House Members Ask SEC to Delay Registration of Private Equity Fund Advisers

In a bi-partisan letter to the SEC, seventeen House Members, including Capital Markets Subcommittee Chair Scott Garrett (R-NJ), asked the Commission to delay the March 30, 2012 implementation of regulations requiring the registration of investment advisers to private equity funds and to exclude advisers of private equity funds that are not highly leveraged at the fund level from the registration. The Members believe that applying these new requirements to private equity is detrimental to capital formation and job creation and does little to protect consumers and address potential systemic risk. Given the lack of systemic risk associated with private equity funds and the sophistication of the investors in private equity funds, the substantial costs of registration outweigh any potential benefits.

In the view of the Members, the SEC’s registration requirements do not sufficiently consider the nature of private equity funds and the significant differences between private equity and other types of investment pools. Private equity firms employ long-term investment strategies by locking in capital for multiple years. Private equity investors are typically highly sophisticated qualified purchasers who have committed capital for a fixed term and cannot withdraw from that commitment.

Further, the Members emphasized that, given the lack of systemic risk associated with private equity funds and the sophistication of fund investors, the substantial cost of requiring registration of the fund advisers outweighs the potential benefits. Private equity funds will have to expend substantial resources for the establishment and ongoing operations of a compliance program, with many of these costs funneling down into the fund’s portfolio companies, creating burdens for those company managers.

In addition, the Members believe that requiring registration by private equity fund advisers not only misdirects resources at private equity firms but also at the SEC. As a result of private equity fund adviser registration, the SEC will have hundreds of new firms to oversee and inspect, thereby diverting regulatory resources from the core duty of protecting retail investors and other new oversight priorities that can contribute in a meaningful way to financial stability.

Senate Set to Pass Legislation to Curb Use of Insider Information by Members of Congress and Staff

The Senate is set to pass legislation barring members of Congress from profiting on inside information they obtain as part of the job and that is not readily available to the public. The dispute over the applicability of insider trading laws to Congress centers largely on the issue of whether Congress owes a legally enforceable fiduciary duty to the source from which they receive material, non-public information. The Stop Trading on Congressional Knowledge (STOCK) Act, S 2038, makes it explicit that Members and staff owe such a duty under the securities laws. The full Senate voted to proceed to debate on the bill by a 93-2 vote on January 30.

Specifically, the legislation provides that, for purposes of insider trading prohibitions under the Securities Exchange Act, the prohibition against Members of Congress and employees of Congress using inside information for personal benefit states a duty of trust and confidence. HR 2038 authorizes the SEC to issue regulations implementing the legislation and otherwise ensuring that Members and staff are subject to insider trading prohibitions. Nothing in the Act diminishes an existing legal obligation of Members and staff and makes clear that the STOCK Act does not limit or otherwise alter existing securities laws.

A public perception has developed that Congress is not covered by insider trading laws, and worse, has exempted itself from them, said Senator Joseph Lieberman (I-Conn.), the sponsor of the legislation. This is not true, he noted, but the legislation eliminates ambiguities in current insider trading rules that might make it harder to prosecute a member of Congress than a member of the public for using inside information for personal benefit.

HR 2308 also makes conforming changes to the Commodity Exchange Act to ensure that the insider trading prohibitions under that Act apply to Members of Congress and staff.

Within12 months of enactment, the STOCK Act directs the GAO to submit a report to Congress assessing the role of political intelligence in the financial markets and the extent to which investors are using access to Congressional insiders and other federal employees to inform their investment decisions. This report is intended to shed light on the practice and better inform any future Congressional action in this area.

The report must discuss what is known about the prevalence of the sale of political intelligence and the extent to which investors rely on such information; as well as what is known about the effect that the sale of political intelligence may have on the financial markets. The report must also examine the extent to which information which is being sold would be considered non-public information and the legal and ethical issues that may be raised by the sale of political intelligence. Importantly, any benefits from imposing disclosure requirements on those who engage in political intelligence activities must be discussed, as well as any legal and practical issues that may be raised by the imposition of disclosure requirements on those who engage in political intelligence activities.

For these purposes, the Act defines political intelligence to mean information that is derived by a seller from direct communications with executive branch and legislative branch officials; and provided in exchange for financial compensation to a client who intends, and who is known by the seller to intend, to use the information to inform investment decisions.

IASB Chair Says US Will Come on Board with IFRS, Details Remaining Convergence Projects

Noting that wherever he goes in the world the one question asked more than any other is will the US come on board with IFRSs, IASB Chair Hans Hoogervorst emphasized that the US will ultimately come on board. While conceding that he has no privileged insight regarding the SEC’s internal decision making, the Chair said at an Ernst & Young IFRS seminar in Moscow that the SEC Chief Accountant recently said that the SEC will make a decision on IFRS in the coming months.

This is not an easy decision to make, acknowledged the IASB Chair, since the US has already developed a sophisticated set of financial reporting standards over many decades. Transitional concerns have to be carefully considered. That is why Chairman Hoogervorst has consistently supported the general approach for the endorsement of IFRSs described by the SEC staff’s work plan. He also noted that the US is committed to supporting global accounting standards under SEC policy and US Government policy. A set of global accounting standards is also the policy of the G20, of which the US is a key player.

There are many practical challenges facing the SEC in making the decision, noted the IASB Chair, and they are real. However, both the IASB and FASB have made it clear that a continued program of convergence by another name is not an acceptable way forward. With regard to the ongoing convergence plan, the IASB head noted that the only projects left to complete are on revenue recognition, lease accounting and financial instruments.

Revenue is the top line number and is important to every business. It is all the more important to get this standard right. Because the topic is so important, the Boards have taken a very careful and conservative approach in developing the revenue recognition standard. A second exposure draft has been published and the consultation period runs a full 120 days until March 2012. The new standard will replace US requirements that are generally considered to be too detailed and international requirements that are not detailed enough.

Lease accounting is a difficult area, said the IASB Chair, but one where improvements are needed. For many companies, lease obligations represent their greatest area of off balance sheet financing. These transactions must be accounted for in a way that is transparent to investors. It seems odd that investors must guess what a company’s liabilities from leasing are, he noted, even though management has this information at its fingertips. These obligations can be substantial, he added. The boards are finalizing the revised proposals and expect to publish a further exposure draft for public comment shortly.

The final project is financial instruments. This project was always going to be difficult, he said, adding that it took more than ten years to develop IAS 39, the existing financial instruments standard. Doing it midway through the worst financial crisis in 80 years has made it even harder. Also, the IASB and FASB have been pulled in different directions, which has made achieving convergence very challenging.

Some difficult choices remain to be made, the Chair averred, beginning with classification and measurement. The Board set out to replace IAS 39 with an entirely new standard. The first part of this work was completed in less than a year, with the issuance of IFRS 9, which the IASB Chair described as a very good standard. Also, the complexity associated with IAS 39 has been reduced.

Meanwhile, FASB has been refining its own approach on classification and measurement. FASB responded to feedback on its exposure draft and moved from a full fair value approach to a mixed measurement model. There are still differences in the Boards’ positions, said the IASB chief, but they are ``not a million miles apart.’’

On impairment, after exploring a number of alternative approaches, the IASB and FASB are finally on the same page with a workable model. The Boards recently agreed on an approach that divides expected loan losses into three categories, he said, referred to by staff as “The Good, The Bad and The Ugly.” He is hopeful that the Boards are now in a position to move quickly to the exposure draft stage. He expects the Boards to finalize this phase of the project before the end of the year.

