House Passes SEC Regulatory Accountability Act

By a vote of 235 to 161 the House of Representatives passed the SEC Regulatory Accountability Act, H.R. 1062. Seventeen Democrats voted to pass the bill. Rep. Scott Garrett (R-NJ), Chairman of the Financial Services Subcommittee on Capital Markets, introduced the SEC Regulatory Accountability Act, which would require the SEC to conduct robust cost-benefit analysis on each new rulemaking to ensure that its costs do not outweigh its benefits, and would make certain that all new and existing regulations are accessible, consistent, written in plain language, and easy to understand.

Executive Orders. The legislation is designed to essentially codify Executive Orders issued by President Obama reforming the regulatory process.  Chairman Jeb Hensarling (R-TX) of the Financial Services Committee said that in many respects the Act carries out Executive Order 13563.

President Obama issued two Executive Orders during his first term on the reform of the federal regulatory process. Executive Order No. 13563 set out general requirements directed to executive agencies concerning public participation, integration and innovation, flexible approaches, and science. It also reaffirmed that executive agencies should conduct a cost-benefit analysis of regulations. Executive Order No.13579 states that independent regulatory agencies, such as the SEC, should follow EO No. 13563. To facilitate the periodic review of existing significant regulations, EO No. 13579 said that independent regulatory agencies should consider how best to promote retrospective analysis of rules that may be outmoded, ineffective, insufficient, or excessively burdensome, and to modify, streamline, expand, or repeal them in accordance with what has been learned.

There is a debate over whether EO No. 13579 directed independent regulatory agencies to conduct a cost-benefit analysis of regulations. The use of the word “should’’ in the Executive Order has led some to conclude that it is not mandatory. According to Chairman Sessions, this fuels the need for federal legislation to codify that independent regulatory agencies, such as the SEC, must conduct a cost-benefit analysis of regulations as executive agencies must do.Thus, as an independent agency, the SEC is not clearly required to follow Executive Orders No. 13563 and 13579. 

Cost-benefit analysis. Specifically, the SEC Regulatory Accountability Act would direct the SEC before issuing a regulation under the securities laws to identify the nature and source of the problem that the proposed regulation is designed to address in order to assess whether any new regulation is warranted and to use the SEC Chief Economist to assess the costs and benefits of the intended regulation and adopt it only upon a reasoned determination that its benefits justify the costs.

Alternatives. The SEC would also have to identify and assess available alternatives that were considered and ensure that any regulation is accessible, consistent, written in plain language, and easy to understand. Under a modified comply-or-explain provision in the bill, the SEC would be required to explain why the regulation meets the regulatory objectives more effectively than the alternatives.

Other considerations. In addition, H.R. 1062 would require the SEC to consider whether the rulemaking will promote efficiency, competition, and capital formation and the impact of the regulation on investor choice, market liquidity, and small business. The Commission must also evaluate whether the regulation is consistent with, incompatible with, or duplicative of other federal regulations.

Comments. The Commission must also explain in its final rule the nature of comments received concerning the proposed rule or rule change and respond to those comments, explaining any changes made in response, and the reasons that it did not incorporate industry group concerns regarding potential costs or benefits.

Review of existing regulations. Further, within one year of enactment and every five years thereafter, the SEC must review its existing regulations to determine if they are outmoded, ineffective, insufficient, or excessively burdensome and must modify, streamline, expand, or repeal them in accordance with such reviews.

Major rule. Whenever it adopts or amends a major rule, the SEC must state in the adopting release the purposes and intended consequences of the regulation, the post-implementation quantitative and qualitative metrics to measure the economic impact of the regulation and the extent to which it has accomplished the stated purposes, the assessment plan that will be used under the supervision of the Chief Economist to assess whether the regulation has achieved those purposes, and any foreseeable unintended or negative consequences.

For purposes of the Act, Title 5, U.S. Code, Section 804(2) defines three alternative ways a regulation can become a major rule under H.R. 1062: It is likely to result in: (1) an annual effect on the economy of $100 million or more; (2) a major increase in costs or prices for consumers, individual industries, federal, state, or local government agencies, or geographic regions; or (3) significant adverse effects on competition, employment, investment, productivity, innovation, or the ability of U.S.-based enterprises to compete with foreign-based enterprises.

Assessment plan. The assessment plan for a major rule must consider the costs, benefits, and intended and unintended consequences of the regulation and specify the data to be collected, the methods for its collection and analysis, and an assessment completion date.

In any event, the SEC Chief Economist must submit the completed assessment report to the Commission no later than two years after the publication of the adopting release, unless the Commission, at the request of the Chief Economist, has published at least 90 days before such date a notice in the Federal Register extending the date and providing specific reasons why an extension is necessary.

Within seven days after the final assessment report is submitted to the Commission, it must be published in the Federal Register for notice and comment. Any material modification of the plan, as necessary to assess unforeseen aspects or consequences of the regulation, must be promptly published in the Federal Register for notice and comment.

Within 180 days of publication of the assessment report in the Federal Register, the SEC must issue for notice and comment a proposal to amend or rescind the regulation, or publish a notice that the Commission has determined that no action will be taken on the regulation. Such a notice will be deemed a final agency action.

House Panel Approves Legislation Directing FSOC Study on Derivatives Credit Valuation Adjustment

The House Financial Services Committee approved legislation requiring the Financial Stability Oversight Council (FSOC) to conduct a study and report to Congress on the likely effects that differences between the U.S. and other jurisdictions in implementing the derivatives credit valuation adjustment capital requirement would have on United States financial institutions that conduct derivatives transactions and participate in derivatives markets. The study would also be required to examine the impact on end users of derivatives and on the international derivatives markets. According to Rep. Stephen Fincher (R-Tenn), the sponsor of the bill, the Financial Competitive Act, H.R. 1341, is needed because of the potential negative impact of Basel III on the U.S. economy.

FSOC study. Specifically, H.R. 1341 requires that the FSOC study include an assessment of the extent to which there are differences in the approaches that the United States and other jurisdictions are taking regarding implementation of the derivatives credit valuation adjustment capital requirement, and the nature of the differences and the impact that the differences would have on U.S. financial institutions that conduct derivatives transactions and participate in derivatives markets, including their ability to serve end users of derivatives.

The study must examine pricing and other costs of, and services available to, end users of derivatives in the United States and other jurisdictions, as well as the competitiveness of U.S. financial institutions and derivatives markets, including the extent to which differences in the credit valuation adjustment capital requirement could shift derivatives business among jurisdictions. The study must also explore the interaction between differing credit valuation adjustment capital requirements and margin rules.

The FSOC study must recommend steps that Congress and the federal financial regulatory agencies that compose FSOC, including the SEC and CFTC, should take to minimize any expected negative effects on U.S. financial institutions, derivatives markets, and end users. The study must also make recommendations encouraging greater global consistency in the implementation of internationally agreed upon capital, liquidity, and other prudential standards.

Rep. David Scott (D-Ga), a co-sponsor of the legislation, noted that certainty and uniformity are needed on the calculation of the derivatives credit valuation adjustment as it relates to Basel III capital requirements. Ranking Member Maxine Waters (D-Cal), in supporting H.R. 1341, observed that regulators must ensure that the calculation of the derivatives credit valuation adjustment is uniform and does not disadvantage U.S. financial institutions.

The Committee approved an amendment sponsored by Rep. Joyce Beatty (D-Ohio) that clarifies that the study must also indentify any risks and threats to financial stability, thereby recognizing FSOC’s mandate to maintain oversight of financial stability. The FSOC study must consider the cost of failing to take regulatory action as well as the cost of taking regulatory action. According to Ranking Member Waters, the amendment requires the FSOC study to report on the impact not just on derivatives markets but also on the wider markets as well.

