not simply the timeliness of financial statements. Under the proposal, an issuer may use financial statements for the year prior to the most recently completed fiscal year, provided that the issuer was not otherwise already required to update the financial statements and updated financial statements are not otherwise available.

If more than 120 days have passed since the end of the issuer's most recently completed fiscal year, the issuer must use financial statements for its most recently completed fiscal year. While the issuer would be required to include a discussion of any material changes in the its financial condition of the issuer, Senator Merkly fears that this could allow issuers to submit financial statements that are more than a year out of date and that cover only a very limited portion of the issuer's existence, leaving out what could be critical information for investors.

The proposal permits a funding portal to rely on the representations of the issuer concerning compliance with the Act's requirements unless the intermediary has reason to question the reliability of those representations. In his view, permitting a funding portal to rely on the representations of an issuer upends the statutory design, and in doing so potentially exposes small businesses and start-ups to increased costs of having to figure out how to comply and also potentially exposes investors to serious risks from the failure of those small businesses and start-ups to adequately comply. Such an approach also exposes the entire crowdfunding marketplace if a reputation for weak compliance or fraud develops. Instead, the senator urged the Commission to adopt standards and guidance for what funding portals must do to ensure that an issuer has satisfied the fairly simple requirements of the Act with respect to the rights investors have in securities.

ESMA Fast Tracks Standards and Regulations Implementing MiFID II

The European Securities and Markets Authority has fast tracked proposed regulations and standards implementing a wide range of provisions under the recently enacted MiFID II legislation, including on high frequency trading, derivatives and investor protection. MiFID is a cornerstone of the regulation of financial markets in the European Union This is the first step in the process of translating the MiFID II requirements into practically applicable regulations to address the effects of the financial crisis and to improve financial market transparency and strengthen investor protection. The public comment period on the proposals will end on August 1, 2014;  and ESMA expects to deliver advice to the European Commission sometime in December of 2014.  

MiFID II introduced changes that will have a large impact on the EU’s financial markets, including transparency requirements for a broader range of asset classes; the obligation to trade derivatives on-exchange; a requirement on high-frequency-trading, and new regulatory tools for commodity derivatives. It will also strengthen protection for retail investors through limits on the use of commissions; conditions for the provision of independent investment advice; and the disclosure of costs and charges.

ESMA proposed enhanced transparency and trading obligations, including pre- and post-trade transparency for exchange-traded funds and derivatives, as well as limitations on the trading of shares over-the-counter, with new obligations to trade derivatives on trading venues;.

ESMA would also refine the definition of high frequency trading and direct electronic access and specify the requirements for operating in the market using algorithmic techniques. New regulatory tools for commodity derivatives are also proposed,, including position limits.

With regard to enhancing investor protection, ESMA proposes new limitations on the receipt of commissions, as well as rules distinguishing independent from non-independent advice. Product governance is front and center, with proposed  requirements on the manufacture and distribution of financial products including target market and risk identification.  Improved information on costs and charges is also mandated, with requirements to provide clients with details of all charges related to their investment (relating to both the investment service and the financial instrument provided) so that they can understand the overall cost and its effect on their investment’s return.

BlackRock urges ESMA to avoid arbitrage in regulation of securities depositories

In order to avoid regulatory arbitrage and related post-trade technical challenges, BlackRock, Inc., the world’s largest asset manager, urged the European Securities and Markets Authority (ESMA) to implement the Central Securities Depository Regulation in a way that limits the scope of individual Member States to deviate from the ESMA standards. In a letter to ESMA, BlackRock emphasized that  a consistent regulatory framework is particularly important for exchange-traded funds that are cross-listed in several European jurisdictions. Establishing the same buy-in procedures or fail penalties notwithstanding the trading, clearing or settlement venue would facilitate the European Single Market, noted the comment letter, while providing end-investors consistency of outcome and eventually reduced cost. Such harmonization can only be effective if the penalties are only issued by one part of the market infrastructure, such as the trading venue or the central counterparty or the central securities depository. Currently, there can be multiple levels of penalty fails in addition to different failed trade regimes, resulting in distortions across European capital markets.

BlackRock pointed out that it has a pan-European client base serviced from 22 offices across the continent. Public and private sector pension plans, insurance companies, third-party distributors and mutual funds, endowments, foundations, charities, corporations, official institutions, banks and individuals all invest with BlackRock.