On hedging, the IASB has come up with a general model that has been very well received and will soon publish on its website a staff draft of the model. This will give FASB additional time to take a closer look at the IASB proposal. The IASB is convinced that its hedging model gives investors a more reliable view on the economic reality of modern business practices. By redressing accounting mismatches it gives investors a much better view of the way in which companies hedge their economic risks. This work will also establish the underlying principles for macro hedging, noted the IASB Chair, which will be subject to a separate exposure draft.

US Sentencing Commission Proposes Enhanced Guidelines in Securities and Mortgage Fraud Cases Pursuant to Dodd-Frank Sec. 1079A Directives

The United States Sentencing Commission has implemented the directives of Section 1079A of the Dodd-Frank Act regarding cases involving securities fraud and cases involving mortgage fraud and financial institution fraud. Section 1079A requires the Commission to review and, if appropriate, amend the guidelines applicable to these offenses and consider whether the guidelines appropriately account for the potential and actual harm to the public and the financial markets from them.

In the course of its Section 1079A review, the Commission became aware that some insider trading defendants engage in serious offense conduct but nonetheless, because of market forces or other factors, do not necessarily realize high gains. The concern has been raised that in such cases the guidelines may not adequately account for the seriousness of the conduct and the actual and potential harm to individuals and markets, because the guidelines use gain alone as the measure of harm.

Thus, with regard to securities fraud, the Commission proposes a specific offense characteristic that applies if the offense involved sophisticated insider trading, which would be defined as an especially complex or intricate offense conduct pertaining to the execution or concealment of the offense. The Commission proposes a non-exhaustive list of factors that federal courts must consider in determining whether the offense involves sophisticated insider trading, including the number and dollar value of the transactions; the number of securities involved; the duration of the offense; whether corporate shells or offshore financial accounts were used to hide transactions; and whether internal monitoring or auditing systems or compliance and ethics program standards or procedures were subverted in an effort to prevent the detection of the offense.

The Commission also proposes an enhancement if, at the time of the offense, the insider-defendant was an officer or a director of a public company; a registered broker or dealer, or a person associated with a broker or dealer; or an investment adviser, or a person associated with an investment adviser; or an officer or a director of a futures commission merchant or an introducing broker; a commodities trading advisor; or a commodity
pool operator.

The Commission also asked for comment on whether it should provide further guidance regarding the causation standard to be applied in calculating loss in cases involving securities fraud. For example, should the Commission provide a loss causation standard similar to the civil loss causation standard articulated by the Supreme Court in Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005), where the Court held that civil securities fraud plaintiffs must prove that their economic loss was proximately caused by the defendant’s misrepresentation or other fraudulent conduct as opposed to other independent market factors.

With regard to mortgage fraud, the Commission proposes two changes to the calculation of loss in mortgage fraud cases. First, the Commission would specify that in the case of a fraud involving a mortgage loan in which the collateral was disposed of at a foreclosure sale, courts should use the amount recovered from the foreclosure sale. Second, in the case of a fraud involving a mortgage loan, reasonably foreseeable pecuniary harm would include the reasonably foreseeable administrative costs to the lending institution associated with foreclosing on the mortgaged property, provided that it exercised due diligence in the initiation, processing, and monitoring of the loan and the disposal of the collateral.

With regard to financial institution fraud generally, the Commission proposes to broadens the applicability of the guidelines, which provide an enhancement if the offense involved specific types of financial harm, such as jeopardizing a financial institution. Currently, courts are directed to consider whether the financial institution suffered one or more listed harms, such as becoming insolvent, as a result of the offense. The Commission proposes to direct federal courts to consider whether one of the listed harms was likely to result from the offense but did not result from the offense because of federal government
intervention.

House Ag Committee Approves Legislation Exempting Inter-Affiliate Swaps from Dodd-Frank Derivatives Requirements

Legislation exempting inter-affiliate swaps from margin and other requirements under the derivatives provisions of the Dodd-Frank Act was approved by voice vote by the House Agriculture Committee. Sponsored by Rep. Steve Stivers (R-OH) and Rep. Marcia Fudge (D-OH), HR 2779, would exempt swaps and security-based swaps entered into by a party that is controlling, controlled by, or under common control with its counterparty. The exempted transactions would be reported to an appropriate swap data repository, or, if there is no such repository that would accept them, to the CFTC in the case of exempted swaps, or the SEC in the case of exempted security-based swaps. Rep. Stivers said that the legislation is designed to ensure that Congress does not penalize companies over the way they choose to do business. The House Financial Services Committee earlier approved HR 2779 in a bi-partisan 53-0 vote.

Inter-affiliate swaps are swaps and security-based swaps executed between entities under common corporate ownership. H.R. 2779 exempts inter-affiliate swap and security-based swap trades that are designed to mitigate risks associated with market-facing trades, where a corporation executes a derivatives transaction with an investment bank or other entity, which may be either a swap dealer or security-based swap dealer.

Currently, companies use inter-affiliate swaps to combine positions and centrally hedge risk. This is accomplished by executing most or all of its external swaps or security-based swaps through a single or limited number of affiliates. Despite the significant differences between inter-affiliate swaps and swaps between unrelated parties, the Dodd-Frank Act treats these swaps the same, which increases the cost of hedging risk for end-users. House Report No. 122-344.

Rep. Stivers noted that inter-affiliate swaps are a type of accounting transaction used to assign risk of swap to the proper entity within the corporate family. The federal government should not be influencing that type of decision by essentially picking winners and losers within a corporate family, said the Representative, who assured the subcommittee that the legislation does not change corporation law. Rep. Stivers also noted that the measure applies only to swaps, not to all derivatives.

An amendment offered by Rep. Stivers and Rep. Gwen Moore (D-WI) designed to prevent entities from using the inter-affiliate swap exemption to evade Dodd-Frank derivatives regulation was agreed to by voice vote. Primarily, the amendment would ensure that financial services companies cannot use the exemption to evade other provisions of Dodd-Frank. Rep. Moore noted that the intent of the amendment is to prevent evasion of clearing and margin requirements. The amendment allows the SEC to adopt regulations to include in the definition of security-based swap any agreement or transaction structured as an affiliate transaction to evade the requirements of Dodd-Frank.

Under H.R. 2779, inter-affiliate swap trades must still be reported to a swap data repository and to the appropriate regulators. While the bill does not exempt security-based swap trades from all of Title VII’s requirements, the bill does exempt such transactions from the margin, capital, clearing and execution, and real-time reporting requirements of Title VII. The bill would also prohibit affiliate transactions from being used as a factor in defining a security based swap dealer or major security-based swap participant.

During the Ag Committee markup of HR 2779, Chairman Frank Lucas (R-OK) expressed strong support for the legislation, noting that HR 2779 ensures that companies can maintain successful business models centralizing risk management expertise in a single or limited number of affiliates. He observed that regulating inter-affiliate swaps would not provide additional risk reduction but would raise costs for many companies.