E.U. Directive. The European Union is currently finalizing its implementation of Basel III, known as the Capital Requirements Directive IV (CRD IV). As drafted, CRD IV would exempt E.U. supervised swap dealers from certain Basel III capital mandates, specifically the credit valuation adjustment, when doing business with non-financial end users, pension funds, and sovereign entities. The securities industry finds the CRD IV exemption troubling in that it is a diversion from a uniform application of capital standards and will result in an unlevel playing field for U.S. and other non-E.U. dealers.

Thus, the securities industry supports H.R. 1341 as part of an effort to promote consistent international standards that provide a level playing field, while avoiding market distortions.

Rep. Fincher noted that Canada recently announced a one-year delay of the derivatives credit valuation adjustment, despite having finalized the rest of Basel III, citing the uncertainty around the provision’s global implementation and its effect on non-financial entities.

A Committee staff memorandum issued in connection with the markup noted that the E.U. exemption for derivatives transactions with sovereign, pension fund, and corporate counterparties has raised concerns that derivatives transactions will be subject to different capital requirements and that the credit valuation adjustment could distort the pricing of trades and limit the amount of liquidity available for non-financial U.S. derivatives end-users, as their transactions would not receive the exemption.

The FSOC study is due within 90 days of enactment to the Chairman and Ranking Members of the Committees on Agriculture and Financial Services of the House of Representatives, as well as the Chairman and Ranking Members of the Senate Committees on Agriculture and Banking.

House FSC Approves Extending SEC Registration Thresholds to Thrifts

The House Financial Services Committee approved legislation to extend to savings and loan institutions the JOBS Act shareholder thresholds for SEC registration and deregistration. Introduced by Rep. Steve Womack (R-Ark), the Holding Company Registration Threshold Equalization Act, H.R. 801, corrects the inadvertent omission of thrifts from the new shareholder thresholds contained in the JOBS Act and thereby effects Congressional intent.

Currently, Section 601 of the JOBS Act raises the number of shareholders permitted to invest in a community bank before triggering SEC reporting and registration from 499 to 1999. It also requires termination of a security registration in the case of a bank or bank holding company if the number of holders of a class of security drops below 1200. H.R. 801 would extend these shareholder thresholds to savings and loan associations.

Rep. Ann Wagner (R-Mo), a co-sponsor of the legislation, noted that these JOBS Act provisions lift outdated burdens off of small lenders and help increase capital raising. She noted that many community banks have already taken advantage of the new shareholder threshold provisions. Thrifts were intended to be included in the new thresholds, she said, since they are regulated like banks and are subject to the same reporting requirements.

Committee Ranking Member Maxine Waters (D-Cal) expressed strong support for H.R. 801, noting that it corrects an inadvertent omission in the JOBS Act. Congress neglected to include thrifts in the JOBS Act, she noted, adding that thrifts are subject to mandatory public reporting requirements.

LegislativeActivity: JOBSAct

House FSC Chairman Emeritus Bachus Fears Regulatory Arbitrage with Financial Reform Regulations

Chairman Emeritus of the House Financial Services Spencer Bachus (R-AL) is very concerned with regulatory arbitrage in the implementation of financial services legislation globally, which is to say that he is concerned that the SEC and CFTC regulations implementing the Dodd-Frank Act will not be equivalent with regulations implementing various pieces of E.U. financial reform regulation, which ultimately is to say he fears that U.s. financial firms may be globally disadvantaged.

Make no mistake, the title of Chairman Emeritus is not just an honarary one. Rep. Bachus is a full voting member of the Committee and serves on two of its most important subcommittees. He attends hearings and questions witnesses before the Committee. Those questions have increasingly focused on the need for regulators to harmonize financial regulations both domestically and globally. At a recent hearing, he expressed frustration with the ability of the Financial Stability Oversight Council to coordinate SEC and CFTC regulations implementing the derivatives provisions of Dodd-Frank, let alone globally. He asked Treasury to provide the Committee with a memo detailing what legislation may be needed to empower FSOC to mandate harmonizatio of financial reform regulations. The Secretary of the Treasury is the permanent chair of FSOC.  The Chairman Emeritus is not alone in these concerns. Last December, before the Bipartisan Policy Center, Senator Mark Warner (D-VA), a key member of the Banking Committee, expressed frustration with FSOC's inability to foster converged finanicial regulations and said he would entertain a legislative fix. Calling FSOC an imperfect creation, Senator said that it has not become the arbiter of conflicting regulations that he had envisioned.

House Panel Approves SEC Regulatory Accountability Act, Full House Vote Expected This Month

The House Financial Services Committee has approved, by a 31-28 vote, legislation directing the SEC to conduct a thorough cost-benefit analyses of its regulations and proposed regulations. Under the SEC Regulatory Accountability Act, H.R. 1062, the SEC must ensure that the benefits of its regulations outweigh the costs. The legislation was introduced by Rep. Scott Garrett (R-NJ), Chair of the Subcommittee on Capital Markets, with ten original cosponsors. The legislation also expresses the sense of Congress that other regulators and self-regulatory bodies, including the PCAOB and the MSRB, and any national securities association registered under the Exchange Act, should also follow the requirements set forth by H.R. 1062. House Majority Leader Eric Cantor (R-VA) has indicated that H.R. 1062 is currently scheduled for full consideration sometime in May.

FSC Chair Jeb Hensarling (R-TX) described H.R. 1062 as common sense legislation that requires the SEC to consider the impact of regulations on jobs and the economy. This is simply codifying what then SEC Chair Mary Schapiro said that the Commission intended to do, he noted, adding that this is a minimal expectation from federal financial regulators.

Ranking Member Maxine Waters (D-CA) opposes H.R. 1062 because it would add a number of additional factors to the cost-benefit analysis that the SEC would have to do and, among other things, impede the Commission’s implementation of the Dodd-Frank Act.

Similarly, in a letter to Chairman Hensarling and Ranking Member Waters, state securities administrators said that H.R. 1062 would require the SEC to conduct new and unreasonably extensive analyses prior to issuing a regulation. The SEC would be permitted to adopt a rule only upon a reasoned determination that the rule’s benefits justify its costs. The SEC must determine, and measure, the effectiveness of a rule even prior to its adoption, said NASAA, and without assessing its ultimate impact on investor protection. Ranking Member Waters had mentioned that the phrase investor protection is absent from the legislation. According to NASAA, the bill also requires the SEC to consider an unduly broad range of considerations before issuing a rule that are much more expansive, and in certain cases, more vague than what is currently required.

Cost-Benefit Analysis. Specifically, the SEC Regulatory Accountability Act would direct the SEC before issuing a regulation under the securities laws to identify the nature and source of the problem that the proposed regulation is designed to address in order to assess whether any new regulation is warranted and to use the SEC Chief Economist to assess the costs and benefits of the intended regulation and adopt it only upon a reasoned determination that its benefits justify the costs.

The SEC would also have to identify and assess available alternatives that were considered; and ensure that any regulation is accessible, consistent, written in plain language, and easy to understand. Under a modified comply or explain provision in the bill, the SEC would be required to explain why the regulation meets the regulatory objectives more effectively than the alternatives.

In addition, H.R. 1062 would require the SEC to consider whether the rulemaking will promote efficiency, competition, and capital formation and the impact of the regulation on investor choice, market liquidity, and small business. The Commission must also evaluate whether the regulation is consistent, incompatible or duplicative of other federal regulations.

The Commission must also explain in its final rule the nature of comments received concerning the proposed rule or rule change and respond to those comments, explaining any changes made in response, and the reasons that it did not incorporate industry group concerns regarding potential costs or benefits.

Review of Existing Regulations. Further, within one year of enactment and every five years thereafter, the SEC must review its existing regulations to determine if they are outmoded, ineffective, insufficient, or excessively burdensome; and modify, streamline, expand, or repeal them in accordance with such reviews.

Major Rule. Whenever it adopts or amends a major rule, the SEC must state in the adopting release the purposes and intended consequences of the regulation, the post-implementation quantitative and qualitative metrics to measure the economic impact of the regulation and the extent to which it has accomplished the stated purposes, the assessment plan that will be used under the supervision of the Chief Economist to assess whether the regulation has achieved those purposes, and any foreseeable unintended or negative consequences.

For purposes of the Act, Title 5, U.S. Code, Section 804(2) defines three alternative ways a regulation can become a major rule under H.R. 1062: It is likely to result in: 1) an annual effect on the economy of $100 million or more; 2) a major increase in costs or prices for consumers, individual industries, Federal, State, or local government agencies, or geographic regions; 3) significant adverse effects on competition, employment, investment, productivity, innovation, or on the ability of U.S.-based enterprises to compete with foreign-based enterprises.

Assessment Plan. The assessment plan for a major rule must consider the costs, benefits, and intended and unintended consequences of the regulation; and specify the data to be collected, the methods for its collection and analysis, and an assessment completion date.

``Act of Congress'' Recounts Fascinating Inside Story on How Dodd-Frank Was Enacted

A book entitled ``Act of Congress: How America's Essential Institution Works and How It Doesn't,'' by Robert G. Kaiser of the Washington Post, provides an excellent and definitive study of how the Dodd-Frank Wall Street Reform and Consumer Protection Act was enacted into law. The book reveals the inside and as yet untold story of how Congress came to pass this monumental, landmark and complicated piece of legislation. The book relates the intense and ultimately unavailing effort of Senator Christopher Dodd (D-Conn) to report a bi-partisan financial regulatory reform bill out of the Senate Banking Committee. The book recounts the lengthy and tortuous negotiations between Chairman Dodd and Senator Richard Shelby (R-Ala), the Committee's Ranking Member, to reach an agreement on a bi-partisan piece of legislation. The author had extraordinary access to the main congressional players and their staffs and relates a detailed and fascinating story. The book also faithfully recounts the efforts of Rep. Barney Frank (D-Mass), Chair of the Financial Services Committee to get the bill passed in the House.

U.K. Financial Conduct Authority Charts New Path of Securities Regulation

On April 1, 2013, the U.K. embarked on the twin peaks model of financial regulation, with the Financial Conduct Authority regulating the securities industry and professionals and the Prudential Regulation Authority regulating the banking industry and financial institutions. In remarks at the London School of Economics, FCA Chief Executive CEO Martin Wheatley indicated that the Authority will employ behavioral economics in its regulatory tool kit. He noted that one of the most significant challenges for modern financial regulators is to recognize that they operate within a very human environment in a fallible world governed and directed by psychology.

Despite this human element, one of the features of regulation historically was that it was all about compliance. In his view, financial regulation had become a robotic exercise focusing on whether a particular set of rules were followed and a particular set of boxes ticked. The question was whether a firm could demonstrate and document that it had followed those rules to the letter. If companies were able to tick those boxes and confidently hold up their product’s terms and conditions in court, he noted, they were assumed safe from regulatory scrutiny.

But in many cases, said the FCA head, this reliance on rules, processes and disclosure simply encouraged firms to hand over more information to customers who were already confused. It resulted in more text, more figures, and more legalese.

The FCA rejects the idea that risk should squarely sit with the consumer. This is the buyer beware or caveat emptor approach that says poor decision making by customers is not the responsibility of businesses. While noting that consumers should take personal responsibility for decisions, the FCA CEO said that buyer beware becomes hard to defend when customers are buying seriously complicated derivatives and other complex financial products.

The senior official said that the FCA will not be afraid to shine a light on the murkier psychological enticements and entrapments that exist in financial services. The pushes and pulls, the frames and biases that are sometimes used to entice customers to buy financial products they may not need or that might be wholly unsuitable for them.

The FCA will be looking across markets to see where and how behavioral economics might support its regulatory activity, such as areas like information disclosure and product complexity. For example, the FCA could use behavioral economics to understand why some consumers do not switch from one savings product to another after a teaser rate expires.

Behavioral economics could also be used to weed out products that are too complex for their target market, and may even be specifically designed to benefit from consumer mistakes. Many structured products fall into this category, noted Mr. Wheatley, products with too many moving parts; products that are almost impossible to take a rational decision on.

Bi-Partisan Senate Legislation Would Delink Federally Insured Banks from Derivatives Dealers and Other Non-Bank Subsidiaries as Part of TBTF

Bi-partisan legislation introduced by Senators Sherrod Brown (D-OH) and David Vitter (R-LA) seeks to end too big to fail and protect federally insured financial institutions from being linked to securities underwriters and derivatives dealers. The Terminating Bailouts for Taxpayer Fairness (TBTF) Act would also require federal regulators to walk away from Basel III and create a new capital regime based on two comment letters sent by Senators Brown and Vitter. Regulators would institute new capital rules that do not rely on risk weights and are simple, easy to understand, and easy to comply with. However, regulators would still be able to use risk-based capital as a supplement for banks over $20 billion, if their supervisory authority proves insufficient to prevent institutions from over-investing in risky assets.

The Senators noted that risk-weighting can obscure banks’ true capital situations, distorting the views of markets and regulators, and undermining investor confidence. They said that Basel II relied on a risk-weighting system that inaccurately assigned safe ratings to mortgage-backed security collateralized debt obligations and credit default swaps that actually amplified risk instead of mitigating it.

Under the legislation, bank holding companies will be restricted in their ability to move assets or liabilities from non-banking affiliates to a banking affiliate within the bank holding company structure. This will ensure that the government safety net begins and ends at the commercial bank and other subsidiaries, such as insurance, securities underwriters, and derivatives dealers must fend for themselves. Similarly, the Federal Reserve and other banking regulators will be prohibited from allowing non-depositories access to Federal Reserve discount window lending, deposit insurance, and other federal support programs. According to the Senators, this will help reduce market expectations of financial assistance for large, complex financial institutions.

The legislation would ensure that financial companies operating under one holding company would be adequately capitalized, as would be required if they were stand-alone companies. The Senators said that the legislation would ensure that highly-leveraged lines of business do not threaten the well being of other affiliates or the entire enterprise. The Senators noted that former FDIC Chair Sheila Bair has said that creating stand-alone subsidiaries will make large, complex financial institutions easier to put into resolution if they run into trouble.

Consumer Groups and Former Comm. Wallman Urge SEC to Incorporate IAC Recommendations in Re-Proposal of JOBS Act General Solicitation Regulation

In a letter to SEC Chair Mary Jo White, consumer groups and former SEC Commissioner Steven M.H. Wallman urged the Commission to re-propose the regulation implementing the JOBS Act provision eliminating the ban on general solicitation so that the recommendations of the SEC Investor Advisory Committee can be incorporated into the final regulation. The groups believe that the re-proposal of a rule that includes the IAC recommendations for appropriate investor protections and that complies with the Commission’s guidelines for economic analysis is the best way to assure that any final rule adopted in this area can be speedily adopted, is legally defensible and enjoys the broad support of the issuer and investor communities. In addition to former Commissioner Wallman, the letter was signed by Barbara Roper, Director of Investor Protection at the Consumer Federation of America.

Title II of the JOBS Act allows private issuers to market their securities through general solicitations and advertising under exemptions to the registration requirements of the Securities Act. The JOBS Act required the SEC to revise its rules to remove the prohibition against general solicitations and advertising in these exemptions within 90 days of its enactment. The deadline for the SEC to revise Rules 506 and 144A was July 4, 2012. The SEC proposed regulations on August 29, 2012, but has not yet adopted the regulations.