Rep. Fudge said that an exemption for inter-affiliate swaps from margin and other requirements of Dodd-Frank Act would allow for centralized hedging whereby a company using inter-affiliate swaps can combine its positions, executing most if not all of its market facing swaps through a single affiliate. These transactions do not pose or increase systemic risk and would not lead to abuse, she averred, because Section 721(c) of Dodd-Frank gives regulators explicit anti-evasion authority and HR 2779 preserves the power to regulate security-based swap transactions under Sections 23A and 23B of the Federal Reserve Act. More broadly, said Rep. Fudge, the legislation balances business needs while protecting investors from abuses.

In earlier testimony supporting HR 2779, ISDA noted that the legislation addresses an issue of significant concern to major swaps market participants. Inter-affiliate swaps are transactions between two legally separate subsidiaries, explained ISDA, and are commonly used by financial institution dealers in connection with their roles as market intermediaries and by end-users to hedge capital and manage balance sheet risks. End-users use inter-affiliate swaps transactions to hedge their capital, manage risks inherent in a particular balance sheet asset/liability mix and manage other related risks arising from their general operations.

Audit Committee Chairs of Global Companies Inform PCAOB that Mandatory Auditor Rotation Would Undermine the Committee

Comment letters on the PCAOB’s concept release on auditor independence and audit firm rotation reveal a growing consensus among the audit committee chairs of complex global corporations that mandatory audit firm rotation would undermine the audit committee as overseer of the company’s relationship with its outside auditor in the post-Sarbanes-Oxley era. Peter V. Ueberroth, audit committee chair of Coca-Cola, Inc. noted that, since the passage of the Sarbanes-Oxley Act in 2002, independent audit committees have had the primary responsibility for engaging, overseeing, and terminating the outside auditor. In passing Sarbanes-Oxley, he noted, Congress clearly recognized that the audit committee brings a unique and informed perspective to consideration of which firm is best positioned to serve as a company’s outside auditor.

The audit committee chair at the Louisiana-Pacific Corporation said that, in the Sarbanes-Oxley Act, Congress explicitly rejected mandated audit firm rotation. Instead, the Act strengthened the role of audit committees, which enhanced the communication between the independent auditors and the audit committee, increased the discussion around independence and provided more transparency to the services provided by the audit firms.

Mr. Ueberroth, a former chair of the United States Olympic Committee board of directors, also posited that imposing a mandatory rotation requirement would inevitably interfere with the audit committee’s responsibility for assessing the effectiveness of the auditor and choosing whether to retain the auditor based on this assessment. That key responsibility would be subordinate to a mandate to choose a new firm, he said, even when that firm, in the judgment of the audit committee, may not be as qualified as the current auditor to serve the company. Further, requiring a company to rotate audit firms would presents serious risks related to the effective functioning of the audit process and, consequently, could lead to a deterioration in audit quality, particularly in the years leading up to, and after, a rotation. Mandatory audit firm rotation also would create a host of practical difficulties for Coca-Cola and similar companies with complex global business operations.


The chair of the Exxon Mobil audit committee, Michael Boskin, former Chair of the Council of Economic Advisers under President George H. W. Bush, emphasized that mandatory auditor rotation could have a detrimental effect on the quality of the independent audit function and would diminish the important role of the board audit committee, a primary function of which is to promote the independence of the audit function. The chair explained that the audit committee accomplishes this through exercising direct responsibility for appointing, compensating, retaining and overseeing the work performed by the independent auditor. Mandating rotation of the audit firm would diminish the audit committee’s responsibility to appoint and retain the independent auditor.

Mr. Boskin also noted that an auditor can achieve a profound understanding of a complex, multinational company only through active engagement over an extended period of time. Attaining this deeper understanding of the company, its philosophy, policies, standards, and systems is critical to audit effectiveness, he remarked, and takes many years to achieve. Mandatory rotation undermines the process for developing this holistic view of a company, he said, and would make audits less effective and more vulnerable to error.

The audit committee chair at AT&T observed that mandatory audit firm rotation would be ineffective in increasing audit quality and protecting investors. It would also diminish the audit committee’s oversight role. The audit committee is best positioned to select the company’s outside auditor, emphasized the chair, and industry expertise combined with institutional knowledge gained over time significantly enhances the quality of the audit.

Echoing the comments of other audit committee chairs, the Union Pacific Corp. audit committee chair noted that mandatory audit firm rotation may lead to increased audit costs as a newly engaged audit firm may require additional staff and time to ensure a comprehensive audit.

The chair of the audit committee at New York Life Insurance Co. said that mandatory audit firm rotation would result in no meaningful improvement in auditor independence, objectivity and professional skepticism and would come with significant cost and risk. The chair stressed the importance of the continued autonomy of the audit committee to choose the right auditor, based on the audit firm's experience and industry knowledge, instead of being forced to choose an auditor due to a mandated requirement. Any
requirement to adopt mandatory rotation would take away discretion from the audit committee to do what is in the best interest of the company. The audit committee is in the best position to evaluate whether the company’s outside auditors are independent, objective and are exercising an appropriate level of professional skepticism.

The chair of the audit committee at Imperial Oil said that mandatory rotation of the audit firm effectively supersedes the board audit committee's important responsibility to appoint and retain the independent auditor. Further, since there are only a limited number of audit firms large enough to audit companies like Imperial Oil, mandatory rotation, based on arbitrary points in time could limit the availability of qualified firms, placing the audit committee in an unacceptable position.

House Ag Committee Approves Legislation Clarifying Dodd-Frank Swap Execution Facility Provisions

The House Agriculture Committee approved by a voice vote bi-partisan legislation providing certainty and direction with regard to the Dodd-Frank definition of swap execution facility. Sponsored by Rep. Scott Garrett (R-NJ), Chair of the Capital Markets Subcommittee, the Swap Execution Facility Clarification Act, HR 2586, is designed to implement congressional intent reflected in the heavily negotiated language of the swap execution facility definition in Dodd-Frank. H.R. 2586 directs regulators to provide market participants with the flexibility they need to obtain price discovery in the market and in the method of execution they use.

The Act would clarify that a swap execution facility cannot be required to have a minimum number of participants, receive or respond to quote requests, or display quotes for a certain period of time. Further, the SEC and CFTC would not be permitted to limit the means of contract execution or require trading systems to interact with each other.

In addition to allowing voice execution on a swap execution facility for any trade, HR 2586 prohibits ‘the 15 second rule,’ restrictions on the request for quote (RFQ) model and a sweep the book requirement. Chairman Garrett believes that the specific nature of this direction is necessary to promote the conditions for a competitive regulated swaps market to thrive in the U.S.

An amendment to HR 2586 offered by Ag Committee Ranking Member Collin Peterson (D-MN) was approved by voice vote. The Peterson Amendment is designed to send a signal to not gut CFTC powers on swap market transparency. In this spirit, the amendment preserves CFTC authority to promote greater transparency. Rep. Peterson noted that swap execution facilities must be open transparent marker places where competition governs. The Peterson Amendment was strongly support by Ag Committee Chair Frank Lucas (R-OK), who described it as a targeted amendment that will give swap execution facilities the flexibility to evolve naturally without hindering liquidity or choice for market participants. ‘

Chairman Garrett praised the Ag Committee’s approval of HR 2586, noting that regulating the execution of swap transactions as mandated by the Dodd-Frank Act is the most significant market structure undertaking since 1934. If Congress and the regulators don’t get it right, he warned, there is a risk of putting the U.S. at a competitive disadvantage with foreign counterparts. While for some the goal is to have swaps trade with continuous pricing like the equity and futures markets, he said, because many swaps are illiquid products with sporadic pricing, that goal simply isn’t practicable at this time. H.R. 2586 is specifically designed to promote the transparent evolution of swaps trading on swap execution facilities and help to ensure that a vibrant swap market develops in the U.S. Importantly, it also protects the confidential trading strategies of asset managers, pension funds, insurance companies, farm credit banks and the ability of commercial end-users to access the swap market to fund long-term projects necessary to create jobs.

During the markup of HR 2586 in the Financial Services A technical amendment offered by Chairman Garrett, and suggested by the SEC, would strike ``trading system or platform’’ from the bill and insert ``method of trading system functionality.’’ According to Chairman Garrett, this is term of art that keeps the congressional intent of allowing different methods of trading while obviating the need for new definitions in the legislation.

FinCEN to Work with SEC in Developing Regulations Requiring Investment Advisers to Set Up AML Programs and Report Suspicious Activities

The Financial Crimes Enforcement Network is working on a regulatory proposal that would require investment advisers to establish anti-money laundering programs and report suspicious activity. In remarks at a recent American Bankers/American Bar Association seminar, FinCEN Director James Fries, Jr. said that FinCEN looks forward to working with the SEC as well as the States in developing the proposed regulations. FinCEN is a bureau within the Treasury Department charged with administering and enforcing compliance with the Bank Secrecy Act and associated regulations.

Although investment advisers are not expressly included within the definition of financial institution under the Bank Secrecy Act, the Act authorizes the Treasury Secretary to include additional types of entities within the definition of financial institution if it is determined that they engage in an activity similar to, related to, or a substitute for an activity of an enumerated entity. FinCEN regulations currently apply to broker-dealers and mutual funds.

On May 5, 2003, FinCEN published a notice of proposed rulemaking in the Federal Register proposing that investment advisers, because of the types of activities they engage in and the services they provide, should be defined as financial institutions for the purpose of requiring them to establish anti-money laundering programs. Many investment advisers provide investment advice to clients who have granted the adviser the power to manage the assets in their accounts, frequently on a discretionary basis, reasoned FinCEN, and thus engage in activities that are similar to, related to, or a substitute for financial services that are provided by other Bank Secrecy Act financial institutions.

Further, advisers managing clients’ assets work so closely with other financial institution, such as by directing broker-dealers to purchase or sell client securities or by directing banks to transfer client funds, that the advisers’ activities are related to those of the other financial institutions. Advisory services can also be a substitute for products offered by investment companies or insurance companies, for example, when clients seek to have advisers manage their assets through other forms of pooled investment vehicles.

Given the amount of time that had elapsed since the initial publication without further regulatory action, on November 4, 2008, FinCEN withdrew the proposed regulations and said that it would not proceed with regulations for investment advisers without publishing new proposals and allowing for industry comments. Since then, there have been significant changes in the regulatory framework for investment advisers with the passage of the Dodd-Frank Act and SEC rules implementing Dodd-Frank. Based on passage of Dodd-Frank and other changes, FinCEN revisited the topic of investment advisers.

According to the Investment Advisers Association, the number of investment advisers registered with the SEC totaled 11,539 in 2011, and the total assets under management reported by all investment advisers increased 13.7% to $43.8 trillion in 2011, from $38.6 trillion in 2010. According to the SEC, there are more than 275,000 state-registered investment adviser representatives and more than 15,000 state-registered investment advisers. Approximately 5% of SEC-registered investment advisers are also registered as broker-dealers, and 22% have a related person that is a broker-dealer. Additionally, approximately 88% of investment adviser representatives are also registered representatives of broker-dealers.

NY Senator Says SEC and CFTC Should Uniformly Enforce the Volcker Rule

The SEC, CFTC and banking agencies must achieve a uniform approach to enforcement of the Volcker Rule so as not to favor certain entities with an advantage and not to create opportunities for regulatory avoidance, emphasized Senator Kirstin Gillibrand (D-NY). In a letter to the regulators, the Senator also questioned how granular the enforcement level would be and said that the market making so crucial to the financial markets must continue under the Volcker regulations.

The proposed regulations implementing the Volcker provisions in Section 619 of Dodd-Frank call for enforcement at the smallest unit of organization. The Senator queried if this meant individual traders or trading desks. In her view, granular enforcement at that level would create a substantially different standard than one focused on a larger picture. In addition, such a standard may require added build time to develop the reporting mechanisms to enable such a standard to function. At the very least, the Senator urged the regulators to clarify the unit of enforcement needed to assess the level at which the standards proposed will be applied.

Further, the Senator pointed out that Congress sought to balance the need of financial institutions to hold assets in order to maintain market liquidity with the Volcker Rule restrictions. The ability of firms to make markets is critical to the competitiveness of the US financial industry and to the maintenance of deep and liquid financial markets that undergird the economic system. The Senator emphasized that the final regulations should strike this important balance in order to ensure the competitiveness and safety of financial institutions.

Securities Industry and Corporate Secretaries Ask SEC to Use Negotiated Rulemaking in Adopting Dodd-Frank Pay Ratio Regulations

The securities industry and the Society of Corporate Secretaries and Governance Professionals have urged the SEC to employ a negotiated rulemaking process when adopting pay ratio regulations under Dodd-Frank that will allow a representative group of stakeholders on a rulemaking advisory committee to join with the Commission in developing a balanced rule that achieves the legislative intent of Section 953(b).

In a letter to the SEC, SIFMA and the Society also asked the Commission to hold a roundtable discussion of experts and stakeholders to better understand the potential issues and unintended consequences of implementing the pay ratio disclosure requirements. The letter was also signed by, among others, the Financial Services Roundtable and the US Chamber of Commerce.

The groups also urged the SEC to submit the proposed regulations to the Office of Information and Regulatory Affairs (OIRA) review process. OIRA is located within the Office of Management and Budget and was created by Congress with the enactment of the Paperwork Reduction Act of 1980 to review federal regulations. In the view of the trade groups, a thorough OIRA review will allow for increased scrutiny to better understand the cost and benefits of the pay ratio rules and aid the SEC in choosing the least burdensome means of implementing Section 953(b). This will ensure that the best and most practical approaches can be included in a proposed regulation that will balance the perceived benefit of this disclosure against the implementation costs.

Moreover, the groups urged the SEC to follow the requirements outlined in Executive Orders 13563 and 13579 to identify alternative approaches and choose the least burdensome means of implementation.

Section 953(b) requires disclosure of the median of the annual total compensation of all employees of an issuer, except the CEO, as calculated in accordance with Item 402(c)(2) of Regulation S-K, the annual total compensation of the CEO, and the ratio of the median annual compensation of all employees to the CEO’s compensation. Recently, the House Financial Services Committee reported out a bi-partisan bill that would repeal Section 953(b). The Burdensome Data Collection Relief Act, HR 1062, is currently awaiting action by the full House of Representatives.

The corporate disclosure regime is designed to provide information that is useful to investors when making investment decisions, noted the groups. While pay ratio disclosure may be of general interest to some investors, they conceded, it is unclear how this disclosure will be material for the reasonable investor when making investment decisions. The ratio will inevitably vary widely among industries or businesses without any relevance to the financial performance of a company. Thus, additional consideration of any possible benefit to be provided by this disclosure must be considered in the rulemaking process and weighed against the costs.