The consumer groups and former Commissioner Wallman believe that the Investor Advisory Committee has issued reasonable proposals that will enhance investor confidence in this market without unduly impeding legitimate offerings. Moreover, given the volume of comment the Commission has already received on these issues,  the consumer groups and Commissioner Wallman believe that the SEC staff should be able to quickly craft a rule proposal that can move very expeditiously,  possibly with the minimum comment period,  through the notice and comment process to final adoption.

The letter notes that the recommendations of the IAC include provisions designed to ensure that the Commission receives the information necessary to provide effective oversight of the Rule 506 offering market, that these private offerings are sold only to those who are appropriately qualified to make such investments, that any performance claims made in such offerings are based on reliable standards, and that bad actors will not be allowed to participate in such offerings.

Specifically, the IAC recommendations would require all issuers intending to rely on the new JOBS Act general solicitation exemption to file with the Commission either a new Form GS or a revised version of Form D. They would also require that all solicitation material prepared or disseminated by or on behalf of the issuer that is being disseminated to the public through a general solicitation or advertising campaign in reliance on the new exemption be furnished to the Commission.

The IAC also recommends the adoption of a safe harbor providing clear and enforceable standards for verification, as opposed to reasonable belief, of accredited investor status, including standards to promote reliance on reliable third parties, such as broker-dealers, banks, and licensed accountants.

Quoting Chairman Volcker, Sen. Wirth Was Prescient in Senate Report on Proxmire Financial Modernization Act

The Proxmire Financial Modernization Act of 1988, which passed the Senate but was never enacted, came to fruition with the passage of the Gramm-Leach-Bliley Act, which repealed the Glass-Steagall Act. The Proxmire bill would have repealed Glass-Stegall and allowed a bank holding company to operate a securities affiliate under Fed and SEC regulation. Just as with Gramm-Leach-Bliley, the Proxmire bill embodied the now largely discredited principle of functional regulation.

In Senate Banking Committee Report No. 100-305, accompanying the Proxmire bill, Senator Tim Wirth (D-CO) noted that there are good reasons to support a cautious approach to new securities activities for bank holding companies. Senator Wirth noted that former Fed Chair Paul Volcker expressed reservations that a bank can ever e truly shielded from its securities affiliates.

This Volcker position in 1988, as reported by Senator Wirth, is not too far from Chairman Volcker’s current skepticism of the U.K. Vickers Commission proposal to allow commercial and investment banking activities within the same holding company, with the investment bank permitted to conduct proprietary securities trading.

In recent testimony before the U.K. Parliamentary Commission on Banking Standards, Chairman Volcker said that the ring-fencing of retail from commercial banking within the same bank holding company would inevitably break down. Mr. Volcker called for institutional separation of retail banking and proprietary trading and sponsoring hedge funds.

When the U.K. Government drafted legislation to implement the Vickers Commission recommendation to ring fence retail banks from investment banks engaged in proprietary trading and sponsoring hedge funds, Parliament took the unprecedented step of creating its own inquiry into banking standards and taking evidence on the draft legislation. The Commission on Banking Standards has heard testimony from eminent authorities, including Chairman Paul Volcker and Martin Wheatley, head of the new Financial Conduct Authority. Recently, the Commission decided to take further evidence in 2013 on whether the full separation of proprietary trading, something akin to a Volcker Rule for the UK, may be appropriate.

House Panel Considers Dodd-Frank Derivatives Correction Legislation

The House Capital Markets Subcommittee held a hearing to consider a number of pieces of legislation to amend the derivatives provisions in Title VII of the Dodd-Frank Act, as well as legislation requiring the Financial Stability Oversight Council to study the competitive impact on U.S. financial institutions of an E.U. exemption from Basel III rules for European financial institutions.

Subcommittee Chair Scott Garrett (R-NJ) described the pieces of legislation amending the derivatives provisions of the Dodd-Frank Act as bi-partisan and common sense bills. He particularly praised the Swap Jurisdiction Certainty Act, H.R. 1256, which would require the SEC and CFTC to have identical cross-border regulations for derivatives regulation. The legislation will limit regulatory arbitrage by ensuring identical standards for all types of swap markets. Limiting regulatory arbitrage is a top priority for Congress, emphasized Chairman Garrett. The legislation would also require that cross-border regulation of OTC derivatives must be effected through rulemaking, not guidance. Noting that the CFTC has issued proposed guidance on cross-border swaps, Chairman Garrett said that the CFTC’s use of guidance has questionable legal authority. Some entities may ignore the guidance.

Rep. David Scott (D-GA) said that, after close and careful examination, he supports the majority of the bills before the Subcommittee. The legislation is not a radical departure from the reforms effected by the Dodd-Frank Act, and will not ``blow a hole in the bottom of Dodd-Frank.’’ They are corrections to Title VII provisions that are not going to work, said Rep. Scott, and have unintended consequences. Importantly, he noted that Dodd-Frank and Basel III must not be allowed to put U.S. financial institutions at a competitive disadvantage. Further, Rep. Scott does not believe that the bills will undermine transparency by lessening the disclosure of trading data. Importantly, Rep. Scott noted that Dodd-Frank and Basel III must not be allowed to put U.S. financial institutions at a competitive disadvantage.

Former Rep. Ken Bentsen, and current SIFMA CEO, testified that the securities industry supports the Swap Jurisdiction Certainty Act, H.R. 1256, because it would harmonize the cross-border approaches to derivatives regulation by requiring the CFTC and SEC to jointly issue a regulation related to the cross-border application of the Dodd Frank Act within 180 days. This joint rule would have to be in accordance with the Administrative Procedures Act. The measure would also ensure that foreign countries with broadly equivalent regimes for swaps would not be subject to U.S. derivatives regulations H.R. 1256 would also require the Commissions to jointly provide a report to Congress if they determine that a foreign regulatory regime is not broadly equivalent to United States swap requirements. On March 20, 2013, H.R. 1256 was approved by voice vote by the House Agriculture Committee to be recommended favorably to the House.

Implementation of the Basel III capital standards accord is an area of great interest and concern for the securities industry and indeed the financial services industry as a whole. Mr. Bentsen testified that the industry strongly supports efforts to promote consistent international standards that provide a level playing field, while avoiding competitiveness issues and market distortions that impact the real economy.

The European Union is currently finalizing its implementation of Basel III, known as the Capital Requirements Directive IV (CRD IV). As drafted, CRD IV would exempt EU supervised swap dealers from certain Basel III capital mandates, specifically the credit valuation adjustment, when doing business with non-financial end-users, pension funds and sovereign entities. SIFMA finds the CRD IV exemption troubling in that it is a diversion from a uniform application of capital standards and will result in an un-level playing field for U.S. and other non-EU dealers.

Thus, the industry supports the Financial Competitive Act, H.R. 1341, authored by Rep. Stephen Fincher (R-TN), and co-sponsored by Rep. Scott, that would direct the Financial Stability Oversight Council to examine differences in the implementation of derivatives capital requirements and the credit valuation adjustment. Further, the bill would require FSOC to assess the effects on the U.S. financial system and to make recommendation to minimize any negative impact on U.S. financial firms and end-users. Rep. Fincher noted that Canada recently announced a one-year delay of the credit valuation adjustment, despite finalizing the rest of Basel III, citing the uncertainty around the provision's global implementation and its effects on non-financial entities.

DTCC Data Repository strongly supports the Swap Data Repository and Clearinghouse Indemnification Correction Act, H.R. 742, a bipartisan bill co-sponsored by Representatives Bill Huizenga (R-MI), Gwen Moore (D-WI), Rick Crawford (R-AR), and Sean Patrick Maloney (D-NY). The legislation was reported out of the House Agriculture Committee on March 20, 2013 with bipartisan support. H.R. 742 will resolve issues surrounding Dodd-Frank’s indemnification provisions and confidentiality requirements.

Testifying on behalf of DTCC, CEO Christopher Childs cautioned that the Dodd-Frank indemnification provision will fragment swap data, and that such fragmentation will hinder regulators’ efforts to oversee a global market. Also, indemnification risks will negate the existing global data sharing framework Sections 728 and 763 of Dodd-Frank apply to swap data repositories registered with the CFTC and SEC. Prior to sharing information with U.S. prudential regulators, the Financial Stability Oversight Council, the Department of Justice, foreign financial authorities, foreign central banks, or foreign ministries, Dodd-Frank requires the swap data repositories to receive a written agreement from each entity stating that the entity must abide by certain confidentiality requirements relating to the information on swap transactions that is provided and each entity must agree to indemnify the swap data repository and the CFTC or the SEC for any expenses arising from litigation relating to the information provided. In practice, said Mr. Childs, these provisions have proven to be unworkable.

Mr. Childs noted that indemnification is a common law concept with its origin in tort law. Many countries and their legal systems do not recognize indemnification, he said, and many foreign governments cannot or will not agree to indemnify foreign, private third parties, such as U.S. registered swap date repositories.

Moreover, the continued presence of the indemnification requirement is a significant barrier to the ability of regulators globally to effectively utilize the transparency offered by a trade repository registered in the U.S. Without a Dodd-Frank compliant indemnity agreement, he observed, U.S.-registered swap data repositories may be legally precluded from providing regulators market data on transactions that are subject to their jurisdiction. In order to access the swap transaction information necessary to regulate market participants in their jurisdiction, global supervisors will be forced to establish local repositories to avoid indemnification.

In turn, the creation of multiple swap data repositories will fragment the current consolidated information by geographic boundaries. While each jurisdiction would have a swap data repository for its local information, noted Mr. Childs, it would be far less efficient, more expensive, and prone to error when compared with the current global information sharing arrangement in place today. Further, he raised the specter that a proliferation of local trade repositories would undermine the ability of regulators to obtain a timely, consolidated, and accurate view of the global derivatives marketplace.

The Dodd-Frank indemnification requirement has not been copied by Asian and European regulators. In fact, he noted that the European Market Infrastructure Regulation (EMIR) considered and rejected an indemnification requirement. H.R. 992, the Swaps Regulatory Improvement Act, introduced by Reps. Randy Hultgren (R-IL), James Himes D-CT), Richard Hudson (R-NC) and Sean Patrick Maloney (D-NY), would repeal most of Section 716 of the Dodd-Frank Act. Section 716 prohibits federal assistance, defined as “the use of any advances from any Federal Reserve credit facility or discount window or FDIC insurance, to swaps entities, which include swap dealers and major swap participants, securities and futures exchanges, swap-execution facilities, and clearing organizations. In effect, Section 716, commonly known as the swap desk “push out” or “spin off” provision, forces financial institutions that have swap desks to move them into an affiliate to preserve their access to Federal Reserve credit facilities and federal deposit insurance. Although the provision allows banks to continue dealing in swaps related to interest rates, foreign currency, and swaps permitted under the National Bank Act, they are prohibited from engaging in swaps related to commodities, equities, and credit.

Rep. Himes called Section 716, ``problematic,’’ adding that interest rate swaps get to remain in banks, while more dangerous swaps, such as those around structured finance, are pushed out. Rep. Hultgren said that H.R. 992 would allow depository institutions to provide a spectrum of services and products. Currently, since foreign jurisdictions are not enacting similar provisions, Section 716 imposes a unilateral prohibition on U.S. financial institutions.

Former Rep. Bentsen, and current SIFMA CEO, said that the securities industry supports H.R. 992, which would modify the push-out provision in the Dodd-Frank Act, Section 716, to ensure that federally insured financial institutions can continue to conduct risk-mitigation efforts for clients like farmers and manufacturers that use swaps to insure against price fluctuations. In addition, the bill would fix a drafting error acknowledged by the Swap Push-Out Rule’s authors, under which the limited exceptions to the rule that apply to insured depositing institutions appear not to include U.S. uninsured branches or agencies of foreign banks.

The Swap Push Out Rule was added to the Dodd-Frank Act at a late stage in the Senate and was not debated or considered in the House of Representatives. It would force banks to push out certain swap activities into separately capitalized affiliates or subsidiaries by providing that a bank that engages in such swap activity would forfeit its right to the Federal Reserve discount window or FDIC insurance. In addition to the increase in risk that would be caused by the Swaps Push-Out Rule, contended SIFMA, the limitations will significantly increase the cost to banks of providing customers with swap products as a result of the need to fragment related activities across different legal entities. As a result, U.S. corporate end users and farmers will face higher prices for the instruments they need to hedge the risks of the items they produce.

He noted that the Swap Push-Out Rule has been opposed by senior prudential regulators from the time it was first considered. Ben Bernanke, Chair of the Federal Reserve, stated in a letter to Congress that forcing these activities out of insured depository institutions would weaken both financial stability and strong prudential regulation of derivative activities. Sheila Bair, former FDIC Chair, said that by concentrating the activity in an affiliate of the insured bank, the U.S could end up with less and lower quality capital, less information and oversight for the FDIC, and potentially less support for the insured bank in a time of crisis, further adding that one unintended outcome of this provision would be weakened, not strengthened, protection of the insured bank and the Deposit Insurance Fund.

The Dodd-Frank Act is silent on the application of swap rules to swaps entered into between affiliates. Inter-affiliate swaps are swaps executed between entities under common corporate ownership. Inter-affiliate swaps allow a corporate group with subsidiaries and affiliates to better manage risk by transferring the risk of its affiliates to a single affiliate and then executing swaps through that affiliate.

In the view of SIFMA, inter-affiliate swaps provide important benefits to corporate groups by enabling centralized management of market, liquidity, capital and other risks inherent in their businesses and allowing these groups to realize hedging efficiencies. Since the swaps are between affiliates, rather than with external counterparties, they pose no systemic risk and therefore there are no significant gains to be achieved by requiring them to be cleared or subjecting them to margin posting requirements. In addition, these swaps are not market transactions and, as a result, requiring market participants to report them or trade them on an exchange or swap execution facility provides no transparency benefits to the market.

Thus, SIFMA urges Congress to enact H.R. 677, the InterAffiliate Swap Clarification Act, which would exempt certain inter-affiliate transactions from the margin, clearing, and reporting requirements under Title VII. On March 20, 2013, H.R. 677 was approved by voice vote by the House Agriculture Committee to be recommended favorably to the House.

The Business Risk Mitigation and Price Stability Act, H.R. 634, introduced by Reps. Michael Grimm (R-NY), Gary Peters (D-MI), Austin Scott (R-GA) and Mike McIntyre (R-NC), would exempt end-users from the margin and capital requirements of Title VII of the Dodd-Frank Act (P.L. 111-203). During consideration of the Dodd-Frank Act, a colloquy among the chairs of the four committees with primary jurisdiction over Title VII (Senators Dodd and Lincoln and Representatives Frank and Peterson) clarified Congress’s intent that the Dodd-Frank Act did not grant regulators the authority to impose margin requirements for end-user transactions. Notwithstanding this expression of Congressional intent, some regulators have interpreted Title VII as granting them the authority to impose margin requirements on end-users merely because they are counterparties to swaps with a regulated entity, such as a swap dealer or financial institution.