According to the groups, there are significant hurdles and burdens faced by the business community in attempting to comply with Section 953(b). There is a widespread misperception that this information is readily available at the touch of a button, noted the letter, but this could not be further from the truth. Companies may have tens of thousands of employees stretched out over dozens of countries, especially the largest companies with operations around the world. Obtaining the data will be difficult and time-consuming as the definition of compensation among countries will vary widely, and companies will face difficulties attempting to rationalize compensation with currency fluctuations.

The requested SEC roundtable could gather information from the people that will handle the practical compliance with this rule. The groups asked that this roundtable discussion, if it occurs, be designated part of the rulemaking record.

Given the lack of discussion about the practical implications of Section 953(b) prior to its enactment, continued the groups, it is of utmost importance during difficult economic times that implementing regulations are carefully and thoughtfully proposed. Further, the SEC should use caution during the rulemaking process to ensure that the economic consequences do not outweigh the objectives of the rule.

Noting that Section 953(b) does not include a deadline for promulgating regulations, the trade associations urged the SEC to resist rushing into proposing regulations, given the substantial cost and implementation burdens that are likely to be imposed on companies. While acknowledging that Section 953(b) is more prescriptive than many Dodd-Frank requirements, the groups said that the SEC has been afforded the time to thoroughly analyze the economic impacts that different alternatives will have on the U.S. economy at large. Thus, the SEC should consider how to provide the most flexibility for the least cost and minimize the disadvantages of unnecessary regulatory expenditures.

Finally, the groups urged the SEC to submit the proposed regulations to the Office of Information and Regulatory Affairs (OIRA) review process. In the view of the trade groups, a thorough OIRA review will allow for increased scrutiny to better understand the cost and benefits of the pay ratio rules and aid the SEC in choosing the least burdensome means of implementing Section 953(b). This will ensure that the best and most practical approaches can be included in a proposed regulation that will balance the perceived benefit of this disclosure against the implementation costs.

Senator Hagan Urges SEC and Other Regulators to Adhere to Legislative Intent in Crafting Dodd-Frank Volcker Regulations

The proposed regulations implementing the Volcker Rule provisions of the Dodd-Frank Act may unintentionally narrow the scope of permitted activities, such as market making, that Congress preserved and could siphon liquidity from capital markets and harm US capital formation, said Senator Kay Hagan (D-NC). In a letter to the SEC and CFTC, the Senator noted that, in crafting Section 619(d), Congress acknowledged that market-making, underwriting, and asset management are critical to capital formation and essential to preserving robust liquidity in U.S. capital markets. The Volcker Rule prohibitions were never intended to restrict or prohibit legitimate structures, she continued, including foreign funds, joint ventures, venture capital funds, loan funds, securitization vehicles, and structured notes, that are not usually thought of as private equity or hedge funds and do not relate to trading the firm's own capital.

Senator Hagan is also concerned that the proposed regulations could inadequately clarify the treatment of certain investments made by insurers. Section 619(d)(I)(F) of Dodd-Frank includes trading in an insurance company's general account as a permitted activity and, by its terms, exempts permitted activities from the proprietary trading ban. While the proposed regulations do provide an exemption from the proprietary trading restrictions for the general account of an insurer, she noted, the section that provides this exemption does not address covered funds.

Further, the covered funds section does not expressly extend the exemption that permits proprietary trading activities on behalf of the general account to allowing the general account to hold an ownership interest in a covered fund. The Senator urged the regulators to conform the rule to Section 619's directive to accommodate the business of insurance and include investments in covered funds within the exemption for insurers.
In Section 619(d)(I)(B) of Dodd-Frank, Congress explicitly permitted market making.

While acknowledging the difficulty in distinguishing market making from prohibited activities, the Senator emphasized the importance of ensuring that regulatory limits on proprietary trading do not unnecessarily prevent firms from engaging in the accepted and legitimate activities necessary to preserve orderly markets and service clients.

Restrictions that impede the ability of firms to make markets could reduce liquidity and trigger unintended consequences, said the Senator. Moreover, the complex monitoring regime proposed by the regulators has the potential to reduce liquidity in secondary markets by causing dealers to limit the size of the positions that they purchase for fear of tripping prohibitions. A reduction in liquidity could limit the ability of mutual funds, pension funds, and other institutions to adequately serve investors, including many US retail customers. Senator Hagan urged regulators to carefully evaluate the impact of the proposal on the ability of firms to make markets and to avoid regulations that could reduce market liquidity, discourage investment, limit credit availability, and increase the cost of capital for companies.

Corporate Secretaries Oppose PCAOB Suggestions of AD&A and Auditor Assurance Outside Financial Statements

The possible revisions to standards on the reports of outside auditors on company financial statements suggested by a PCAOB concept release would fundamentally change the role of the auditor from an independent analyst to an original source of information for investors, said the Society of Corporate Secretaries and Governance Professionals. In a comment letter to the PCAOB, the Society said that the net effect of many of the suggestions in the concept release would make the auditor a guarantor of the accuracy and completeness of the financial statements and, indeed, of the company’s historical results of operations and financial condition.

While the PCAOB would retain the outside auditor’s pass/fail opinion on a company’s financial statements, the Society believes that the pass/fail approach would be vitiated by the alternatives set out in the release. Depending on the nature and extent of the auditor’s comments in the proposed Auditor’s Discussion and Analysis (AD&A), and in any required assurance on disclosures outside the financial statements, the audit would yield the equivalent of high pass, medium pass, low pass, and similar grades, which would add complexity and uncertainty for investors that does not exist with the current pass/fail system.

The Society strongly disagrees with requiring an AD&A because it would be counterproductive to the PCAOB’s goal of providing greater transparency to investors and would substitute the auditor’s judgment for management’s judgment, which could ultimately undermine the auditor’s independence and management’s responsibility for the financial statements and related disclosures. Management is ultimately responsible for the preparation of the financial statements and related disclosures and is in the best position to understand its business and discuss its financial results. If an auditor were required to provide its own analysis of critical audit risks and close calls, reasoned the Society, the auditor would essentially be taking ownership of the financial statements.

Moreover, providing more detailed disclosure by the auditor of the matters considered and underlying considerations with regard to an issuer’s financial statements would not meet the PCAOB’s stated objectives of increasing transparency and making financial statements more relevant to users, noted the Society, rather it would likely increase confusion and the length of disclosure documents without a corresponding benefit. In addition, the nature and process of review and approval of the AD&A would greatly increase the difficulty of meeting tight time frames for filings under the securities laws, particularly filings of large, accelerated filers whose financial statements are generally complex.

According to the Society, even if the AD&A does not become boilerplate, which is a fear, the lack of consistency and comparability among different issuers’ AD&As would cause confusion. In the Society’s view, to add a discussion on difficult and contentious issues, particularly including close calls on the application of complex accounting standards, would create an unproductive situation where there are two potentially competing views on accounting matters.

The Society also disfavors the proposed assurance on items outside of the financial statements. While auditors are familiar with the figures and disclosure upon which the MD&A, earning releases, and non-GAAP measures are based, the cost of requiring an auditor opinion on MD&A or these other disclosures would provide relatively little benefit compared to the cost. Auditors already routinely comment on these matters and issuers routinely take such comments into account, noted the Society, and their responsibilities include consideration of whether such information is materially inconsistent with the financial statements.