Rep. Peters noted that H.R. 634 allows companies to manage risk and clarifies that non-financial end-users are exempt from Dodd-Frank margin rules. Rep. Grimm noted that legislation identical to H.R, 634 passed the House last year, H.R. 2682, adding that the legislation ensures that the working capital of non-financial end users is not diverted to margin accounts.

In Letter to Treasury, Global Finance Ministers Urge Consistent Cross-Border Regulation of Derivatives under Substituted Compliance or Equivalence

In a letter to U.S. Treasury Secretary Jack Lew, with copies to the Chairs of the SEC and CFTC, global Finance Ministers expressed their concern at the lack of progress in developing workable cross-border regulations as part of reforms of the OTC derivatives market. The ministers, joined by E.U. Internal Market Commissioner Michel Barnier, said that they are already starting to see evidence of fragmentation in this vitally important financial market as a result of a lack of regulatory coordination. Without clear direction from global policymakers and regulators, they cautioned, the derivatives markets will recede into localized and less efficient structures, impairing the ability of global business to manage risk. In turn, this will dampen liquidity, investment and growth. The letter was signed by, among others, U.K. Chancellor of the Exchequer George Osborne, German Finance Minister Wolfgang Schäuble, and Japanese Finance Minister Taro Aso.

The ministers said that they share a common commitment with respect to OTC derivatives reform, and are implementing regulations across very different markets with different characteristics and different risk profiles, to support this global initiative. They warned that an approach in which jurisdictions require that their own domestic regulations be applied to their firms’ derivatives transactions taking place in broadly equivalent regulatory regimes abroad is simply not sustainable. Market places where firms from all respective jurisdictions can come together and do business will not be able to function under such burdensome regulatory conditions.

A coherent collective solution is therefore needed for cross-border derivatives, said the Finance Ministers, and regulators must work together to avoid outright conflicts in regulation and minimize overlaps as far as possible. In this regard, mutual recognition, substituted compliance, exemptions, or a combination of these would all be a valid approach, and careful consideration should be given with respect to registration requirements for firms operating across borders. Recent experience shows that these discussions can only proceed if they are based on a shared understanding of the overall outcome being sought.

The senior officials emphasized that the basic principles on which cross-border derivatives regulations should be based are clear and widely shared. They urged the SEC, CFTC and other regulators to carefully consider the principles to avoid cross-border conflicts.

Former SEC Commissioners File Amicus Brief with DC Circuit in Stanford Ponzi Scheme Action

Former SEC Commissioners Paul Atkins and Joseph Grundfest, and former SEC General Counsel Simon Lorne, filed an amicus brief in the DC Circuit in a case involving an SEC request to compel the Securities Investor Protection Corporation to file an application for a protective decree and commence a liquidation proceeding in relation to the fraudulent activities of Robert Allen Stanford. A federal court jury convicted Stanford of conspiracy, wire fraud, mail fraud, obstruction of justice and money laundering in connection with the sale of fraudulent certificates of deposits issued by a foreign bank that was not a SIPC member and marketed by a broker-dealer that was a SIPC member. A federal district court found that the bank CD purchasers were not customers of the broker-dealer within the meaning of the Securities Investor Protection Act. The former Commissioners asked the DC Circuit to reject the SEC’s unprecedented interpretation of the term “customer” and affirm the district court’s judgment. SEC v. SIPC, CA of DC, Civil Action No. 12-5286, April 19, 2013.

In their amicus brief filed with the DC Circuit, the former SEC officials contended that the SEC’s efforts to so dramatically expand the scope of persons covered through SIPC should be rejected for at least three distinct reasons. First, the SEC’s proposal to deem purchasers of CDs issued by a foreign bank to be customers of a domestic broker-dealer contravenes the plain language of the statute, conflicts with the relevant statutory history, and is at odds with more than forty years of judicial precedent. Second, the SEC’s unwarranted expansion of the definition of the term “customer” would substantially increase the financial exposure of the SIPC Fund. Third, the SEC’s proposed redefinition of the term “customer” does not warrant Chevron deference.

Where a statute is administered by more than one entity, noted the former SEC Commissioners, no single entity can claim Chevron deference. Here, the relevant statute is also administered by SIPC, a body governed by a seven-member board composed of presidential and executive branch appointees. SIPC’s views are diametrically opposed to the SEC’s, said the former officials, and should be accorded more deference.

According to amici, the SEC has presented no economic analysis considering the financial implications of this expanded coverage for the industry that must pay fees in order to support the SIPC Fund and the U.S. Treasury, which is statutorily required to provide a line of credit to help support the SIPC Fund, which line of credit is more likely to be drawn down if the scope of coverage is expanded as the SEC requests. The SEC’s proposed expansion of SIPC protection, absent even the most rudimentary consideration of any financial consequences, would radically transform SIPA and threaten SIPC’s ability to function as Congress intended. Under the SEC’s interpretation, noted the brief, SIPC would become another version of the FDIC, with SIPC obligated to provide blanket protection against investment fraud.

The critical aspect of the “customer” definition under SIPA is the entrustment of cash or securities to the broker-dealer for the purposes of trading securities. The investors in the CDs had no cash or securities on deposit with the broker-dealer at the time it failed. Thus, said amici, the SEC does not seek the return of any cash on deposit with the broker-dealer for the purpose purchasing CDs because there is none. It is undisputed that the investors had purchased and received those CDs at the time the broker failed. Instead, said the brief, the SEC is essentially seeking to force SIPC to generate rescission damages for CDs already purchased and received. But SIPC has no such authority, emphasized the former Commissioners.

Senate Legislation Would Require Impact Study on Regulations Implementing Basel III Accord

Bi-partisan Senate legislation would require the Federal Reserve Board, the FDIC and the OCC to conduct an empirical impact study on proposed regulations relating to the Basel III agreement on general risk-based capital requirements, particularly as they apply to community banks. The Basel III Commonsense Approach for Small Entities Act (Basel III CASE Act), S. 731, was introduced by Senators Joe Manchin (D-WV) and Dean Heller (R-NV). The bill has the support of the banking industry.

In a letter to Senators Manchin and Heller, the American Bankers Association noted that, although the new capital standards were originally intended to set appropriate levels of high quality bank capital for internationally active financial institutions, the regulations proposed by the federal banking agencies go far beyond the Basel III framework and would impact financial institutions of all sizes and business models and have adverse consequences for the communities they serve and the overall U.S. economy.

The proposals are complex and would have a multitude of unintended consequences. In fact, posited the ABA, notwithstanding the fundamental changes and the broad scope of the proposed rules, the federal banking agencies did not present a thorough quantitative analysis of the proposals. Although there were quantitative impact studies of the potential impact on the largest financial institutions, there was no empirical study of the impact of the proposals on all segments of the U.S. banking sector, customers, and the broader U.S. economy.

In the view of the ABA, S. 731 corrects this flaw by requiring the federal banking agencies to perform an empirical impact study of the proposed rules on the entire financial services sector before any final rules are issued, and this is specifically to include community, mid-size, and regional financial institutions. In addition, the study must be made public and subject to comment, and any new rules issued must be based upon the results of the study and comments.

E.U. Moving Closer to Single Platform for Clearing and Settlement of Securities Transactions

As the E.U. moves towards a single platform for the clearing and settlement of securities transactions, there is a growing consensus that the proposed Central Securities Depository Regulation must be harmonized with Target2 Securities (T2S), an initiative on the operation of securities settlements. The President of the European Central Bank, Mario Draghi, emphasized that T2S is the necessary platform for setting up a single European market for securities. In recent remarks in Frankfurt Am Main, he said that T2S will make the post-trade environment safer and more efficient. It will reduce the cost of settling securities transactions and bring about significant collateral savings for market participants.

These collateral savings are particularly valuable at a time when demand for high-quality collateral continues to increase, as a result of both the crisis and new regulatory developments. But reaping the full benefits from the launch of T2S, noted the ECB chief, requires that it is complemented by the provisions laid out in the CSD Regulation proposed by the European Commission. The CSD Regulation is critical to post-trade harmonization efforts in Europe. The ECB’s Governing Council has stated its strong support for the proposed Regulation, which will enhance the legal and operational conditions for cross-border settlement in the EU in general and in T2S in particular. In this respect, the ECB has recommended that the proposed Regulation and the corresponding implementing acts be adopted prior to the launch of T2S.

Clearing and Settlement. The European Commission proposed a European common regulatory framework for the institutions responsible for securities settlement, called Central Securities Depositories. The proposal is intended to bring more safety and efficiency to securities settlement in Europe. It also seeks to shorten the time it takes for securities settlement and to minimize settlement fails.

The settlement period will be harmonized and set at a maximum of two days after the trading day for the securities traded on stock exchanges or other regulated markets. Market participants that fail to deliver their securities on the agreed settlement date will be subject to penalties, and will have to buy those securities in the market and deliver them to their counterparties. Issuers and investors will be required to keep an electronic record for virtually all securities, and to record them in CSDs if they are traded on stock exchanges or other regulated markets.

Target2 Securities. The Commission believes that the objectives of the proposed Regulation are consistent with those of Target2 Securities, a project launched to create a common technical platform to support CSDs in providing borderless securities settlement services in Europe. The two initiatives are complementary in that the proposed Regulation harmonizes legal aspects of securities settlement and the rules for CSDs at European level and T2S harmonizes operational aspects of securities settlement.

In a recent interview, European Securities and Markets Chair Stephen Maijoor said that ESMA stands ready to implement the CSD Regulation through proposed standards and guidance once political agreement is reached by the legislative bodies. ESMA is establishing working groups to start quickly when the Regulation is enacted. ESMA will need about one year to do its work, he noted, since the standards will necessarily be highly technical. Chairman Maijoor noted that because the CSD is a Regulation, not a Directive, it will be uniform throughout the European Union.

U.K. Parliamentary Committee Questions Extraterritorial Reach of E.U. Financial Transaction Tax

In a letter to Treasury Financial Secretary Greg Clark, the U.K. Parliament’s European Union Committee warned that the financial transaction tax being implemented by eleven E.U. member states, including Germany and France, under the principle of enhanced cooperation could have a significant impact on non-participating states through the residency and issuance principles embedded in the tax.

The European Parliament has approved the European Commission’s proposal for a financial transaction tax, which would impose a 0.1% tax for shares and bonds and a 0.01% tax for derivatives. The adopted text includes an issuance principle under which financial institutions located outside the E.U. would be obligated to pay the financial transaction tax if they traded securities originally issued within the E.U.

The issuance principle means that financial instruments issued in a participating state will be taxed when traded even if those conducting the trade are outside the financial transaction tax zone. For example, the tax would apply when a U.K. pension fund purchased German shares from a U.S. bank. Manfred Bergmann, Director of Indirect Taxation and Tax Administration for the European Commission, told the Committee that the issuance principle was a key element of the financial transaction tax and an important anti-avoidance measure. Director Bergmann estimated that the issuance principle would bring another 4 percent of trades within the scope of the tax, with the other 95 percent already covered by other criteria. The Committee remains concerned about the scope of the issuance principle.

More broadly, the Committee believes that the proposal for a financial transaction tax does not satisfy the criteria for enhanced cooperation, in particular the requirement to respect the rights and obligations of non-participants. The Committee finds it particularly unacceptable that a full analysis of the impact of the tax on non-participating member states was not made available before the vote on enhanced cooperation was taken. The Committee urged Treasury to consider challenging the tax in the European Court of Justice.

Director Bergmann also assured the Committee that there would be no legal obligation on U.K. tax authorities to collect the financial transaction tax. He said that U.K. and U.S tax authorities might be invited to collect the tax, but it would be entirely voluntary. In theory, the financial institution in the participating member state could be requited to pay the tax.

 Despite this assurance, the Committee was concerned with possible adverse consequences for U.K. financial institutions. For example, in the case of a financial transaction involving German shares between a U.S. and a U.K. financial institution, application of the issuance principle would mean that a financial transaction tax would be imposed on both parties payable to the German tax authorities. Given that collecting the tax from the U.S. financial institution may prove difficult, the German tax authorities could impose joint and several liability for both instances of the tax on the U.K. entity and recover the entire amount using the E.U. mutual assistance regime.

 The Committee also took a skeptical view of the European Commission’s belief that the E.U. financial transaction tax would pave the way for a global financial transaction tax. While it is true, as pointed out by Director Bergmann, that the eleven E.U. members implementing the tax represent 90 percent of the eurozone economy, it does not follow that it will be difficult for other world financial centers to resist the tax. The Committee stated that it is almost certain that the U.S. will never enact a financial transaction tax and, indeed, may even view such a tax with hostility as an extraterritorial tax.

In Letter to Fed, Senator Shelby Calls for More Transparency in Rulemaking Implementing Basel III Accord

Senator Richard Shelby (R-AL) has asked the Federal Reserve Board to provide the analysis used to determine that the proposed regulations implementing the Basel III Accord would leave the banking system adequately capitalized. In a letter to the Fed, he also asked the Board to provide a quantitative analysis of how the proposal will affect the capitalization levels of US banks by size and asset class. The Ranking Member of the Senate Banking Committee also requested that the Fed provide a cost-benefit analysis of the impact these rules would have on both the US banking system and the overall economy.

By omitting key data from this important rulemaking, he noted, the Fed is preventing public understanding of the impact of the rules and undermining the ability of Congress to hold federal agencies accountable for the regulations they promulgate. Senator Shelby emphasized that it is imperative that Congress and the public have the information they need to independently assess the proposed regulations before they are adopted.

While reaffirming his belief that strong capital requirements are essential to safety and soundness, Senator Shelby said that the proposal fails to explain how the Basel III Accord is appropriate for the US banking system and how the agencies calibrated Basel III for domestic financial institutions. Although he agrees with the Fed’s assertion that the financial crisis showed that the amount of high-quality capital held by banks globally was insufficient to absorb losses during the financial crisis, the Senator said that the proposed regulations do not explain why Basel III will ensure the adequate capitalization of the US banking system.

The Senator also strongly believes in transparent cost-benefit analysis in the federal rulemaking process to ensure full disclosure of the impact of new regulations. In that regard, the proposal implementing Basel III fails to explain with the requisite specificity the impact of the proposed regulations on the banking system and the overall economy. He asked the Fed to provide Congress with a cost-benefit analysis estimating how existing capitalization levels will change, the cost of complying with the rules and their aggregate impact on the economy.

While the banking agencies said that they conducted an impact analysis using bank regulatory input data, and made assumptions when such data was unavailable, noted the Senator, such assumptions and the underlying data were not disclosed. Essentially, the banking agencies have proposed regulations based in large part on a global quantitative impact study using non-public data and relying on non-public assumptions. More transparency is needed in this process, concluded the Senator, adding that such a cloistered approach to rulemaking is inconsistent with US democracy.

Senator Warner Would be Worthy Senate Banking Committee Chair

With the announcement of the fact that Senator Tim Johnson, Chairman of the Senate Banking Committee, will not seek re-election in 2014, speculation began on who would be the Chair of the Senate Banking Committee in 2014. The name of Senator Jack Reed was mentioned. Senator Reed has seniority and has chaired the Securities Subcommittee and has shown a great deal of interest in issues around securities regulation.

I would also put the name of Senator Mark Warner into the mix as the next Banking Committee Chair. Senator Warner operates in a bi-partisan manner and is well-versed in the issues around financial regulation. he was a key player in drafting Titles I and II of the Dodd-Frank Act.