Thus, the scope and nature of these other disclosures is unlikely to materially change as a result of requiring a more formal assurance on the part of auditors, reasoned the Society, but would only increase the cost. The illustration of a possible attestation in the release appears to suggest that such an attestation would have to contain a legal opinion that the MD&A satisfies SEC regulations, as well as assurance or comfort regarding the amounts and numbers contained therein. The Society cautioned that these requirements would be well beyond the scope of auditors’ duties and would require an auditor to develop expertise in areas not currently associated with auditing responsibility.

House Ag Committee Approves Legislation Clarifying End-User Exemption from Dodd-Frank Derivatives Margin Requirements

The House Agriculture Committee has approved bi-partisan legislation clarifying that commercial end users would not be subject to margin requirements for uncleared swaps under derivatives provisions of the Dodd-Frank Act. The Business Risk Mitigation and Price Stabilization Act, HR 2682, sponsored by Rep. Michael Grimm (R-NY) and Gary Peters (D-MI), passed the committee by voice vote with strong support from Chairman Frank Lucas (R-OK) and Ranking Member Colin Peterson (D-MN). The legislation has already been approved by the Financial Services Committee on a voice vote.

The Dodd-Frank Act does not require regulators to impose margin requirements on end users and the legislative history clarifies that Congress did not intend to impose margin requirements on non-financial end users. Nonetheless, the legislation was driven by end user uncertainty about whether they will be subject to margin requirements.

At the markup of the bill, Chairman Lucas said that, while the CFTC has followed congressional intent, the banking regulators have proposed to require margin in the form of cash or highly liquid securities from non-financial end users, thereby ignoring congressional intent. Thus, he viewed this legislation as critical to reaffirming congressional intent to expressly and clearly provide an end-user exemption. In this regard, Chairman Lucas noted a letter sent by Senators Chris Dodd (D-CT) and Blanche Lincoln (D-AK) to House oversight chairs stating that the Dodd-Frank Act does not authorize federal regulators to impose margin on end users that use swaps to hedge or mitigate commercial risk.

Rep. Grimm said that HR 2682 clarifies the intent of Congress to provide an explicit exemption on the posting of margin by end users. He emphasized that the legislation ensures that federal regulators will not impose margin requirements on true ends users that use swaps to manage their business risks, like to lock in the cost of raw materials.

True end-users are companies that use derivatives to manage an actual business risk, he noted, generally to hedge against fluctuating prices, currency rates, or interest rates, and not to speculate. Forcing true end-users to post margin can have several negative consequences, he noted, such as the costs of hedging could be become so high that they stop hedging, resulting in a detrimental rise in prices for consumers. Also, capital would be restricted that would otherwise be used for job creation or reinvestment to make US companies more competitive in the global economy. Further, the high costs of hedging could drive business overseas to foreign derivatives markets and could also increase regulatory arbitrage.

UK Financial Conduct Authority Product Intervention Powers Explained by Martin Wheatley

The product intervention powers of the new UK Financial Conduct Authority will be exercised around a strong governance framework in a flexible and proportionate manner assured Martin Wheatley, designated CEO of the FCA. In remarks to the British Bankers Association, he said that the power to ban a financial product will not be used either lightly or indiscriminately and pledged that regulatory intervention will not prevent innovation and product development. In addition, the FCA will set out principles for when it will use these types of powers. While the intervention powers will be a useful regulatory tool for protecting investors, he noted, it will not be the first tool the FCA reaches for and it will not be the norm. He does not envision FCA staff walking around offices ``with clipboards waiting to jump in and stop’’ the next good financial product idea.

The UK is in the process of fundamentally reforming its domestic financial regulatory regime. The Financial Services Authority is being abolished in its current form. The new Financial Conduct Authority will oversee the conduct of financial services firms, the operation of markets and the protection of consumers, with new powers to ban the sale of toxic products. Martin Wheatley is currently the Managing Director of the FSA Consumer and Markets Business Unit; and is slated to be the first CEO of the FCA. He was formerly CEO of the Hong Kong Securities and Futures Commission.

With regard to product intervention, the official set out some scenarios where intervention could be used. The FCA could intervene to ban inherently flawed products, such as products that offer such poor value or have such disadvantageous features that most consumers are unlikely to benefit from them. Also, intervention could be proper when there is widespread promotion or selling to customers for whom the product is unsuitable. Another example could be products where there is a strong incentive for a mis-sale, such as instances where profitability is so great that the product is just being sold to everyone, regardless of whether it is appropriate for them, and the usual regulatory measures will not put a stop to it.

Mr. Wheatley also detailed a number of forms of product intervention that the FCA could employ. For example, the FCA could intervene to ban the sale of a particular type of product to all customers, or to certain categories of customer. Moreover, intervention could be used to mandate the inclusion or exclusion of specific product features. Or sales could only be allowed in certain specified situations, such as only selling the product if it includes or excludes specified features, and if sales are limited to particular categories of customer, or through particular distribution channels.

On a separate point, the official urged people to follow the FSA guidance for creating structured financial products that was published last year. The guidance sets out four steps the FSA expects people designing and selling such products to go through. First, identify the target audience and design a product that meets their needs so it is clear who you are aiming it at, and that your high risk, high return investment is not meant for ``the 80 year old widow who visits your branch looking for a way to save without losing her money. ‘’

Second, test the products to ensure that they can deliver fair outcomes. This can involve looking to see how the product would fare under different scenarios. Third, have in place a robust approval process before the products go on sale. This means that the sales process gets the product in the hands of the right people. Fourth, monitor the product to see who is buying it and how it is performing. This is not just about selling it and moving on, said the official, but taking an interest in how it is actually working in practice.

NASAA Proposes Model Crowdfunding Exemption

The Small Business Capital Formation Committee of the North American Securities Administrators Association (NASAA) has released for internal comment a proposed new NASAA Model Crowdfunding Exemption. The proposed model rule would create a transactional exemption at the state level for the sale of securities through an Internet-based offering to numerous small investors, a procedure known as "crowdfunding."

As discussed in the Request for Member Comments, the key elements of the proposed exemption include the following:

- Issuers are limited to an aggregate offering amount of $500,000 over a 12-month period.

- Individual investments are limited to $1,000 per year, per offering, with a multi-investment limit of eight percent or less of annual income.

- Issuers must make a one-stop filing in the state of the issuer’s principal place of business, using proposed new Form CF.

- Issuers must disclose certain information, including their business plans and proposed use of proceeds, on a website accessible to all state securities regulators.

- Cautionary language has been developed to provide investors with important information about the general investment risks of crowdfunding.

- Issuers must escrow investor proceeds until they reach the target offering amount.

- Individuals and companies with prior disciplinary history will be disqualified from using the exemption.

- Offerings must be conducted through an intermediary that is registered as a broker- dealer, but the intermediary is exempted from certain rules applicable to traditional broker-dealers.

The proposed exemption will not become viable at the state level unless a corresponding exemption is created under federal law. The Committee noted that the proposed model rule contains a lower aggregate offering limit than the current proposals that have been introduced in Congress in H.R. 2930, S. 1791, and S. 1970, but the Committee believes that the model rule otherwise represents a compromise between the competing federal proposals.

In the Committee's view, the most important aspect of the proposed rule may be the requirement that intermediaries register as broker-dealers, presumably because intermediaries would thus fall within the current definition of a "broker-dealer" by accepting transaction-based compensation. The rule, however, sets up a framework for exempting the intermediary from some of the rules that apply to traditional broker-dealers, provided the intermediary’s activities are limited to crowdfunding. In particular, the proposed rule exempts the intermediary from the normal rules related to SRO membership, short sales, penny stocks, suitability, and prospectus delivery requirements. The Committee observed that this approach is similar in some respects to the treatment of security futures dealers in Section 15(b)(11) of the Securities Exchange Act of 1934.

NASAA members will have until February 7, 2012 to comment on the proposed exemption.

US Hedge Fund Industry Comments on EU Derivatives Regulation, Supports Sound Central Counterparty Governance

The US hedge fund industry strongly supports the European Union Regulation promoting central clearing designed to increase transparency of the derivatives market and reduce counterparty and operational risk in trading. In a comment letter on the proposed Regulation, the Managed Funds Association broadly posited that balanced central counterparty governance is critical to promoting competition in the derivatives market and that clients have an interest in sound governance requirements that foster fair and objective risk-based access, broad product offerings and competitive pricing.

In that spirit, the MFA said that EMIR (European Market Infrastructure Regulation) should affirmatively mandate the inclusion of non-dealer, client representatives on central clearing counterparty boards and risk committees. As a significant proportion of the trading volume in the OTC derivatives market, clients are important stakeholders. Thus, the MFA reasoned that they should have their views reflected in the critical decisions of these bodies and should be entitled to attend and vote at meetings, not merely consulted.

The MFA feared that, without such a mandate, narrow interests will dominate and central counterparties may not adequately take into account the views of all market participants. In addition, in order to completely effect fair representation and balanced governance of central counterparties, no single group of market participants should constitute a controlling majority of any boards or risk committees.

The MFA also suggested that the Regulation allow central counterparty employees to have representation on risk committees. Such employees are motivated to expand the scope of central counterparty products and services, offer optimal capital, margin and cost management and maintain risk management procedures, which prevent losses to the central counterparty, clearing members and the market. Moreover, such employees provide further counterbalance to the potential conflicts of interest of other constituencies represented on risk committees.

The MFA also supports portability measures facilitating a client’s ability to transfer freely all or part of its portfolio and related margin between clearing members. Clients should be able to negotiate transfers of their positions to another clearing member at any time, whether prior to or following the default of their current clearing member.

The Regulation should clarify that ceding clearing members must effect such transfers as promptly as technologically feasible and without imposing fees or other conditions that could act as a barrier or deterrent to portability and competition in the provision of clearing services. If a central counterparty transfers only part of a portfolio, the untransferred portion must be appropriately margined, in accordance with the margining methodology agreed to by the clearing member and client, or absent express agreement, as previously applicable to the client’s portfolio.

It is also important for the Regulation to permit netting arrangements allowing parties to net initial and variation margin amounts across a broad range of exposures and assets, including across cleared and uncleared exposures, as well as across related legal entities. Such netting will reduce aggregate counterparty credit risk, lower trading costs, allow for efficient use of capital, provide better transparency as to counterparty risk and reduce complexity and settlement risk. Without permitting robust netting arrangements, liquidity will drain from the derivatives market as participants seek other execution strategies to prevent over-collateralization.

The European Securities and Markets Authority (ESMA) will draft technical standards specifying the minimum margin standards, including the percentage of margin that central counterparties must collect as well as the related time horizons. The MFA urged ESMA to be mindful of the increased costs that margin regulation may impose on clients both in terms of the margin amount and of the increased administrative costs associated with collecting margin and verifying calculations.

Praising real time clearing, the MFA urged that the Regulation require immediate acceptance or rejection of a trade upon submission for clearing by both central counterparties and clearing members. Providing open access to real-time clearing of trades will promote market efficiency by enabling participants to reduce their counterparty credit risk without delay, said the hedge fund group, and by ensuring unrestricted access to the broadest range of executing counterparties, more liquidity and competitive pricing.

Real-time clearing will also enhance market transparency and protect the anonymity of a client’s executing counterparties and will avoid the imposition of additional credit limits, fragmentation of liquidity, delays in acceptance of trades and/or the imposition of barriers to access to clearing such as inappropriate execution documentation.

The MFA has consistently advocated for the protection of client collateral in cleared and bilateral trades based on its belief that segregation protects investor positions and margin from clearing member insolvency. The EU Parliament Text of the Regulation provides greater protections for clients than the EU Council Text as there is a positive segregation requirement with an opt-out in the Parliament Text as opposed to a requirement to offer an opt-in. Specifically, the Parliament Text requires that a clearing member must distinguish in separate accounts with the central counterparty the positions of the clearing members from those of its clients. The MFA strongly supports providing clients with a robust level of protection for both their positions and assets that also promotes efficient portability.

The hedge fund group supports the recognition of third country central counterparties. The three criteria for the recognition of third country central counterparties set out in the Commission’s proposal remain in the Council and Parliament texts but with certain amendments. In particular, the Council Text reflects the MFA’s suggestion that coordination with non-European regulators on the approval procedures would ensure that the equivalency test applied is reasonable and not unduly restrictive towards the regulatory frameworks of third countries.

In addition, both the Council Text and the Parliament Text contain a reciprocity requirement, which provides that ESMA may only recognize a central counterparty established in a third country when ESMA deems the legal framework of that third country to provide for an effective equivalent recognition of central counterparties authorized in the EU.

In the MFA’s view, this restriction would be difficult to implement in practice, does not significantly increase the protections available to EU entities, and is likely to have the effect of unduly restricting the ability of EU entities to access third country central counterparties. As a result, the MFA recommends eliminating this reciprocity requirement.

Cordray Outlines to House Panel His Vision for a CFPB with Full Enforcement Authority

Director Richard Cordray’s vision is that the new Consumer Financial Protection Bureau will make consumer financial markets operate fairly in order to protect consumers, support honest businesses, and play a crucial role in helping to safeguard the overall economy. In testimony before a House oversight panel chaired by Rep. Patrick McHenry (R-NC), he said that the Bureau will benefit consumers by clarifying the prices and risks of consumer financial products and services.

When consumers know the true costs, benefits, and risks of competing products, he reasoned, they will be better able to make informed decisions. It will also help people avoid being ambushed by costly surprises buried in the fine print, he continued, so that they can have proper confidence that the terms of the deal stated today are the terms they will actually be living with down the road. The Bureau will benefit honest businesses by leveling the playing field and ensuring that financial institutions play by the same set of rules.

He also noted that Bureau has launched the first federal nonbank supervision program, one of the central new authorities provided by the Dodd-Frank Act. There are thousands of nonbank providers of financial products and services that make up a significant portion of the consumer financial marketplace, including mortgage lenders, mortgage servicers, mortgage brokers, payday lenders, consumer reporting agencies, debt collectors, and money services corporations.

The Director said that the nonbank supervision program will include conducting individual examinations and may also include requiring reports from businesses to determine what areas need greater focus. The Bureau will determine what degree of supervision to perform based on an analysis of the risks posed to consumers, including factors such as the nonbank’s volume of business, types of products or services, and the extent of state oversight for consumer financial protection.

Now that the CFPB has a Director, the Bureau has full authority to investigate and bring enforcement actions to ensure that financial providers are held accountable if they violate the law, and that the rules of the road governing banks and nonbanks are applied evenhandedly to all participants. In this area, observed Director Cordray, the Bureau is also cooperating closely with other law enforcement agencies to avoid any duplication of work and to coordinate limited resources. The Bureau has many tools to address problems in the financial markets, he said, including supervision, rulemaking, and enforcement. The Director emphasized that filing lawsuits or administrative actions will be necessary at times to ensure that the law is followed and respected, and that harm to consumers from unlawful conduct is remedied.