House Panel Examines SEC Failure to Meet JOBS Act Rulemaking Deadline, Comm. Walter Says Accredited Investor Definition Is Outdated

At a hearing of the Subcommittee on Oversight and Investigations of the House Financial Services Committee examining the failure of the SEC to meet the statutorily imposed deadline for implementing Title II of the Jumpstart Our Business Startups Act (JOBS) Act, SEC Commissioner Elisse Walter testified that the Commission will move ahead to adopt final regulations implementing Title II as expeditiously as possible. This is a top priority for the SEC, she emphasized. During the hearing, Commissioner Walter said that she favors a revision to the definition of accredited investor to focus more on the amount of money a person already has invested.

Title II of the JOBS Act allows private issuers to market their securities through general solicitations and advertising under exemptions to the registration requirements of the Securities Act. The JOBS Act required the SEC to revise its rules to remove the prohibition against general solicitations and advertising in these exemptions within 90 days of its enactment. The deadline for the SEC to revise Rules 506 and 144A was July 4, 2012. The SEC proposed regulations on August 29, 2012, but has not yet adopted the regulations.

Lifting Ban on General Solicitation. Subcommittee Chair Patrick McHenry (R-NC) noted that Title II lifts the ban on general solicitation and Title II is now the law. Thus, in the Chairman’s view, the SEC has lost its authority to enforce the ban on general solicitation for issuers who abide by Title II, adding that at the very least the enforceability of the ban is now questionable.

Commissioner Walter noted that the SEC received approximately 220 ``quite substantive’’ comment letters on the proposed regulations, which generated a meaningful discussion of the issues. She added that the comments were very beneficial in this rulemaking. Moreover, the Commissioner noted that the comment letters were sharply divided, with some commenters saying that the proposal would facilitate capital formation, while others were concerned that the proposed rules would result in an increase in fraudulent offerings.

A Subcommittee staff memorandum related that, on June 28, 2012, then SEC Chairman Mary Schapiro testified at a hearing before the Committee on Oversight and Government Reform’s Subcommittee on TARP and Financial Services, chaired by Rep. McHenry, that the SEC would miss the July 4, 2012 deadline for implementing Title II, but that the Commissioners would vote on a draft rule during the summer of 2012. Within the SEC, an interim final rule was distributed that would have implemented Title II and permitted companies to use its provisions to raise capital. Rather than holding a vote on the interim final rule, Chairman Schapiro instead recommended that the Commissioners vote on a proposed rule, which was approved on August 29, 2012.

Rep. Stephen Fincher (R-TN), a lead sponsor of the JOBS Act, cautioned that, if all the sections of the Act are not implemented together, the full effect of the Act to create jobs and foster economic growth will not be realized. Rep. Dennis Ross (R-FL) said that the SEC has deviated from clear and unambiguous statutory language. Rep. Ann Wagner (R-MO) noted that the mood of investors and entrepreneurs has gone from excitement to frustration over the delay in implementing the JOBS Act.

Commissioner Walter noted, while the 90-day statutory deadline was clear, the SEC needs good cause to dispense with notice and comment and use an interim final rule process. The SEC must also comply with the Administrative Procedure Act. While noting that it is not inevitable that lifting the ban on general solicitation will lead to fraud, Commissioner Walter emphasized that the SEC has an obligation to address the investor protection issues. She also said that the Commission should also put in place a review program and ascertain if there has been an increase in fraud after the lifting of the general solicitation ban and come back and tell Congress the results of the review program.

Definition of Accredited Investor. Shifting the emphasis of the hearing, Rep. Maxine Waters (D-CA), Ranking Member of the full Financial Services Committee, asked if the SEC intends to redefine the definition of accredited investor. Commissioner Walter said that the definition of accredited investor is outdated and should be redefined. Not only should the numerical standards be changed, testified the Commissioner, the SEC should change the criteria entirely on how to measure sophistication. In her view, the current definition of accredited investor does a poor job of screening out people who are unsophisticated. The definition currently covers people who lack the sophistication to evaluate the investment.

Currently,  the definition of “accredited investor” includes natural persons with an individual net worth, or joint net worth, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person; natural persons with incomes exceeding $200,000 in each of the two most recent years or joint incomes with spouses exceeding $300,000 for those years; or businesses in which all the equity owners are accredited investors.

Rep. Denny Heck (D-WA) asked if a review of the accredited investor definition is currently underway. The Commissioner said that the SEC has started to look at the issues.

In reply to a query from Rep. Heck on how she would change the definition, Commissioner Walter said that, in addition to, or in lieu of, raising the numbers in the definition, a new and different criteria should be employed that would look at the amount a person has already invested, since prior experience in investing would be an good objective indicator of financial sophistication. Borrowing from the Title III crowdfunding provisions of the JOBS Act, the Commissioner said that it might be beneficial to require investors to demonstrate an understanding of basic concepts, showing a degree of financial  knowledge. That element could be imported into the accredited investor definition.

Responding to Rep. Heck’s question on how much of an investment would indicate sophistication, Commissioner Walter said that the amount would have to be relatively high, mentioning, for example, $500,000.

ESMA Provides Guidance on E.U. Short Selling Regulation Exemption for Market Making

In order to ensure a level playing field, consistency of market practices and convergence of regulatory practices, the European Securities and Markets Authority has issued guidance under the provisions of the E.U. Short Selling Regulation providing an exemption for market making activities and primary market operations. The Regulation prescribe the notification of intent to make use of the exemption to be made to the home Member State for the market making exemption and the relevant competent authority of the concerned sovereign debt for the authorized primary dealer exemption, while the exempted activities might also take place in other jurisdictions outside the supervisory remit of that authority. In the case of third country entities not authorized in the E.U., the notification has to be sent to the competent authority of the main trading venue in the Union in which the third country entity trades.

ESMA noted that the exemption only covers activities when, in the particular circumstances of each transaction, they are genuinely undertaken in the capacity of market making as defined in the Regulation. Thus, persons notifying of the intent to make use of the exemption are not expected to hold significant short positions, in relation to market making activities, other than for brief periods. Arbitrage activities, particularly those executed between different financial instruments but with the same underlying security, are not considered market making activities under the scope of the Regulation and therefore cannot be exempted.

The over-riding principle for all asset classes is that an entity notifying its intention to make use of the exemption for its market making activities must provide liquidity to the market on a regular and ongoing basis by posting firm, simultaneous two-way quotes of comparable size and at competitive prices. Market making activities that are exempted under the Short Selling Regulation will be those where a person is offering prices that are competitive and in comparable sizes, in line with the specified qualifying criteria for at least the stated mandatory time presence where relevant.

When carrying out hedging activities under the Regulation, said ESMA, the size of the position acquired for the purpose of hedging should be proportionate to the size of the exposure hedged in order for these activities to qualify for exemption. The person should be able to justify upon request from the competent authority why an exact match in size was not possible. The discrepancy should, in all cases, be insignificant.

The Regulation defines market making activities, in part, as dealing as principal in a financial instrument. Consequently, the exemption applies to activities in a financial instrument, emphasized ESMA, on an instrument per instrument basis, and should not be considered as a global exemption for market making activities in general. The notification submitted when notifying of the intent to use the exemption, and further use of this exemption should, therefore, concern a financial instrument issued by a particular issuer subject to the Regulation, such as shares of an issuer falling under the regime and a sovereign issuer as defined by the Regulation.

Further, any such notification of the exemption should identify, with regard to shares, the individual instrument for which market making activities are notified for the purpose of exemption and, for sovereign debt and credit default swaps in sovereign debt if applicable, the sovereign issuer in the debt of which market making activities are notified for the purpose of the exemption.