Massachusetts Provides Guidance on Social Media Use by Investment Advisers

Investment advisers that discuss business with existing or prospective clients on any of the 21st Century Internet platforms for socializing, e.g., facebook, twitter or LinkedIn, must be aware that their communications may be subject to state regulation, according to the Massachusetts Securities Division. Investment advisers do not violate Massachusetts' investment adviser rules per se by using the new social media but must be particularly mindful of the State's advertising, recordkeeping and supervisory requirements because of the risk for harming a large number of investors by virtue of the media's ability to reach an immensely wide audience.

An adviser's web page on facebook, twitter or LinkedIn, for example, would likely be "advertising" if it can be accessed by the general public. Moreover, a web page is "advertising" in Massachusetts if the page is created or maintained in the adviser's name, or contains business-related content about the firm, or solicits advisory services. Even a sole-proprietor adviser's web page is "advertising" if the adviser discusses services in the name of the adviser's representative. And the long-standing restrictions against using testimonials or making misleading statements apply to an adviser's web pages on social media. Similarly, the prohibition against advertising an adviser's past specific profitable recommendations applies to posting those recommendations on a web page unless the adviser posts a list of all the adviser's recommendations made within the last one-year period. Now, new restrictions on the use of social media hold advisers responsible for web page content even if the advisers did not create the content, if the advisers were somehow "entangled" or involved in its creation or preparation by another person, or if the advisers explicitly or implicitly "adopted" or approved or endorsed the content after it's creation by another person.

As for recordkeeping, SEC Rule 204-2 requires advisers to retain their advertisements, and Massachusetts, in addition, requires advisers to maintain a correspondence file or log. Regarding supervision, the long-standing requirement that advisers create and enforce written procedures for supervising their investment adviser representatives applies to supervising their representatives' use of social media and, moreover, instructs state investment advisers to consider recently released SEC guidelines for federally-registered investment advisers on the proper use of social media by their representatives.

Securities and Derivatives Groups Must First Challenge CFTC Position Limits Regulations in District Court Says DC Circuit

A three-judge panel of the U.S. Court of Appeals for the District of Columbia Circuit dismissed a challenge by securities and derivatives industry associations to rules establishing derivatives position limits adopted by the Commodity Futures Trading Commission. Citing circuit precedent, the court stated that the “normal default rule” is that “persons seeking review of agency action go first to district court rather than to a court of appeals.”

According to Judges Rogers, Garland and Brown, “Initial review occurs at the appellate level only when a direct-review statute specifically gives the court of appeals subject-matter jurisdiction to directly review agency action …There is no express congressional authorization of direct appellate review applicable to the petition for review in this case.”

SIFMA and ISDA filed a petition for review of the CFTC’s position limits regulations in the DC Circuit. Simultaneously, noting that there may be a question as to the proper forum for the challenge due to lack of direct precedent, the associations also filed a complaint in the District Court for the District of Columbia.

In Letter to House Leader, SEC Chair Details Work of Economists on Potential Regulations on Broker-Adviser Fiduciary Standard

There are currently three economists working within the Division of Risk, Strategy and Financial Innovation on the topic of retail financial advice and the differences between the broker and investment adviser regulatory regimes, said SEC Chair Mary Schapiro in a Jan. 10, 2012 letter to Rep. Scott Garrett, Chair of the House Capital Markets Subcommittee. The letter was in response to Chairman Garrett’s recent questions on the progress of SEC economists in gathering and analyzing data necessary for a meaningful consideration of potential standard of conduct regulations for brokers and investment advisers providing retail investment advice.

In the letter, Chairman Schapiro also said that the SEC staff is drafting a public request for information to obtain specific data on the provision of investment advice and regulatory alternatives. She noted that, in addition to the work of the SEC economists, it is especially important to ask the public for additional data and empirical analysis.

Although SEC employees do not track their time by specific projects, the SEC Chair assured Chairman Garrett that the Risk Fin economists spend a significant amount of their time on the issues of the standard for brokers and advisers providing retail investment advice. Specifically, they have reviewed and catalogued the publicly available data, including academic articles, reports and surveys and opinion pieces discussing the market for retail financial advice. The search encompasses information describing differences between regulatory regimes based on fiduciary and suitability standards, the economics of the financial advice industry, the quality of financial services, conflicts of interest, consumer disclosure, and retail investment behavior.

In December of 2011, Risk Fin communicated a summary of the available literature to the SEC and the Risk Fin economists discussed the evidence and its relevance to potential regulation. Risk Fin economists are also conducting an ongoing dialogue with financial economists at other agencies and from academia. The SEC believes that this interaction will give Commission economists a useful and different perspective on how to conduct an economic analysis in this area.

According to Chairman Schapiro, the Risk Fin economists have also proactively reached out to industry groups and finance and law academics to ascertain the availability of data important to any future economic analysis and also to obtain additional points of view. Similarly, Risk Fin economists are working with other SEC staff to develop focus group and survey questions to obtain additional information and insights through investor testing.

In moving forward with regulatory action, the SEC will follow its usual practice of including its economic analysis for review and public comment as part of any proposal. This process has the important benefit of providing a mechanism for refining the economic analysis by seeking feedback on specific issues and making requests for private data, she said, especially in this area where the data needed to conduct an analysis may not be publicly available.

Based on its review of the broker-dealer and investment adviser industries pursuant to a study mandated by Section 913 of the Dodd-Frank Act, in 2011 the SEC staff recommended the adoption of a uniform federal fiduciary standard for brokers and advisers that would be no less stringent than the standard currently applied to investment advisers under Advisers Act Sections 206(1) and (2). The new standard would apply uniformly to both brokers and investment advisers when providing personalized investment advice about securities to retail customers

In her letter to Chairman Garrett, Chairman Schapiro noted that two Risk Fin economists were members of the interdivisional drafting team responsible for publishing the study. These economists continue to regularly meet with staff from the Division of Investment Management and the Division of Trading and Markets to collectively discuss the topic and meet with outside interest groups. Investment Management and Trading and Markets staff also contribute to the economic analysis by providing industry insights and legal analysis.

In a letter sent to Chairman Schapiro on March 17, 2011, Chairman Garrett said that, while Section 913 of Dodd-Frank Act gives the SEC the discretion to adopt a uniform fiduciary standard for brokers and investment advisers, the statute does not mandate the adoption of such a standard, and in no way suggests a congressional intent that the SEC move forward on such a rulemaking without a sufficient basis. The letter was also signed by 13 members of the Financial Services Committee.

The Garrett letter also notes that the SEC has not identified and defined clear problems that would justify a rulemaking and does not have a solid basis on which to move forward. The SEC should conduct a thorough cost benefit analysis that considers customer preferences while evaluating the specific impact that any market changes would have for investors, as well as assessing the broader practical impact that such changes might have throughout the entire financial marketplace. For example, if the SEC’s activities should involve a relationship with the Department of Labor’s incipient changes to the existing definition of fiduciary under ERISA, advised Chairman Garrett, this should factor into the SEC’s analysis and subsequent activities in order to minimize disruption to the provision of financial services to investors.